IMF Executive Board Concludes 2008 Article IV Consultation with the Dominican RepublicPublic Information Notice (PIN) No. 08/22
February 19, 2008
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On January 14, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Dominican Republic.1
Prudent macroeconomic policies since the 2002-04 financial/economic crisis, which have been supported by a Fund arrangement, have allowed the Dominican economy to recover strongly and quickly. Real growth has averaged near double digits since then and has been among the highest in the region, inflation has been contained to single digits, fiscal consolidation has been considerable with the fiscal position shifting from primary deficits to primary surpluses and public debt ratios declining, and the fundamentals of the banking system have strengthened significantly. The international reserve position of the central bank has been substantially bolstered, with gross international reserves of the central bank reaching record levels and now exceeding three times short-term external debt coming due.
Over the same period, steps have been taken to begin addressing structural weaknesses in the Dominican economy. A new legal framework has been put in place for fiscal management, bank supervision has been bolstered and moving toward a supervisory framework of risk-based consolidated supervision, a recapitalization plan for the central bank has been approved by congress and will be put in place over the next ten years, and electricity theft and fraud has been criminalized, a key step for improving the financial performance of this sector.
Notwithstanding the good macroeconomic performance since the crisis and advances in structural areas, challenges remain. The output gap has closed and aggregate demand and oil price shock pressures widened the external current account deficit signifcantly in 2007. While reserve accumulation has been strong, the Dominican Republic still has one of the lowest reserve adequacy indicators among emerging market economies; all the while public debt ratios remain substantially above pre-crisis levels and a significant amount of peso-denominated debt needs to be rolled over in the short run. Financial sector vulnerabilities have been reduced, but will remain until risk-based consolidated supervision can be fully implemented and institutional capacity strengthened further. The improvement in the fiscal balance during the program period has reflected a substantial increase in revenues, in part due to the positive external environment (e.g., higher nickel-related revenue in 2007), while primary spending was kept broadly constant (in terms of GDP) since 2004, even though subsidy programs (for electricity and liquefied gas) remained large and poorly targeted.
Executive Board Assessment
Executive Directors commended the Dominican Republic authorities for the country's impressive recovery from the 2002-04 financial crisis. Prudent macroeconomic policies in a favorable external environment have restored confidence and delivered a strong macroeconomic performance, with rapid growth, single-digit inflation, declining debt ratios, a robust external position, and a strengthened financial system. Directors observed that the medium-term economic outlook is generally positive, provided remaining vulnerabilities are managed carefully.
Directors noted that, although the external current account deficit has widened over the last two years, it remains in line with economic fundamentals. Directors considered that the managed float exchange rate regime has served the country well, and noted the staff's assessment that the exchange rate of the peso appears to be broadly in equilibrium. They supported the central bank's policy of building up international reserves as insurance against shocks, as the level of reserves remains low in comparison with that in similar economies.
Directors commended the central bank's skillful monetary management, and considered appropriate its use of intermediate base money targets to meet the inflation reduction goal. Directors concurred that it would be important for the authorities to stand ready in the period ahead to tighten monetary policy, if needed to forestall incipient inflation pressures. They welcomed the central bank's commitment in this regard.
Directors considered that the main fiscal policy challenge over the medium term will be to increase and better target social spending, while generating primary surpluses to lower the consolidated public debt burden to pre-crisis levels. Many Directors recommended aiming for primary surpluses averaging 2.5 percent of GDP over the medium term, although some other Directors viewed a somewhat slower pace of adjustment as appropriate. Directors encouraged the authorities to pursue reforms to widen the tax base, mainly by rationalizing tax exemptions, and to limit poorly-designed energy subsidies. They called for firm control of public spending during the upcoming electoral period. Directors also encouraged continued improvements in debt management, given the significant amount of peso-denominated debt which is still short term.
Directors noted that key structural reforms have significantly strengthened the policy framework, and looked forward to continued efforts to make these reforms fully operational. They welcomed the reorganization of fiscal management institutions and improved procedures that will allow for better fiscal and public debt management. Directors commended the authorities for the decision to criminalize electricity theft, which will help reduce budgetary support to the electricity sector. They welcomed legislation to recapitalize the central bank, which will strengthen its accountability and financial independence.
Directors commended the considerable progress which has been made in prudential regulation and financial supervision, including the establishment of a macro-financial stress-testing framework. They advised continued vigilance regarding the growth of mortgage and consumer lending. Directors encouraged the authorities to continue to work toward the complete implementation of fully risk-based consolidated supervision and the further strengthening of institutional capacity, which will require approval of the amendments to the Monetary and Financial law. It will also be important to ensure that the legal framework for the creation of an international financial center in the Dominican Republic does not undermine efforts toward consolidated supervision. Directors looked forward to the Financial Sector Assessment Program update in 2008.
With respect to the reporting of data to the Fund, Directors encouraged the authorities to continue their efforts to ensure the accuracy of key information, particularly on the current account.