US embassy cable - 05TEGUCIGALPA284

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 000284 
 
SIPDIS 
 
STATE FOR EB, WHA/EPSC, AND WHA/CEN 
TREASURY FOR DDOUGLASS 
STATE PASS AID FOR LAC/CAM 
 
E.O. 12958: DECL: 02/08/2015 
TAGS: ECON, EINV, PGOV, HO 
SUBJECT: HONDURAS:  IMF GENERALLY PLEASED 
 
 
Classified By: Economic Chief Patrick Dunn; reasons 1.4 (b) and (d). 
 
1. (C) Summary:  The IMF Article IV mission currently 
visiting Honduras is pleased with the GOH's significant 
progress on fiscal discipline, monetary policy reforms, and 
compliance with all but one quantitative target of the 
current Poverty Reduction and Growth Facility (PRGF).  One 
non-quantitative performance criterion (new regulations for 
teachers' salaries) remains unmet, but the Fund recognizes 
that political difficulties preclude resolving this issue 
before the March Board Meeting.  The Fund is seeking 
reassurance from the GOH that these reforms will be completed 
soon, and fully implemented on schedule by 2007, but 
otherwise feels it would be "disproportionate to make this a 
make-or-break issue."  Concerning HIPC's eight Performance 
Criteria (PC), the team found that all appear to have been 
met (or will be during the Board's March meeting) with the 
exception of the last:  "substantial compliance" with the 
Basel Core Principles.  The Fund team intends to seek a 
waiver of this PC, given continuing progress towards 
compliance and the mitigating circumstance of a Hurricane 
Mitch-weakened banking sector that impeded prompt 
implementation.  The Fund team will not, however, make a 
formal recommendation about Honduran eligibility for HIPC 
Completion Point at the conclusion of its mission this week. 
Instead, the team will await developments during and after 
the political primary elections on February 20 before 
finalizing its recommendation only just prior to delivering 
its report to the Board in late March.  End Summary. 
 
Strong Economic Performance 
--------------------------- 
 
2. (C) On February 2, IMF Review Team leader Luis Breuer 
briefed the international donor community on the results of 
the Fund's Article IV review of Honduras, concluding this 
week.  Breuer said the team had found a "very positive" 
macroeconomic scenario, with good growth (estimated at 4.6 
percent in 2004) and a strong recovery in agriculture (which 
grew at an estimated 8.6 percent in 2004).  The challenge of 
foreign reserves accumulation of over USD 500 million was 
handled well by GOH monetary authorities.  Inflation, at over 
9 percent, exceeded targets, due primarily to the rising cost 
of energy inputs.  Breuer said the team was favorably 
impressed, nevertheless, that Honduras could grow at a strong 
4.6 percent, given the high oil prices of 2004, and still 
keep inflation in the single digits. 
 
3. (C) Asked for prospects for 2005, Breuer offered the 
following preliminary analyses.  Growth in 2005 is expected 
to slow to 4.2 percent, due to fewer large projects, slowing 
growth in agriculture, and slowing growth in the U.S. 
economy, Honduras' largest trade partner.  (Comment: This 
contrasts with recent comments by President Ricardo Maduro 
that growth in 2005 is expected to exceed 5 percent.  End 
comment).  Inflation is expected to return to under seven 
percent, assuming relatively stable energy input prices on 
the commodities (such as bunker fuel) that Honduras imports. 
The fiscal deficit is expected to fall by one-half percent of 
GDP, to 3 percent, thanks to flat expenditures and a growing 
economy.  Remittances are predicted to slow their rate of 
increase from this year's estimated 30 percent to a still 
robust 18 percent in 2005.  Monetary policies to handle such 
large forex inflows will remain a challenge, though current 
actions to reform liquidity controls should help.  The 
current account deficit should fall to 2.6 percent of GDP as 
capital imports for large projects decline.  However, 
offsetting this somewhat, continuing growth in remittances 
and a booming domestic economy will likely contribute to an 
increase in imports of consumer goods. 
 
Team's Conclusions Largely Positive 
----------------------------------- 
 
4. (C) The team examined progress on the Fund's own Poverty 
Reduction and Growth Facility (PRGF), as well as the question 
of whether the GOH has met the eight heavily Indebted Poor 
Countries (HIPC) Performance Criteria (PC).  The two reviews 
-- and programs -- are distinct but interrelated.  For 
example, a successful PRGF review is one of the eight PCs 
under HIPC, as is Board approval of the Joint Staff 
Assessment following this annual review. 
 
5. (C) The team has preliminarily concluded that the GOH has 
met all PRGF quantitative criteria, with one minor exception. 
 There was apparently slight overspending (approximately USD 
50,000) on wages.  The team noted that this does not 
constitute a breaking of the wage ceiling.  The unbudgeted 
spending resulted from restructuring the Supreme Court of 
Accounts (TSC) as part of the GOH anti-corruption strategy, 
and the team considered this a "prudent fiscal policy."  The 
GOH wage bill grew in absolute terms by 8.8 percent in 2004, 
or less than the rate of inflation.  Thus, when combined with 
GDP growth, the percentage of national income devoted to 
wages fell in 2004. 
 
6. (C) The Poverty Reduction and Growth Facility (PRGF) 
Performance Criterion on teachers' wages -- requiring the 
issuance of regulations by December 2004 with compliance by 
2007 -- was not met, but there is no fiscal consequence of 
this for 2005, since no action is required until 2007.  Per a 
2003 salary law and a 2004 agreement with teachers, the 
wage-related benefits for teachers (such as additional 
payments for seniority) should be folded in to their wage 
scale by 2007.  In recent years, growth in teachers' salaries 
has exploded, rising much faster than inflation and rising 
from six percent of GDP to eleven percent in just a few 
years.  One unsustainable consequence is that an estimated 96 
percent of the entire Ministry of Education budget is spent 
on teachers' wages, leaving just 2 percent for the national 
university (UNAH) and 2 percent for everything else, 
including books and facilities. 
 
7. (C) The Fund is seeking a waiver of this PC, but only 
because: they see the 2005 program in Honduras as "fully 
financed"; they recognize the extreme political difficulty in 
passing such regulations in an election year; and they 
recognize the significant progress the GOH has made on more 
pressing fiscal and monetary reforms.  That said, the Fund 
must have a "clear agreement" with the GOH that the 
regulations will be implemented.  If the GOH cannot build its 
credibility with the international community before HIPC 
Completion Point is reached, the Team asked rhetorically, how 
would it be able to do so after?  In the final analysis 
though, Fund Central America Director Adrienne Cheasty told 
the group, that it would be "disproportionate to make this a 
make-or-break issue." 
 
8. (C) On HIPC's eight triggers in moving towards Completion 
Point, the team found that all appear to have been met (or 
will be during the Board's March meeting) with the exception 
of the last:  "substantial compliance" with the Basel Core 
Principles.  The Fund team intends to seek a waiver of this 
PC.  In the team's view, there has been "impressive progress" 
but not "substantial compliance," if one defines that 
("poorly written") performance measure as meeting half of the 
principles.  Of course, the team noted, about half of all 
Latin American countries fail to meet that standard, so 
Honduras should not be judged too harshly.  Additionally, it 
took the GOH time to determine the solvency of many banks in 
the post-Hurricane Mitch environment.  Over time it was 
discovered that many were weaker than at first thought, and 
therefore a quick, rigorous application of the Core 
Principles could have led to the collapse of a large portion 
of the banking system.  In view of the circumstances, a more 
gradual approach was called for. 
 
9. (C) The Fund team will not make a formal recommendation 
about Honduran eligibility for HIPC Completion Point at the 
conclusion of this mission this week.  Instead, they will 
only highlight the substantial progress the GOH has made and 
await developments during and after the political primary 
elections on February 20.  Taking into account any 
developments during the month of March, the team will 
finalize its recommendation only just prior to delivering its 
report to the Board in late March. 
 
International Community Counsels Leniency 
----------------------------------------- 
 
10. (C) Responding to the Fund's presentation, Germany noted 
that the teachers' wages issue could not be solved before the 
March Board meeting, so how the issue is presented to the 
Board will be critical.  The international community in 
Honduras, meanwhile, should play its role in talking to the 
crop of presidential candidates about transition issues and 
the need to keep faith with the Fund.  However, it will be 
difficult to get the candidates to be "reasonable" during a 
campaign.  Japan echoed these comments, noting that the team 
should avoid putting the wrong conditionalities before the 
Board.  Moreover, even if HIPC Completion Point is reached, 
the international community retains some leverage through 
ongoing programs to press this issue in the coming months. 
 
11. (C) Spain noted that the GOH macroeconomic performance 
has been "outstanding" and argued strongly that imposing 
additional conditionalities after the GOH has taken so many 
difficult economic reform measures would be "unfair."  The 
GOH should not be "punished" for falling short on this one, 
non-critical PC, but instead should be "given the benefit of 
a doubt."  Several other donors agreed with this view. The 
Interamerican Development Bank noted that the GOH had made 
great strides, particularly in fiscal discipline, and that 
any delay in HIPC Completion Point would "send the wrong 
signal."  The international community should instead focus on 
supporting the GOH through its coming electoral transition, 
with a view towards making the recently enacted reforms 
sustainable over the long-term. 
 
12. (C) The European Commission noted that the issue of 
teachers' salaries was not currently a feature of the 
political debate and should stay that way.  To raise the 
profile of the issue would politicize it, and then getting 
"reasonableness" from the various parties to the dispute will 
become impossible.  The Fund replied that all should refrain 
from making teachers' salaries "too much of an issue" since 
the needed reforms "are already the law."  Even though the 
GOH missed this PC, "the program remains intact." 
 
13. (C) Sweden asked why, if the GOH is doing so well, the 
poor do not seem to be benefiting.  Breuer pointed out that 
the Fund is examining the impact on the poor in its 
evaluation of the Poverty Reduction Strategy Program (PRSP). 
While Honduras has shown positive but limited progress (e.g. 
18 percent movement toward completion of the Millennium 
Development Goals, 0.8 percent increase in per capita income 
in 2004), in general progress towards social targets is slow. 
 Furthermore, a majority of the financing made available 
under HIPC interim debt relief has been budgeted by the GOH 
for social services rather than economic growth and, 
therefore, does not directly impact per capita incomes.  The 
World Bank agreed, noting that the GOH long-term strategy of 
poverty reduction is targeted through 2015, and is unlikely 
to show dramatic progress in any one year.  The real question 
is whether the GOH appears sufficiently committed to these 
long-term goals, "and the answer appears to be yes." 
 
14. (C) Next steps:  The Fund will now generate its Second 
Report on the PRGF, its Recommendations concerning HIPC 
Completion Point, its Progress Report, and a Joint Staff 
Assessment.  These reports will be presented to the Board two 
weeks before the Board meeting, likely to take place in late 
March.  The team is also currently negotiating terms for 
2005, the second year of the Fund's three-year PRGF program 
in Honduras.  Foci will include improving tax collection, 
continuing strong reforms of the financial sector (led by "an 
ambitious program by the National Banking and Insurance 
Commission"), and continued wage restraint.  The medium-term 
redesign of teachers' wages will remain a key challenge. 
Palmer