US embassy cable - 02TEGUCIGALPA2996

UNCLAS SECTION 01 OF 02 TEGUCIGALPA 002996 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CEN, WHA/PPC, EB/OIA, INR/B 
STATE PASS AID FOR LAC/CEN 
STATE PASS USTR, EXIM, OPIC 
STATE PASS USED IDB, USED WB, USED IMF 
GUATEMALA FOR COMMAT:DTHOMPSON 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, EINV, PGOV, HO, ETRDECD 
SUBJECT: RENEWED DEBATE ON DOLLARIZATION IN HONDURAS, BUT 
GOH POLICY UNLIKELY TO CHANGE ANY TIME SOON 
 
 1. (SBU) SUMMARY.  Liberal Party congressman and businessman 
Jaime Rosenthal Olivia and banker Jorge Bueso Arias have 
renewed their appeals for dollarization in recent weeks.  The 
two bankers argue that replacement of the lempira with the 
dollar would help increase capital investment and lower 
interest rates.  They claim the GOH has used gradual 
depreciation of the lempira, the Honduran national currency, 
as a tax on the public to generate revenue.  GOH officials 
have downplayed the issue, simply commenting that the 
preconditions for dollarization do not exist in Honduras. 
The leadership of the Congress has agreed to hold hearings at 
Rosenthal's request but there are no plans in the legislature 
to push for dollarization either.  End Summary. 
 
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Rosenthal's Complaint is With the Exchange Rate Policy 
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2.  (SBU) Jaime Rosenthal Olivia, Secretary-General of the 
Liberal Party (PL) and a private businessman with banking 
interests, renewed his public calls for dollarization in 
early October.  Rosenthal's key concern appears to be the 
Central Bank's policy of gradual depreciation (currently five 
to six percent annually) designed to maintain purchasing 
power parity with the U.S. and competitiveness of Honduran 
exports.  Jorge Bueso Arias, president of Bank Occidente and 
an active member of the Liberal Party, has expounded upon 
Rosenthal's argument.  Bueso Arias terms the exchange rate 
policy, in which the lempira has lost 26 percent of its value 
since 1998, as a tax on average Hondurans.  Bueso Arias 
believes that if the GOH keeps devaluing the lempira, it 
would be better to dollarize. 
 
3. (SBU) Rosenthal terms the steady depreciation of the 
lempira as instability that undermines Honduras' economic 
development.  He argues that dollarization, by eliminating 
currency risk, would increase foreign and domestic 
investment.  He asserts that dollarization would lower the 
risk premium for investments in Honduras and result in lower 
interest rates and inflation.  He also claims that 
dollarization would increase remittances and reduce capital 
flight (which he discusses in terms of Hondurans who protect 
the value of their savings by converting their lempiras into 
dollars).  The bankers' arguments imply they believe that 
dollarization would lead to more sound fiscal policies. 
 
4. (SBU) Comment: There are a number of apparent fallacies in 
Rosenthal's argument.  The GOH has instituted its exchange 
rate policy purposely in order to avoid pressures that would 
result in a sudden devaluation of the lempira and a financial 
crisis.  Hondurans are able to both save and lend in dollars 
or lempiras, so there is no impetus toward capital flight or 
a disincentive to the sending of remittances (which have been 
growing at a high rate since 1998).  The high interest rates 
and limited availability of medium and long term loans are 
related to country risk, problems in collection of loans, and 
the weakness of the banking sector (there have been several 
bank failures in recent years); currency risk appears to play 
a small role.  The Central Bank has brought inflation down 
steadily since 1999.  Because of Honduras' high indebtedness, 
the government is restricted in its ability to print money to 
finance deficits.  Finally, the Liberal Party contingent of 
the Congress has been a major impetus for the pop 
ulist, budget-busting legislation which has caused the 
government's intractable fiscal problems.  Dollarization 
would not fix this.  End Comment. 
 
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The GOH  - Honduras is Not Ready 
-------------------------------- 
 
5. (SBU) GOH officials in the Maduro administration, just 
like their predecessors in the Flores government, have 
downplayed the proposal, explaining quietly that Honduras is 
not in a position to dollarize at this time. 
 
6. (SBU) Maria Elena Mondragon, president of the Central Bank 
of Honduras, and Ana Cristina de Pereira, president of the 
National Commission of Banking and Insurance, have noted that 
the country must lower inflation and the fiscal deficit to 
U.S. levels before dollarization can be considered. 
Mondragon also has noted to the press that international 
reserves equal four months of imports, reducing the risk of 
an abrupt devaluation.  Mondragon also said that 
dollarization will not solve the country's economic and 
financial problems.  Cristina de Pereira has explained to the 
press it would take at least five years for the country to 
make the necessary economic structural reforms before the 
country can dollarize. 
 
7. (SBU) President Ricardo Maduro has commented publicly that 
while Central America is on the road to dollarization, 
Honduras is not ready.  He has been clear that the GOH will 
not pursue dollarization during his four-year administration. 
 
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USG Official Neutrality 
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8. (SBU) Per U.S. policy, Embassy officials will not take a 
position on dollarization if asked.  EmbOffs will point out 
that this is a decision for the government of Honduras to 
make, after balancing the pros and cons.  If in the unlikely 
event that GOH officials ask our advice, Post will refer the 
inquiries to the Treasury Department. 
 
9. (SBU) Comment: The Embassy does share the GOH's assessment 
that the preconditions for dollarization do not exist in 
Honduras at this time.  The GOH has not achieved fiscal 
stability (fiscal deficit exceeded six percent of GDP in 
2001).  Inflation is declining but is still far higher than 
U.S. inflation rates, resulting in the need for gradual 
depreciation to avoid making exports uncompetitive.  The 
financial system is fragile, and despite improved supervision 
under the Maduro administration, much remains to be done. 
Exchange rate reserves, at about four months worth of 
imports, are adequate but not sufficient to ward off a 
financial crisis.  To date, we have not seen clear political 
commitment and civil society support for the types of 
structural reforms that would make dollarization feasible. 
Without these conditions in place, dollarization would lead 
to greater economic stagnation and unemployment because of 
the inability of the economy to adjust to external shocks. 
End comment. 
 
Pierce 
PIERCE