IMF Executive Board Concludes 2009 Article IV Consultation with the Dominican RepublicPublic Information Notice (PIN) No. 09/128
November 16, 2009
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 November 9, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the 2009 Article IV consultation with the Dominican Republic.1
The Dominican economy has been adversely affected by the global crisis. Output has been below potential as real Gross Domestic Product (GDP) growth is decelerating rapidly from over 5 percent in 2008 to an estimated 0.5 to 1.5 percent in 2009. Inflation has fallen rapidly to -0.3 percent year-over-year in October 2009 as the supply shocks of last year have unwound. The external current account deficit is estimated to be around 6 percent of GDP in 2009, about 4 percentage points lower than in 2008, as imports have fallen more than exports, tourism and remittances. The banking system has withstood the global crisis and remains liquid, well-capitalized and profitable.
Monetary authorities have responded to the crisis in a timely manner, but fiscal policy has been constrained by a lack of external financing. The Central Bank lowered its policy interest rate by 550 basis points to 4 percent during 2009, and reserve requirements were also lowered by 250 basis points to 17.5 percent. Following a relaxed stance in 2008, fiscal policy has been tight in the first 3 quarters of 2009, as a decline in tax revenues of 10 percent to September (with respect to January–September 2008) was met with a larger decline in expenditures. The deficit of the consolidated public sector was about 2 percent of GDP during the first three quarters of 2009, or around 1 percentage point of GDP lower than during the first three quarters of 2008.
Structural impediments in the fiscal and electricity sector put a heavy burden on public finances. There is a risk that the decline in tax revenues observed in 2008-09 (of more than 10 percent) may be partly related to undue use of tax exemptions contained in competitiveness laws. Serious structural weaknesses continue to leave the state-owned electricity distribution companies with large losses. Untargeted subsidies to cover these losses remain a drain on public finances, absorbing over one percent of GDP in 2009. Notwithstanding these subsidies, the quality of service to citizens in the electricity sector remains very poor.
The authorities’ program aims to limit the effects of the global slowdown on the economy while establishing the conditions for robust and sustainable growth. The program is expected to catalyze financing from multilaterals for the conduct of a countercyclical fiscal policy in the short term, while monetary policy will remain flexible to respond to the liquidity needs of the economy. The medium-term program calls for a gradual fiscal consolidation to ensure sustainability as the economic activity rebounds. International reserves will also be increased to comfortable levels as the exchange rate is gradually made more flexible and the Central Bank adopts a full-fledged inflation targeting regime in the medium-term. The authorities’ program also aims to address fiscal impediments, especially in the area of revenue collection, and to eliminate untargeted electricity subsidies. The authorities‘ economic program is supported by a Stand-By Arrangement with the IMF, which was alslo approved by the Executive Board on November 9 (see Press Release 09/393).
Executive Board Assessment
Executive Directors agreed with the thrust of the staff appraisal. They noted that the global economic recession has significantly weakened the Dominican economy, with growth declining markedly in 2009. Inflation has remained subdued and the current account deficit narrowed. Directors welcomed the authorities’ economic program, which aims at returning the economy to its high, sustainable growth path, through flexible, countercyclical policies in the short run, and pursuing over the medium term a fiscal consolidation strategy and an ambitious structural reform agenda.
Directors supported the temporary fiscal stimulus in 2009-10, including the full play of automatic stabilizers, in light of well below potential output and as financing constraints are relieved. Fiscal policy could be relaxed as additional external financing is secured, targeting investment projects with high social returns while strengthening social safety nets. At the same time, Directors called on the authorities to follow through on their commitment to medium-term sustainability by shifting to a fiscal consolidation effort beginning in the second half of 2010. Work should start promptly on the planned structural measures, in particular improvements in tax administration, with Fund technical assistance, and on the elimination of untargeted electricity subsidies. The finalization and implementation of a comprehensive plan to address structural impediments in the electricity sector also remain a high priority.
Directors welcomed the flexible implementation of monetary policy, with a timely shift to an accommodative stance in 2009 to stimulate economic activity. While this stance remains appropriate at present, Directors noted the limited scope for further reducing policy interest rates, as well as banks’ high liquidity preference. Directors encouraged the monetary authorities to remain vigilant and stand ready to withdraw liquidity gradually as private credit picks up. They commended the authorities for the progress in strengthening the central bank as an effective monetary authority, and stressed the importance of proceeding with the recapitalization plan to enhance its credibility further.
Directors welcomed the monetary authorities’ commitment to a flexible exchange rate, and took note of the staff assessment that the real effective exchange rate is broadly in line with fundamentals. Given the relatively low level of international reserves, gradually introducing more flexibility within the current managed floating regime would help cushion potential external shocks. Consideration would also need to be given to continued strengthening of the monetary anchor, and Directors supported the authorities’ intention to move to an inflation-targeting regime once the supporting institutional framework has been put in place.
Directors welcomed significant improvements in the regulation, supervision, and financial strength of the banking system. As a result of previous reforms, the Dominican banking system remains liquid, solvent, and profitable, despite the global credit crunch. Directors emphasized the need to continue monitoring the system closely and stand ready to take necessary measures to prevent systemic problems. They encouraged the authorities to advance the implementation of risk-based consolidated bank supervision and regulation, and to formulate strategies for domestic capital market development and debt management.