US embassy cable - 05TEGUCIGALPA1845

C O N F I D E N T I A L SECTION 01 OF 02 TEGUCIGALPA 001845 
 
SIPDIS 
 
STATE FOR EB/IFD, WHA/EPSC, INR/IAA, AND WHA/CEN 
TREASURY FOR DDOUGLASS 
COMMERCE FOR MSIEGELMAN 
STATE PASS AID FOR LAC/CAM 
 
E.O. 12958: DECL: 09/07/2015 
TAGS: ECON, EFIN, PGOV, ELAB, HO 
SUBJECT: HONDURAS: IMF VERY PLEASED WITH GOH PERFORMANCE TO 
DATE 
 
REF: A) TEGUCIGALPA 0600 
 
Classified By: Classified By: Economic Chief Patrick Dunn for reasons 1 
.4 (b) and (d). 
 
1. (C) On September 2, an International Monetary Fund (IMF) 
team completed its two-week long review of GOH macroeconomic 
policies.  Team Leader Luis Breuer told Charge that the GOH 
is slightly outperforming its assigned fiscal and monetary 
targets and the Fund is very pleased with what they have seen 
to date. This performance is particularly impressive given 
the sharp rise in fuel prices recently and the temptation for 
the GOH to lose fiscal discipline as the November 27 
elections approach.  Breuer noted that the GOH has held firm 
in resisting strong political pressures to exceed spending 
caps to better position the ruling National Party for the 
upcoming elections.  (Note:  Post has previously commented on 
the very hard line Minister of Finance William Chong Wong has 
taken, refusing any new proposed spending that is not 
explicitly offset by new revenue or spending cuts elsewhere. 
End note.) 
 
2. (C) After reviewing the GOH's books, the Fund privately 
confirmed to Post that there is still some money available 
for the GOH to complete many of its projects such as port 
improvements and anti-poverty projects.  Despite this buffer 
funding, the GOH continues to tell petitioners that there is 
no money left.  Complicating the GOH financial outlook is an 
IMF-imposed spending cap on investments for CY 2005.  The GOH 
has complained on numerous occasions that this cap threatens 
to make it impossible for the GOH to access even concessional 
funding for important social spending programs such as school 
infrastructure rehabilitation.  Post raised this issue with 
IMF ResRep Hunter Monroe and with World Bank ResRep Adrian 
Fozzard.  After considering the GOH's argument, Breuer 
reported that the IMF believes that the GOH should invest 
about $100 million more on capital spending.  The Fund will 
engage in a negotiation with the GOH to reach an agreement on 
an investment plan covering the rest of this year. 
 
3. (C) The team also met with both leading presidential 
candidates, Liberal Party candidate Mel Zelaya and National 
candidate Porfirio "Pepe" Lobo, to discuss fiscal 
responsibility.  The Fund was favorably impressed with both. 
The Fund met with both last March in a quasi-secret meeting 
in Miami (ref A) to secure their agreement to abide by the 
terms of the Poverty Reduction and Growth Facility (PRGF) and 
to request the candidates refrain from politicizing the Fund 
agreement during the campaign (which would make it much 
harder for the next government to implement).  That said, the 
Fund recognizes it will also need to negotiate the next 
program with the new government. 
 
4. (C) A few issues of particular concern remain.  The Fund 
is acutely aware of the political difficulties that will face 
the new government in implementing wage reforms for the 
powerful teachers union, which must be completed by 2007 
under the current agreement with the Fund. The Fund is also 
wary of some of the more populist proposals coming from the 
campaigns.  For example, Pepe Lobo has proposed eliminating a 
fuel surcharge on electricity bills, which would create an 
estimated 300 to 600 million lempira (USD 16 to 32 million) 
hole in the budget annually. The Fund considers this proposal 
"a very bad idea."  Manuel "Mel" Zelaya, also under pressure 
to propose solutions to the problem of sharply rising energy 
prices, has proposed cutting fuel taxes, one of the primary 
sources of revenue for the GOH, and one that will become 
increasingly important as revenues from customs duties dry up 
when CAFTA is implemented.  Zelaya recognizes that offsetting 
cuts must be identified to fund such a proposal, but to date 
has not suggested where those (substantial) cuts would come 
from.  Each of these proposals is additional to the existing 
targeted subsidy for electricity and for mass transportation 
that benefits the poorest Hondurans (defined as those that 
use less than 300 kilowatts).  This subsidy is already 
included in the budget and has been approved by the Fund. 
Recognizing the political pressures brought about by rapidly 
rising prices, the Fund concedes that there is some prospect 
of increasing the electricity subsidy to the poor and is 
working with the GOH on this. 
 
5. (C) ResRep Monroe told Post that initial figures suggest 
remittances to Honduras have risen an astonishing 53 percent 
year-on-year to approximately USD 1.5 billion, a figure he 
said he cannot yet explain.  Remittances throughout the 
Central American region have been growing by approximately 25 
percent per year for the last several years.  Conventional 
wisdom attributes this rise to higher numbers of Honduran and 
other Central American emigrants, improved earning power in 
the U.S., and overall economic recovery in the U.S.  All of 
these factors combined, however, seem insufficient to explain 
this year's projected jump in remittances.  (Note:  There is 
a significant Honduran expatriate population in New Orleans 
-- variously estimated at up to 150,000 -- that was hard hit 
by hurricane Katrina. This could reduce remittance inflows 
this year by USD 100 million or more, and could potentially 
result in reverse flows for a short time as Hondurans seek to 
assist their relatives in the U.S.  However, even this 
socio-economic catastrophe and its attendant drop in 
remittances is dwarfed by the USD 400 million projected 
increase in total remittances this year alone.  End note.) 
 
6. (C) These remittances are increasingly routed through 
safer and less expensive formal transmission channels, rather 
than via relatives or hawala-type arrangements.  Once 
received in a Honduran bank, the Central Bank of Honduras 
(BCH) imposes a 100 percent surrender requirement on these 
dollars nightly.  To prevent the lempira issued for these 
surrendered dollars from sparking inflation, the BCH 
sterilizes the flows by issuing absorption certificates 
(known as CAMs), which currently yield 11.5 percent.  The 
result has been a stable single-digit inflation rate (8.6 
percent year on year as of July), but a rapid accumulation of 
forex reserves (estimated at about 5 months of import cover 
and rising).  The interest rate differential between the CAMs 
and dollar-denominated instruments has resulted in a large 
quasi-fiscal deficit for the BCH, which the GOH seeks to 
eliminate by moving all bond issuance activities to the 
Ministry of Finance and limiting the BCH role to money-desk 
operations (for liquidity management and interest-rate 
signaling). 
 
7. (C) Liberal candidate Mel Zelaya has proposed eliminating 
the CAMs as a way of increasing liquidity to the system, to 
ease the credit crunch in the rural sectors.  President of 
the Foundation for Investment and Export Development and 
former Vice Minister of Finance Vilma Sierra de Fonseca told 
EconChief that this plan is terribly risky, as it would 
expose the economy to intense inflationary pressures.  The 
long term solution, she said, is a more flexible exchange 
rate mechanism.  (Note:  IMF ResRep Monroe made similar 
comments separately to EconChief.)  That will take some time, 
she said, and when it happens, the lempira -- which has been 
depreciating slowly relative to the dollar (in nominal terms) 
for several years -- will need to appreciate.  Former 
Minister of Trade and current Ambassador to the U.S. Norman 
Garcia made similar comments to EconChief in July before 
departing for his Washington assignment.  (Note:  The 
exchange rate is currently a managed float, pegged to a 
trade-weighted basket of currencies, overwhelmingly the U.S. 
dollar.  The currency depreciated 4.4 percent relative to the 
dollar last year in nominal terms, and is expected to 
depreciate an additional 2.5 percent this year.  The lempira 
settled at 18.87 to one USD last week, down slightly from the 
previous week's 18.86 to one.  End note.) 
 
8. (C) Comment:  This is as positive a review as Post has 
heard from the IMF in quite some time, and is particularly 
welcome in this election season.  Post shares the Fund's 
satisfaction that the GOH has thus far avoided inflationary 
pressures from energy cost spikes and sharp increases in 
remittance inflows, and has resisted the temptation to forego 
fiscal discipline in the run-up to the November 27 elections. 
 We will continue to watch closely, both as the elections 
approach, and as the GOH begins to appropriate an estimated 
USD 212 million in savings from HIPC debt service forgiveness 
this year.  End Comment. 
 
Williard 
Williard