Dominican Republic and the IMF
Press Release: IMF Approves Two-Year US$600 Million Stand-By Arrangement for the Dominican Republic
August 29, 2003
Country's Policy Intentions Documents
Free Email Notification
of Intent, Memorandum of Economic Policies, and Technical
Memorandum of Understanding
Mr. Horst Köhler
The deterioration in the external environment and the failure of a large private bank have adversely affected confidence, put pressure on the peso, and weakened the public finances. The Government is committed to addressing these problems through a comprehensive economic program aimed at strengthening the banking system and macroeconomic conditions, thus laying the foundation for a resumption of strong and sustainable growth.
As described in the attached Memorandum of Economic Policies (MEP), the program focuses on: (1) measures to strengthen confidence in the banking system; (2) steps to reinforce the public finances and ensure debt sustainability; and (3) a flexible exchange rate regime accompanied by strict monetary discipline.
In support of these efforts, the Government requests a 24-month Stand-By Arrangement from the Fund, in an amount equivalent to SDR 437.8 million.
The policies set forth here are adequate to achieve program objectives, but we are prepared to take any further measures that may become necessary for this purpose. We will consult with the Fund on the adoption of these measures, and in advance of any revision to the policies contained in the MEP, in accordance with Fund policies on such consultations.
Reviews under the arrangement will be completed by October and December 2003, February, May, August, and November 2004, and February and May 2005. These reviews will assess overall performance under the program and observance of the associated performance criteria and benchmarks (Tables 1-2).
Dominican Republic—Memorandum of Economic Policies
1. After a period of strong growth and low inflation over the past decade, tensions have developed in the economy since 2001 as a result of a deterioration in the external environment and, more recently, the failure of a large private bank (Baninter) because of fraud and weakness in some other banks. There has been a need for substantial liquidity assistance to banks from the central bank. Thus, the peso has depreciated and inflation has increased in 2003, while the public sector debt—and the cost of servicing it—has risen considerably.
2. The government is committed to reversing these trends. We have prepared a comprehensive program to restore macroeconomic stability, maintain confidence in the banking system, ensure debt sustainability, and resume strong growth. Broad-based social and political support is being secured for this effort. Assistance from the international financial community is also needed, including a stand-by arrangement from the Fund.
3. The government is taking decisive steps to improve economic and financial transparency and governance. This is particularly important with regard to the banking system, where we are keeping the public well informed of the difficulties in certain banks and the steps being taken to address these problems. We have also started publishing more comprehensive economic data on a regular basis and will finalize preparatory steps to participate in the Fund's Special Data Dissemination Standards in 2004.
II. Macroeconomic framework
4. The implementation of our program will help restore macroeconomic stability. Inflation is expected to peak at around 35 percent in 2003, reflecting the recent shock to the exchange rate, but to decline to single digits by 2004. After falling in 2003, real GDP is projected to rise slightly in 2004, and to recover strongly thereafter. Consistent with these assumptions, the current account deficit shifts into surplus for much of the program period and net international reserves should also recover.
Main Macroeconomic Projections
III. Strengthening the Banking System
5. The government took immediate corrective actions following the discovery of the Baninter fraud. These actions, which included intervening the bank and providing liquidity assistance, were aimed at 1) safeguarding the payments system; 2) protecting all legitimate depositors, 3) preventing payment of ineligible liabilities, and 4) preserving the value of the bank's assets. At the same time, to send a clear signal that the government will not condone fraud, the main shareholder and top management of Baninter were jailed and their assets seized according to the law.
6. Building on these measures, we have designed a comprehensive strategy to strengthen depositors' confidence in the banking system. This strategy seeks to enhance transparency and provide a legal framework for bank resolution that effectively protects all deposits in the system. It consists of four pillars: 1) addressing the problems of identified weak banks, 2) ensuring strong governance in the banking system, with safeguards against fraud, 3) implementing an improved bank resolution framework, and 4) strengthening prudential regulations and banking supervision. This strategy and its timeline are summarized in Box 1 of the Technical Memorandum of Understanding. We are also committed to follow up on the recommendations of the 2002 FSAP.
7. The first pillar involves immediate actions to address the problems of three weak banks in a way that minimize systemic risk and limit the monetary and fiscal impact.
8. The second pillar seeks to strengthen governance in financial institutions.
9. The third pillar strengthens the legal framework for bank resolution. A bill has been submitted to congress to protect systemic stability while minimizing fiscal costs. It is expected to be approved by end-September (structural performance criterion).
10. The fourth pillar reinforces prudential regulations and banking supervision, with assistance from the Fund and other international organizations.
IV. Fiscal Policy and Debt Sustainability
11. Given the buildup in public debt implied by recent problems in the banking sector, the government is determined to strengthen public finances. Traditionally, the Dominican Republic has been well known for sound fiscal policies and low public debt. However, the weakening of economic activity in recent years had strong adverse effects on the public finances, and these effects were compounded by the failure of Baninter and the associated fiscal costs. So far, assistance from the central bank to Baninter and Bancredito has amounted to 13.5 percent of GDP, but it could rise to about 17 percent if no assets are recovered. Reflecting such pressures, as well as the impact of currency depreciation, public debt had risen to about 45 percent of GDP by mid-2003.
12. Reducing public debt over the medium-term is a key objective. The debt ratio is projected to reach about 49 percent of GDP in 2004, but is targeted to decline steadily thereafter, falling to around 35 percent by the end of this decade. This will be achieved mainly through a gradual increase in the primary surplus to 3.5 percent of GDP (about twice the average in the 1990s) facilitated by a number of fiscal structural reforms (see paragraph 17-19, below). Assets sales, amounting to about 6 percent of GDP over the next three years (2 percent of GDP during the program period), will also contribute to achieving this objective. These assets include land, mining projects, and real estate.
Public Sector Debt
13. A critical element of the strategy to ensure debt sustainability will be to contain the public sector deficit to 3.5 percent of GDP in 2003, to 2.5 percent in 2004, and to around 1 percent in 2005. The fiscal effort will focus on the nonfinancial public sector as the quasi-fiscal deficit of the central bank will remain high during this period.
14. Expenditure will be restrained, and strict limits have been imposed on purchases of goods and services and transfers; low priority capital projects have also been cut in order to contain public investment outlays to about 5 percent of GDP in 2003 and 2004. The public sector minimum wage was adjusted in January 2003, and no additional wage increase will be granted in 2003; any adjustment in 2004 will be in line with expected inflation.
Combined Public Sector Summary Accounts
15. A number of revenue measures with an annual yield of about 2 percent of GDP were recently introduced, including the doubling of the airport exit tax, an adjustment in the fuel tax, and temporary tax increases including a 2 percent import surcharge, and a 0.15 percent tax on bank checks. A proposal has been submitted to congress to eliminate some tax exemptions for the financial sector. Also, to help finance a more gradual adjustment in electricity tariffs (see below), we have introduced a temporary 5 percent tax on windfall gains in the tourism and export sectors resulting from currency depreciation. This measure and the import surcharge are being implemented under provisional decrees, with congressional approval sought by end-August. We aim to eliminate this tax by end-2004 at the latest as part of the broader tax reform (see paragraph 17). A draft budget for 2004, and its consistency with the program's objectives, will be the main focus of the second review (approval of this budget is a structural performance criterion for end-December 2003).
16. A key objective of the government is to improve the efficiency and finances of the electricity sector. The increase in generating costs from currency depreciation, together with the need to minimize the economic and social disruption from a sharp increase in regulated prices, has put pressure on the finances of distributors and generators. To place the sector on a viable footing, we aim to increase the price of electricity gradually by 3 percent per month to the level needed to meet costs. However the poor will be protected by leaving the price paid by small users unchanged. Until the tariff structure has been rationalized, fiscal subsidies will be transferred to the distribution companies to compensate them for the losses that result from the compression of tariffs using the proceeds from the windfall tax on exports and tourism (0.5 percent of GDP in 2003). At the same time, we aim to put in place a more comprehensive program to address problems in the sector, including theft, transmission and distribution losses, and the past and current accrual of arrears, and to improve targeting of subsidies. This program, supported by a World Bank loan, is expected to be in place in the last quarter of 2003.
V. Fiscal Structural Reforms
17. The government will seek congressional approval of a tax reform in 2004. The current tax structure will require major changes as a result of expected new bilateral trade agreements and the need to replace the temporary tax measures introduced in 2003. The goal is to establish a strong revenue base to ensure debt sustainability over the medium term. A tax reform proposal will be finalized in the second half of 2003 to address these issues, with technical assistance from the IFIs. While the specific elements of this reform will come out of this preparatory work, the proposal will need to include a greater reliance on domestic consumption and income taxes, and the elimination of distortions and special privileges, to increase the efficiency and equity of the tax system. The proposal will be submitted to congress by July 2004, with approval expected by September 2004.
18. We have been working for nearly a year on a reform of the public sector which will be presented to congress by the end of 2003.
19. The government is also taking steps to strengthen debt management. This includes smoothing the medium term external debt-service profile by using smaller bond issues and on longer term maturities and reducing rollover risk by pre-financing of government needs. Efforts are also being made to restore government access to the domestic bond market. Finally, we will develop by end-2003 a plan to improve the timeliness, accuracy, and coverage of the debt statistics, especially for private sector debt.
VI. Exchange Rate and Monetary Policies
20. The government will unify the foreign exchange markets before end-2003. Technical assistance from the Fund is being provided on the private exchange market regulations to ensure an orderly transition to a unified market. On this basis, a timetable for the transfer to the private market of all transactions remaining in the official market will be defined by September 2003. This transfer process will be completed no later than December 2003 (structural performance criterion). During the transition to a fully unified market, the official exchange rate has been set equal to the prevailing private market exchange rate.
21. The government is committed to a freely floating exchange rate. Intervention is being limited to what is necessary to achieve the net international reserves targets and to prevent excessive exchange rate volatility. However, if in the remainder of 2003 the net international reserves fall below the continuous monthly floor specified in the TMU, a general discussion of monetary and intervention policies will be initiated with IMF staff. A mechanism will be developed by end-November 2003 for the central bank to competitively access the private foreign exchange market. For this purpose, IMF technical assistance is being sought.
22. Monetary policy has been tightened with the primary objective of ensuring price stability. Consistent with the inflation targets described above, the growth of monetary base will be limited to no more than 27 percent in 2003 (excluding the effect of the recent increase in reserve requirements and the recycling of Baninter's informal deposits to the rest of the system) and 12 percent during 2004. In line with these objectives, the program includes quantitative ceilings limiting the expansion of the net domestic assets of the central bank. Monetary developments will be closely monitored in light of uncertainties.
23. Monetary policy will be implemented through greater reliance on indirect market-oriented instruments. Traditionally, monetary policy has been conducted through direct net placement of central bank paper, but public auctions to place this paper will be introduced in August. An overnight deposit window and a Lombard rate-type window will be created by end-September 2003. The temporary increase in reserve requirements, which expires in August, will not be renewed, with the monetary effect sterilized with market instruments.
24. The government is strengthening the independence of the central bank and its ability to conduct monetary policy. Major changes in the structure and management of the bank were approved as part of the monetary and financial law and will be implemented gradually in the months ahead, according to the timeline envisaged in the law. In particular, by-laws are being prepared to regulate the activities of the monetary board, the appointment of its members, and the transparency of its activities. These by-laws will be introduced gradually in the coming months and will be completed by September 2004. As part of the 2004 Budget, a plan will be prepared to ensure a positive net worth of the central bank.
VII. Balance of Payments and Financing Assurances
25. The program aims at bolstering international reserves to reduce vulnerabilities. For 2003, the shift into surplus of the external current account will help offset, at least in part, adverse developments in the capital account, especially private capital outflows. These outflows are expected to diminish in the second half of the year and further in 2004. World Bank and IDB disbursements are expected to amount to more than US$600 million until mid-2005, which would supplement the US$600 million (100 percent of quota) requested from the Fund. We anticipate that such financing, combined with our comprehensive economic program, will strengthen confidence. Gross international reserves will more than double to over US$1.3 billion by the end of the program; associated NIR floors are set in Table 1.
VIII. Policies for Protecting Vulnerable Groups
26. The government is working to mitigate the adverse effects of the crisis on vulnerable groups. Containing inflation is an important part of these efforts. The recently announced poverty reduction strategy is helping improve coordination of the existing social programs. This strategy also aims at reallocating government expenditure toward the social sector, increasing them by 2 percent of GDP over the next five years, while improving the quality and efficiency of social expenditure and the targeting of social programs. This strategy will help shield priority social programs from expenditure cuts in 2003 and in the 2004 budget, particularly programs in education, health and nutrition, social safety nets, and basic infrastructure for poor households. To support these efforts, the government has requested additional assistance from the IDB and the World Bank. As discussed above the government is also shielding the poor from electricity tariff increases.
IX. Program Monitoring
27. The 24-month SBA will be monitored on the basis of eight reviews, on a bi-monthly basis in 2003 and on a quarterly basis thereafter. Aside from prior actions (Table 2.A), we have established quantitative performance criteria for end-August, end-October, and end-December 2003, structural performance criteria for end-September 2003 and end-December 2003, structural benchmarks for the first three reviews, and indicative targets for 2004 (Tables1-2). Performance criteria and structural conditionality for 2004 will be set by the time of the second review of the program. Quarterly performance criteria and structural conditionality for 2005 will be set in the fifth review of the program. The attached technical memorandum of understanding defines the key policy variables and program assumptions.
28. An IMF adviser on bank supervision is providing technical assistance to the government on the implementation of financial sector reforms and we have requested that a Fund staff member be posted in Santo Domingo to help monitor program implementation.
Technical Memorandum of Understanding
1. This memorandum presents the definitions of the variables included in the quantitative performance criteria and indicative targets annexed to the Memorandum of Economic Policies, and the information requirements needed to ensure adequate monitoring of the economic and financial situation, including actions in the banking sector.
I. Quantitative Performance Criteria: Definition of Variables
A. Cumulative Floor on the Non financial Public Sector (NFPS) Balance
2. The balance of the non financial public sector comprises the results of the central government, and the rest of the non financial public sector (decentralized entities and public enterprises).
3. The balance of the central government will cover government activities as specified in the budget. Central government revenue will not include proceeds from the sale of public assets, which will be considered as financing, below the line. Fees on checks cleared through clearing houses, collected by the central bank, will be included as central government revenue. Central government expenditure will include subsidies to the electricity sector as a result of the operation of the fondo compensador. The balance will be measured from below the line as the change in central government's net financial position (assets minus liabilities). The net financial position of the central government must include: (a) non financial public sector debt, domestic and external, including short-term debt; (b) changes in external and domestic bank borrowing and deposits, including the central bank; and (c) any other nonbank financing, domestic or external, including the sale of public assets. External debt flows, (disbursements and amortization), will be converted to Dominican pesos at the exchange rate of the respective conversion dates.
4. The increase in domestic debt as a result of the recognition of debts incurred prior to 2002, with a limit of RD$14 billion1 will not be considered as deficit, in the measurement of the central government balance.
5. The balance of the rest of the non financial public sector will be measured from below the line on the basis of the information on domestic bank borrowing and deposits provided by the central bank (file cable.xls). It will also include the portion effectively used of authorizations to contract debt approved by the Secretary of Finance according to Decree # 581-02.
6. Profits and losses arising from valuation changes of foreign currency denominated assets and liabilities will not be considered to determine the balance of the non financial public sector.
7. In 2003, the cumulative floor will be measured from end-December 2002. In 2004, from end-December 2003.
8. The information to compute the balance of the non financial public sector will be provided by the central bank.
B. Cumulative Ceiling on the Change in the NFPS Borrowing from the Domestic Banking System
9. The NFPS borrowing from the domestic banking system, excluding the central bank, refers to the stock of loans and advances of the central government and the rest of the non financial public sector, including public bonds held by banks, at each relevant date, in foreign and domestic currencies.
10. In 2003, the cumulative ceiling will be measured from end-June 2003. In 2004, from end-December 2003.
11. The data used to monitor banking debt developments will be provided by the central bank.
C. Ceiling on Central Bank Net Domestic Assets (NDA)
12. The net domestic assets (NDA) of the central bank are defined as the difference between end of period Augmented Monetary Base (AMB) and Augmented Net International Reserves (ANIR). AMB is the sum of emision monetaria and deposits held by financial institutions at the central bank to meet reserve requirements on foreign currency deposits. ANIR is the sum of Projected Net International Reserves (PNIR), as defined below, and the central bank foreign currency holdings that are the counterpart of the reserve requirements on banks' foreign currency deposits held at the central bank. Emision monetaria includes currency issue (currency in circulation plus cash in vault) and peso deposits held by financial institutions at the central bank (peso reserve requirements and other peso deposits).
13. For accounting purposes, dollar figures will be converted to pesos at the exchange rate of July 25, 2003 (DR$35.5).
D. Continuous Ceiling on NFPS Arrears
14. The central government and any other entity of the non financial public sector, as defined above, will not incur in arrears in the payment of their obligations at any time during the program. Arrears are defined as a delay in the payment of contractual obligations beyond the terms set in the respective contracts.
E. Cumulative Ceiling on the Contracting of External Debt by the Public Sector
15. The contracting of external debt 2by the public sector is defined as the gross disbursement of external funds to the central government and the rest of the non financial public sector, and to the central bank, at each relevant date. Gross disbursements will be measured in US dollars.
16. The limit on the contracting of external debt will be adjusted in the following way:
17. In 2003, the cumulative ceiling will be measured from end-December 2002. In 2004, from end-December 2003.
18. The data used to monitor the contracting of debt will be provided by the central bank.
F. Floor on Central Bank Net International Reserves (NIR)
19. NIR is defined as the difference between gross international reserves of the central bank and short-term liabilities. Gross international reserves include all foreign currency assets that are in the direct effective control of the central bank and are readily available for such purposes of the central bank as intervention or financing of payment imbalances. Such assets include gold (valued at US$356.05 per ounce), cash, deposits abroad (excluding funds used as collateral for central bank or other non financial public sector liabilities), holdings of SDRs, and the IMF reserve position. The counterpart of reserve requirements on foreign currency denominated domestic deposit will not be included in the gross reserves. Short-term liabilities include deposits at the central bank in foreign currency not related to reserve requirements and debt with the IMF (valued at US$1.41 per SDR).
20. The levels of NIR which will trigger immediate consultation with Fund staff on monetary and intervention policies (Projected NIR or PNIR), mentioned in paragraph 21 of the MEFP are the following (in millions of US dollars):
Projected NIR 3
II. Indicative Targets: Definition of Variables
A. Cumulative Ceiling on Central Government Expenditure
21. The cumulative ceiling will apply to central government expenditure, as defined in 3 above, and reported by the central bank according to the current methodology in the table "Ingresos y Gastos del Gobierno Central, Financiamiento del Resultado Presupuestario (segun metodología FMI)" with information provided by the National Treasury and Contraloría General de la República. Central government expenditure will include subsidies to the electricity sector as a result of the operation of the fondo compensador. If, in any period, net financing from below the line is higher than the above the line reported deficit, reported expenditure will be increased accordingly.
22. In 2003, the cumulative ceiling will be measured from end-December 2002. In 2004, from end-December 2003.
B. Cumulative ceiling on the Quasi-fiscal Loss of the Central Bank
23. The quasi-fiscal loss of the central bank is the negative of the quasi-fiscal balance of the central bank. The quasi-fiscal balance is defined as interest earnings on gross international reserves and other earnings in cash, effectively received by the central bank, including those on other foreign and domestic assets, minus all operating expenses, commissions, and interest paid on all liabilities.
24. Profits and losses arising from valuation changes of foreign currency denominated assets and liabilities will not be considered to determine the quasi fiscal balance.
25. In 2003, the cumulative ceiling will be measured from end-December 2002. In 2004, from end-December 2003.
26. The information on the quasi fiscal balance will be provided by the central bank.
C. Ceiling on the Central Bank Certificates
27. Central bank certificates are the instruments used by the Central bank to sterilize the monetary effect of the liquidity assistance granted to banks. This definition will extend to any other instrument that the central bank may use in the future with the same objective.
28. The ceiling on central bank certificates will be adjusted in the following ways:
29. The data used to monitor the stock of certificates will be provided by the central bank.
III. Reforms in the Banking Sector
30. All measures contained in the attached matrix of financial sector reforms have to be implemented in full consultation with Fund staff.
IV. Unification of the Foreign Exchange Market
31. The unification of the foreign exchange market mentioned in paragraph 20 of the MEP will entail that all foreign exchange transactions are settled in a single free market including petroleum imports and public sector debt service payments.
V. Information requirements
32. To ensure adequate monitoring of economic variables and reforms, the authorities will provide at least the following information:
• Deposits in the banking system, exchange rate in the official and free markets, interest rates on bank loans and deposits, NIR, currency in circulation, deposits held by financial institutions at the central bank, excess reserves of the banking sector in local and foreign currency, liquidity assistance to banks, central bank certificates, and all other remunerated liabilities of the central bank.
• Deposit of and liquidity assistance to troubled institutions, by institution.
• Central bank intervention in foreign currency (purchases and sales in the official market and net intervention in the free market).
• Central bank intervention operations in domestic currency, including results of auctions of central bank paper (interest rates, details of bids, including minimum and maximum rates, volumes, and maturities).
• Tax collections.
• Savings-investment account of the central government.
• Net financial position of the central government.
• Balance sheet of the central bank, Banco de Reservas, and deposit money banks (cable file).
• Quasi-fiscal balance of the central bank.
• Foreign exchange cash flow of the central bank (la balanza cambiaria).
• Stock of central bank certificates by type of holder.
• Maturity of certificates, detailing weekly amortizations in the following four weeks and the following 12 months (i.e., following the end of the current month).
Information in the first three items above should be published in the central bank webpage.
• Decisions of the Superintendencia de Bancos and Resolutions of the Junta Monetaria, in relation to actions included in the matrix of financial sector reforms.
• Results of actions taken by Superintendencia de Bancos, in relation to the matrix of financial sector reforms.
• Financial statements of banks and their compliance with prudential regulations.
1 Including Law 104-99 (RD$3 billions remaining), the current draft law being considered by Congress (RD$5,5 billions), and administrative debt subject to verification being paid in cash (RD$5,5 billion).
2 The term "debt" has the meaning set forth in point no.9 of the Fund's Guidelines on Performance Criteria with Respect to Foreign Debt (Decision no.6230-(79/140,August 3, 1979) and Decision no.12274-(00/85, August 24, 2000) as amended).
3 Excludes reserve requirements on domestic foreign currency deposits.