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Dominican Republic and the IMF

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Public Information Notice (PIN) No. 03/123
October 14, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with the Dominican Republic

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On August 29, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Dominican Republic.1

Background

After a strong economic performance during 1992-2000, the Dominican Republic economy is facing a serious crisis. The country experienced a series of external shocks, starting in 2001, including a rise in oil prices, the September 11 events, and the ensuing economic slowdown in the United States and Europe. However, the country faced a bigger shock in 2003 with the failure of a large private bank following revelations of fraud. The banking problems contributed to pressures on the peso and to a sharp rise in public sector debt. Economic activity has weakened and inflation is expected to rise to an annual rate close to 35 percent in 2003 reflecting the weaker exchange rate. With a drop in consumer confidence and investment, economic activity has declined by around 1.5 percent so far in 2003, and is projected to decline by 3 percent for the year as a whole, after rising by 4 percent in 2002.

The banking crisis arose mainly from governance problems that went undetected for many years, including accounting malpractices, mismanagement, and fraud. Unregistered liabilities amounting to several times registered deposits were found in Baninter, the third largest bank in the country at the time. This bank was intervened by the Central Bank in April 2003 and was granted considerable liquidity assistance to prevent contagion and protect the payments system. However, contagion soon extended to two other medium-sized banks with management deficiencies. These banks have also been assisted by the Central Bank, and are currently being restructured. The authorities have launched a comprehensive program to strengthen the banking system, including conducting audits of banks, reinforcing the legal framework for bank resolution, and strengthening prudential regulation and bank supervision.

To compensate for this assistance and mop up liquidity, the Central Bank issued large amounts of certificates, leading to increases in quasi-fiscal losses of the central bank, the public sector debt, and the combined fiscal deficit. Public sector debt has increased to around 45 percent of GDP, from around 26 percent in 2002, raising concerns about debt sustainability. To address these concerns, the authorities have taken a number of measures to contain the deterioration in the public finances, including expenditure cuts and new revenue measures, including a tax on checks, an import surcharge, and other temporary measures. Further measures and reforms are envisaged for the coming months and the public sector deficit is projected to be contained at 3.5 percent of GDP in 2003.

Exports and tourism have recovered so far in 2003, and imports have fallen as a result of the downturn in the domestic demand and the sharp real depreciation of the peso. The external current account has shifted into a surplus of about 1 percent of GDP in the first half of the year, from a deficit of 4 percent in 2002. The financial account has weakened sharply, despite the placement of a US$600 million sovereign bond in early 2003; foreign direct investment has declined and there have been capital outflows. Net international reserves fell by about US$65 million in the first half of the year bringing gross international reserves to around US$500 million at end-June, or less than 1 month of imports.

Executive Board Assessment

Directors recalled that the Dominican Republic had long been one of the fastest growing and stable countries in the region, they focused on the policy framework that would help the economy recover from recent shocks, notably the after-effects of September 11, 2001 and, especially, the recent banking crisis that was triggered by massive fraud. This crisis has induced a substantial depreciation of the peso, a sharp increase in inflation, and a deceleration in economic activity.

Directors endorsed the authorities' policy package to address the severe consequences of these shocks. They expressed confidence that the authorities' strategy—which centers on improving governance, accountability and oversight of the banking system, and strengthening the public finances—will help reverse the recent slowdown in growth, the overshooting of the depreciation of the peso, and the associated sharp increase in inflation.

Directors welcomed the recent actions the authorities have taken to strengthen the banking sector, including dealing with three weak banks and the steps to avoid further contagion. A number of Directors regretted that the bank oversight structure had not caught signs of the banking problems at an earlier stage—especially in light of the recently completed Financial Sector Assessment Program. Directors agreed with the high priority given to the immediate assessment of the health of the banking system through internationally assisted inspections of banks, and urged prompt corrective actions in response to any weaknesses that are identified. They also supported the measures to strengthen the legal framework, prudential regulations, and bank supervision. Restoring public confidence in the supervisory framework is of the essence, and Directors welcomed the authorities' commitment to initiate an inquiry into regulatory lapses that contributed to the delay in discovering the banking fraud.

Directors observed that the public debt ratio has increased sharply to almost 50 percent of GDP as a result of currency depreciation and the assistance provided to the banking system. Therefore, they favored an increase in the primary fiscal surplus to enable the authorities to offset some of the higher cost of servicing debt, and allow a gradual reduction in the debt ratio over the medium term. The authorities are working through legal channels to attach the assets of shareholders of banks where fraud has been found, and any recoveries from the sale of such assets would also help limit the public costs of bank resolution. Directors also welcomed the actions undertaken by the authorities to avoid a bailout of the former owners. Forensic audits will seek to establish the responsibility of former owners and managers for the banks' losses.

Against this background, Directors supported steps to raise revenue and curtail expenditure to limit the budget deficit in the period ahead. They stressed the importance of the authorities' plan to replace expenditure compression and temporary revenue measures with comprehensive tax and expenditure reforms, which will be key to generating higher primary surpluses over the medium term. Directors urged the authorities to advance approval of a tax reform to broaden the base of consumption and income taxes, and to seek prompt approval of budgetary reforms to improve the efficiency of public spending. They also noted that the sale of public assets could contribute to the reduction of public debt over the medium term.

Directors emphasized the need to protect the poor from the effects of the crisis, and to shield social spending from expenditure cuts, as poverty remains high. They welcomed the authorities' efforts to improve the efficiency of social programs and subsidies, including through better targeting. Directors also welcomed the steps to reduce the impact on the poor of electricity price increases. However, they noted that the effectiveness of electricity subsidies could be improved by better targeting.

Directors considered that a tight monetary stance will be crucial to limit pressures on the exchange rate and bring inflation back to single digits. Particular care is needed to ensure that liquidity support provided to individual banks does not result in excessive monetary expansion in the system as a whole. Directors favored greater reliance on market-based instruments to achieve monetary targets, and welcomed the recent start of open market operations through auctions for central bank paper.

Directors welcomed the decision to unify the exchange market and the authorities' commitment to a fully flexible exchange rate policy. They supported the steps that are being taken to eliminate the multiple currency practice arising from the existence of an official exchange rate and a market rate for current exchange transactions, and approved this multiple currency practice until September 30, 2003.

Directors considered that the realization of the Dominican Republic's considerable medium-term growth potential requires structural reforms beyond the banking, governance, and fiscal areas. In particular, it will be important to open up the economy further to international trade and investment and to eliminate infrastructural bottlenecks, especially in the power sector, where high electricity tariffs hamper competitiveness. In this context, Directors emphasized the urgency of placing the power sector on a sustainable financial basis, and they encouraged the authorities to work closely with the World Bank to implement reforms in these areas.

Directors welcomed the significant progress the Dominican Republic has made in recent years in combating money laundering and the financing of terrorism, and encouraged the authorities to build on this success in the context of strengthening the financial system.



Dominican Republic: Selected Economic and Financial Indicators


 

   

Prel.

Proj.

 

1999

2000

2001

2002

2003


           
 

(Annual percentage changes, unless otherwise indicated)

           

National accounts and prices

         

Real GDP

7.8

7.3

2.9

4.1

-3.0

Real GDP per capita

6.1

5.4

1.4

2.3

-4.7

Consumer price index (end of period)

5.1

9.0

4.4

10.5

35.0

Unemployment rate (in percent)

13.1

13.9

15.6

16.1

...

Gross domestic investment (in percent of GDP)

24.2

24.0

23.1

23.2

21.7

Gross national savings (in percent of GDP)

21.8

18.8

19.7

23.2

22.7

           

Banking system

         

Liabilities to private sector

24.3

11.7

21.3

13.2

44.6

Lending interest rate (period average)

25.3

26.8

24.6

26.1

39.4

           
 

(In percent of GDP)

           

Public finances

         

Central government

         

Primary balance

-2.5

-1.3

-1.1

-1.3

1.9

Overall balance

-3.2

-2.1

-1.9

-2.2

-0.4

Consolidated public sector

         

Primary balance

-1.7

-0.8

-1.0

-1.3

1.1

Overall balance

-3.0

-2.0

-2.1

-2.6

-3.5

           
 

(In millions of U.S. dollars, unless otherwise indicated)

           

Balance of payments

         

Current account

-429

-1,026

-752

-875

159

Merchandise trade balance

-2,904

-3,742

-3,503

-3,699

-3,076

Exports

5,137

5,737

5,276

5,183

5,525

Imports

-8,041

-9,479

-8,779

-8,883

-8,602

Services and transfers (net)

2,475

2,716

2,751

2,824

3,235

Of which: interest

-180

-201

-196

-215

-272

Capital and financial account

1,068

1,580

1,724

952

1,318

Foreign direct investment

1,338

953

1,079

961

621

Change in gross international reserves (-=increase)

-194

70

-519

526

-155

           

Current account (in percent of GDP)

-2.5

-5.2

-3.4

-4.0

1.0

Exports (in US$, annual percentage change)

1.0

16.1

-8.4

-1.8

6.6

Imports (in US$, annual percentage change)

6.3

23.2

-7.2

1.2

-3.2

Terms of trade (annual percentage change)

-4.8

-6.0

0.8

0.9

-0.3

Real effective exchange rate (end-period, depreciation -)

3.3

5.9

2.4

-16.7

...

           

International reserve position and external debt

     

Gross official reserves

706

637

1,155

630

785

(in months of imports)

1.3

1.0

1.9

1.0

0.9

Net official reserves

547

442

962

376

347

           

Outstanding external public debt, in percent of GDP

21.0

18.6

19.6

20.9

33.8

Total debt service ratio (in percent of exports of goods & services)

5.0

5.2

7.1

8.0

8.6

Gross reserves/short-term debt (in percent)

71.1

52.4

79.7

46.8

58.5


Sources: Central Bank of the Dominican Republic; World Bank; and IMF staff estimates and projections.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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