US embassy cable - 02TEGUCIGALPA3149

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 003149 
 
SIPDIS 
 
STATE FOR WHA, WHA/CEN, WHA/ESPC, DRL/IL, EB/EFD/OMA 
STATE PASS AID FOR LAC/CEN 
STATE PASS USTR, EXIM, OPIC 
STATE PASS USED IDB, USED WB, USED IMF 
TREASURY FOR JOHN JENKINS 
LABOR FOR ILAB, ROBERT WHOLEY 
PANAMA FOR CUSTOMS 
 
E.O. 12958: DECL: 11/18/2012 
TAGS: EFIN, ECON, EAID, ETRD, ELAB, PGOV, PREL, HO 
SUBJECT: HONDURAS: IMF PROGRAM NEGOTIATIONS DELAYED UNTIL 
SPRING 2003, PENDING GOH PROGRESS ON ECONOMIC REFORM 
 
REF: TEGUCIGALPA 3023 
 
Classified By: Economic Counselor Robin Matthewman; Reasons 1.5 (B) and 
 (D). 
 
------- 
Summary 
------- 
 
1. (C) As expected, the IMF mission did not/not reach 
agreement with the GOH on draft terms of a three-year Poverty 
Reduction and Growth Facility Program (PRGF) during its 
November 4-15 visit to Honduras.  In consultations with the 
IMF mission, the GOH developed a plan to improve the fiscal 
situation in the next few months.  If all goes well, the team 
will return to Honduras in March or April to begin 
negotiations on a program.  The delay of a program will put 
into jeopardy USD 240 million in debt relief, concessional 
loans and grants from some donors.  It also puts into doubt 
the utility of a Consultative Group meeting currently planned 
for February 3-4.  Two or three donors were highly critical 
of the IMF's approach.  The IMF countered that the situation 
is unsustainable, unless donors want to continue to fund 
public sector salaries for Honduras year in and year out, and 
watch investment in poverty reduction programs continue to 
dwindle.  Embassy recommends supporting the IMF on its push 
for real fiscal and economic reform in Honduras.  End Summary. 
 
--------------------------------------------- --- 
Deteriorating Finances Dragging Down the Economy 
--------------------------------------------- --- 
 
2. (SBU) In a briefing for key donors (the G-15) on November 
15, the head of the IMF mission, Mario Garza, said that the 
IMF is very worried about the current economic situation. 
The economy remains depressed, primarily because of the 
fiscal policy pursued in 2001 and 2002.  If nothing is 
changed, the policy will continue to drag down the Honduran 
economy in 2003.  Garza commended the improvements in revenue 
collection which the GOH has realized since passage of the 
tax reforms last spring; however, he noted that this 
improvement in tax administration will only arrest the 
alarming growth in the government's budget deficit.  It will 
not put the GOH's finances on a sustainable path. 
 
3.  (SBU) Garza explained that the key figure the mission 
looked at is public sector savings (revenues minus current 
expenditures for the central government and other public 
sector entities), because it provides an indication of the 
amount of funds the government is able to generate for 
capital investment and discretionary social programs.  Public 
sector savings declined from nine percent of GDP in 1999 to 
two percent in 2002 (a staggering decline of seven percentage 
points).  With savings that weak, the government is unable to 
fund the needed social programs from its own resources; it 
has come to rely on foreign aid to do so.  To highlight the 
enormous size of the foregone public sector savings each 
year, IMF PermRep Chungsuk Cha added that the planned HIPC 
debt relief (a one-time benefit for government finances for 
Highly Indebted Poor Countries) is ten percent of GDP.  This 
figure pales in significance compared to losses every year of 
seven percent of GDP because of the GOH's current fiscal 
policy.  In its press release, the IMF mission pointed out 
that Honduran exports and imports have contracted and that 
the lack of investment was an important contributor to the 
problem (as well as the decline in key commodity prices). 
 
4. (SBU) Causes for the declining public sector savings can 
be found both on the expenditure and revenue sides.  For 
example, current expenditures (primarily salaries) for the 
central government rose from 16.7 percent of GDP in 1999 to 
18.6 percent in 2001 and 18.9 percent in 2002.  At the same 
time, taxes declined from 17.5 percent of GDP in 1999 to 16.2 
percent in 2001 and 15.6 percent in 2002.  The public sector 
wage bill has risen from 8 percent of GDP in 1999 to 10 
percent of GDP in 2001 and almost eleven percent in 2002. 
The average figure for the public sector wage bill in other 
PRGF countries is five to six percent of GDP, according to 
the IMF. 
 
-------------------------------------- 
Need for GOH to Develop Plan of Action 
-------------------------------------- 
5. (SBU) Garza said that the government clearly sees the 
problem but is finding it difficult to quickly turn around 
the inherited problems.  President Ricardo Maduro announced 
his intentions (on November 13) to push for a Fiscal 
Responsibility Pact with all sectors of society.  The GOH 
intends to show the public the gap between revenues and 
needed expenditures and to engender enough public 
understanding to undertake the needed structural changes. 
The government will be working in the next few months on: 1) 
an assessment of tax policy; 2) a study of current 
expenditures to identify priority areas; 3) a review of the 
subsidy policy, to see where subsidies can be targeted to the 
sectors of society most in need; 4) a review of the financial 
situation of public enterprises, where savings have been 
declining over time; and 5) public sector administrative 
reform.  The IMF mission also recommended that the GOH take a 
fresh look at the poverty reduction strategy paper (PRSP) 
first prepared in 2001 and identify the priority areas of 
public expenditures, given current macroeconomic constraints. 
 
6. (C) The government believes it can identify necessary 
measures by March or April and would like to restart 
negotiations with the IMF at that time.  This would mean that 
under the best case scenario, it will be June or July before 
Honduras once again has an IMF program.  Until that time, 
many World Bank and IDB loans, grants from some donors, and 
debt relief will be held up.  Garza estimated these add to 
USD 240 million in 2003.  A large amount of this sum is Paris 
Club debt service.  PermRep Cha indicated that the IMF will 
continue to be positive in its communications with the Paris 
Club about its continued work with the GOH.  The IMF does not 
expect creditor countries in the Paris Club to push for 
resumption of debt service payments (only Germany indicated 
that it has been receiving demarches from its capital pushing 
the GOH to pay its Paris Club debt).  On the margins of the 
meeting, the World Bank rep - just back from consultations in 
Washington - noted that while existing projects will continue 
(which includes its Reengineering Government project), new 
lending will be limited to what it considers its Low Case 
scenario. 
 
-------------------------------- 
Is the IMF Being Fair to Maduro? 
-------------------------------- 
 
7.  (C) Garza dodged questions from the G-15 and the press on 
reasons the Fund gave a favorable review of the GOH's 
financial performance in September 2001, despite the 
existence of the same problems at that time.  The German 
Ambassador, the Italian Ambassador, the Swedish counselor, 
and the UNDP rep all criticized the Fund's stance as unfair 
to the Maduro administration.  They noted that the bulk of 
the growth in the current government expenditures (especially 
the wage bill) occurred during the Flores government, and the 
IMF did not declare the GOH off its program at that time. 
They argued that the IMF's position basically punishes the 
wrong people and that the economic difficulties the 
government will soon face because of its lack of an IMF 
program will result in destabilization of this reformist 
government.  Other donors emphasized that the lack of an IMF 
program puts into doubt the utility of a Consultative Group 
meeting currently planned for February 3-4. 
 
8.  (C) In turn, the IMF reps urged the G-15 Ambassadors to 
encourage the GOH to seize the moment and make the necessary 
structural reforms.  The IMF reps noted that the situation is 
not sustainable except in the unlikely circumstance that 
donors are willing to finance the government's fiscal deficit 
indefinitely (in addition to needed poverty reduction 
programs).  They stated that they saw genuine commitment on 
behalf of the GOH to make these changes in the context of a 
Fiscal Responsibility Pact, and GOH needs the support of the 
donors to get it done.  This window of opportunity would not 
last very long and may not come again, explained the IMF 
officials.  In response to a question on the IMF's 
recommendations on tax policy, Garza noted that the 
discussions with the GOH centered on elimination of sales and 
income tax exemptions and not on increases in tax rates. 
 
9.  (U) In statements to the press, the IMF mission noted 
that actions by the National Banking and Insurance Commission 
(CNBS) had been satisfactory and that the Central Bank's 
policy of gradual depreciation of the lempiras is 
appropriate.  They also mentioned that foreign reserves (four 
and a half months of imports) are adequate. 
 
------- 
Comment 
------- 
 
10.  (C) The IMF's approval of the GOH's macroeconomic 
performance last year was based on projections on spending 
and tax collection that proved fallacious.  At the end of the 
Flores administration traditional election year overspending 
was only delayed rather than avoided.  To make the 2002 
budget numbers work, then Finance Minister Gabriela Nunez 
apparently assumed an impractical 20 percent increase in tax 
revenues at the same time the Congress was enacting (and 
Flores was signing) a series of new tax exemptions and 
unfounded spending initiatives. 
 
11.  (C) Past inaction on macroeconomic and structural 
reforms has resulted in a stagnant economy and an 
unsustainable central government fiscal deficit.  Post 
believes that the GOH macroeconomic team is committed to 
working toward the necessary changes in fiscal policy. 
However, all of these reforms will require political will on 
the part of a government that has a very slim coalition 
majority in Congress.  High level officials in the Maduro 
government have continually asked the USG and other donors to 
push the IMF for flexibility and to understand what it views 
as political realities. 
 
12. (C) Except in the area of improved tax administration, 
Post is not sanguine about the GOH's commitment and ability 
to push through long-lasting and structural economic reforms. 
 Many of the measures that the GOH is only now trying to 
analyze - such as consolidation of ministries, improvement of 
the finances of the public enterprises and the reorientation 
of resources in the education ministry to teaching and away 
from administrative resources - could have been undertaken 
during the past ten months but were not.  By the time this 
government is done with its study and analysis, its finances 
will only be that much further in the hole.  While the Maduro 
government's rhetoric is strongly reformist, its actual 
performance to date indicates that it is unwilling to act and 
follow through on unpopular, but necessary, policy 
prescriptions.  Embassy recommends supporting the IMF on its 
push for real fiscal and economic reform in Honduras.  End 
Comment. 
 
PALMER