## 1hndea2019002

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---

### Revenue Mobilization (REVENUE MOBILIZATION)
- Scope: Assessment of Honduras’ revenue mobilization progress, benchmarking, and prospects for tax expenditure rationalization.
- Key findings:
  - Revenue mobilization contributed to reducing the NFPS deficit by 6½ percentage points of GDP between 2013 and 2018.
  - Tax revenue increased by 3.3 percent of GDP during this period, mainly driven by the December 2013 fiscal package (VAT rate increase and introduction of a minimum corporate income tax).
  - Creation of Servicio de Administración de Rentas (SAR) in 2015 and use of AML legislation helped prosecute tax fraud.
  - Real GDP growth averaged 3.8 percent over 2010-18.
  - Honduras was the country with the second highest private investment-to-GDP ratio in CAPDR in 2018, at 20.8 percent. During 2014-17, private investment averaged 13.3 percent of GDP.
  - Inbound FDI flows to Honduras have outpaced the average level registered in comparators in Latin America since the early 2000s.
  - Benchmarking using an output-oriented bootstrapped DEA model (Simar and Wilson, 2000) on 93 emerging or low-income countries indicates Honduras’ efficiency gap is positive but considerably lower than in Latin American countries.
  - If all inefficiencies were removed, Honduras could increase tax collection by about 4 percentage points of GDP.
- Comparative statutory and collection metrics:
  - Statutory tax rates are comparable to regional peers for PIT, CIT, and VAT.
  - Honduras is top performer among CAPDR countries in revenue from corporate income and consumption taxes; relatively high collection of personal income tax.
  - Honduras has a marginal corporate tax rate of 30 percent for high-profit companies (the “Aportación Solidaria”), applying to 15 percent of the corporate taxpayer base and contributing slightly above 10 percent of total collection.
  - Minimum CIT (MIT) originally applied to companies with gross income above US$0.5 million; limit increased to US$12 million in 2018, to US$24 million in 2019, and to US$40 million in 2020.
- Policy implications and recommendations:
  - Sustain medium-term revenue mobilization to finance poverty reduction, infrastructure investment, and achieve public debt reduction envisaged in the MTFF.
  - Strengthen revenue mobilization to secure fiscal space for contingent liabilities (nonfinancial SOEs, public banks, PPPs).
  - Prioritize reforms that increase efficiency and compliance: base broadening (reduce tax exemptions), strengthen tax administration/enforcement to mitigate evasion.
  - Anti-evasion and base-broadening reforms are key to improving efficiency and equity; widespread exemptions and tax amnesties incentivize informality and evasion.
- Tax expenditures:
  - Honduras’ tax expenditures are reported at 6.8 percent of GDP — characterized as one of the highest levels in the world.
  - Bulk of tax expenditures attributable to special CIT regimes and VAT exemptions.
  - Large tax incentives induce revenue leakage through increased avoidance and evasion and favor unfair competition.
  - Cost-benefit assessment principles for prioritizing exemption reforms:
    - Reduce expenditures on less elastic bases (e.g., fuel consumption).
    - Target those with negative externalities (e.g., unhealthy food items).
    - Target those with small macroeconomic effects (e.g., higher income individuals with lower marginal propensity to consume; financially unconstrained firms).
    - Reassess CIT holidays aimed at increasing exports and/or employment that have failed to deliver.
  - Over the medium term, base broadening can enable lowering corresponding statutory rates.

### Electricity Reform: International Experiences (ELECTRICITY REFORM: INTERNATIONAL EXPERIENCES)
- Objective: Summarizes common components of successful electricity sector reforms to improve solvency; draws on FAD (2013) and Albania (2009-17).
- Key reform components (three-pronged approach):
  - Cost reduction in energy production: private sector participation and liberalization across the value chain to foster competition and reduce generation costs.
  - Reduction of distribution losses: infrastructure investment to limit technical losses; credible enforcement to limit non-technical losses (criminal penalties for theft, forced disconnections, reduce collusion between meter readers and consumers).
  - Cost-recovery tariffs: scale back implicit/explicit subsidies to guarantee operational solvency; accompany tariff increases with improved targeting of social welfare, a single compensatory cash transfer at reform time, and dual-rate electricity meters; public awareness campaigns linking bill payments to service reliability.
- Albania (2009-17) case study (parallels with Honduras):
  - Pre-reform problems: net energy importer, volatile electricity costs, frequent prolonged blackouts, distribution losses reached 46 percent in 2012.
  - Burden of electricity companies accounted for 0.9 percent of GDP in 2014; outstanding debt of public electricity companies over 9 percent of GDP.
  - Reform outcomes: losses reduced by 14 percent in three years; quasi-fiscal burden curtailed to 0.1 percent of GDP in 2017.
  - Short-term measures employed:
    - Criminal penalties for electricity theft.
    - Forced service disconnection for nonpayment.
    - Provisionally fixed tariff for consumers without a meter.
    - Tariff increases for commercial clients between 10-39 percent.
    - Elimination of subsidized lower block tariff for residential consumers; one-off partial subsidy to low-voltage consumers receiving social assistance.
    - Removal of commercial high-voltage consumers from regulated tariffs to a liberalized market.
  - Medium-term measures:
    - Investment in infrastructure to reduce technical distribution losses (World Bank support).
    - Sound regulatory framework with more frequent and automatic tariff updates to ensure cost recovery.
- Key take-aways for Honduras:
  - Strong political will and an independent, reliable regulatory framework are critical.
  - Critical reform elements: credible sanctions for noncompliance (including criminal penalties), reduce technical losses, improve generation efficiency, regularly updated cost-recovery tariffs, and coverage for poor consumers during reform.
  - Privatization of distribution is complex and may not be effective in reducing losses.

### The Buffering Role of Exchange Rate Flexibility (THE BUFFERING ROLE OF EXCHANGE RATE FLEXIBILITY)
- Purpose: Discusses benefits of greater exchange rate flexibility to support adjustment to external shocks, notably negative terms of trade shocks.
- Mechanism:
  - Exchange rate flexibility supports adjustment through expenditure switching: depreciations foster exports and import substitution.
  - Evidence suggests the export channel of expenditure switching is particularly strong in CAPDR countries, especially Honduras.
- Exposure to real external shocks:
  - CAPDR countries, and Honduras in particular, are exposed to similar terms of trade (ToT) shocks as many other Latin American countries.
  - ToT shocks are typically associated with the volatility of commodity prices.
  - In LA5 and other South American commodity-exporting countries, shocks mainly reflect variations in export prices.
  - In CAPDR countries, shocks tend to be driven by fluctuations in import prices, reflecting:
    - Larger shares of commodity exports—fuels and metals—in South American peers.
    - CAPDR exports dominated more by manufactures, including textiles, typically with less volatile prices.
    - CAPDR countries tend to have higher shares of fuel and food imports.
- Exchange rate flexibility evidence:
  - Countries with less exchange rate flexibility lose more international reserves and experience greater compression in domestic demand and imports following negative ToT shocks.
  - Countries with more flexible exchange rate regimes experience much more limited reserve losses and stronger export recovery and import substitution via exchange rate depreciation (expenditure switching effects), reducing the sacrifice ratio of falling domestic demand to support external adjustment.
  - Honduras’s current arrangement: the country’s crawling peg arrangement is designed to keep the multilateral real exchange rate (REER) roughly constant by pairing nominal bilateral depreciations of the Lempira vis-á-vis the U.S. dollar with inflation differentials and exchange rate adjustments vis-à-vis the U.S. dollar in trading partners.
  - Empirical contrast (2013–16 and 2016–18 episodes):
    - During falling commodity export prices in 2013-16, LA5 countries with more flexible regimes experienced REER depreciations similar or larger than the reduction in their ToT.
    - During rising imported oil prices between 2016 and 2018, Honduras showed just a slight REER adjustment despite one of the greatest declines in ToT in CAPDR.
  - Policy-relevant consideration:
    - While exchange rate adjustments can have pass-through and balance sheet effects that must be considered, the evidence suggests Honduras could benefit from greater exchange rate flexibility to harness expenditure switching effects that buffer external shocks.
- Export channel of adjustment:
  - Sensitivity of Honduran exports to the REER indicates expenditure switching would operate mainly through the export channel.
  - Estimated elasticities:
    - CAPDR export elasticities to the REER are significantly larger than in the rest of Latin America and emerging Asia, reflecting a smaller role for commodities and a larger role for textiles in the regional export basket.
    - El Salvador and Honduras have particularly high implied REER elasticities because they have the highest share of textiles in their total exports.
  - Quantified effect for Honduras:
    - A 10 percent depreciation of the REER would lead to an approximately 2½ percent increase in total exports.
  - Caveat and research need:
    - Additional research is needed to assess the strength of the import substitution channel in CAPDR countries, where greater dependency on imports due to limited local productive capacity is a policy concern.

### References (selected as listed)
- Estevão, M. and I. Samake, 2013, “The Economic Effects of Fiscal Consolidation with Debt Feedback”, IMF Working Paper 13/136.
- Fenochietto, R. and C. Pessino, 2010, “Determining Countries’ Tax Effort”, Revista de Economía Pública, 195-(4/2010): 65-87.
- Fenochietto, R. and C. Pessino, 2013, “Understanding Countries’ Tax Effort”, IMF Working Paper 13/244.
- Gupta, Abhijit, 2007, “Determinants of Tax Revenue Efforts in Developing Countries,” IMF Working Paper 07/184.
- Kapsoli, J. and I. Teodoru, 2017, “Benchmarking Social Spending Using Efficiency Frontiers”, IMF Working Paper 17/197.
- Simar, L. and P. W. Wilson, 2000, “A General Methodology for Bootstrapping in Non-Parametric Frontier Models,” Journal of Applied Statistics, Vol. 27, N°6, pp. 779-802.

*Prepared by Maria Coelho, Javier Kapsoli, and Catherine Koh; prepared by Maria Coelho for electricity reform note. Source: https://www.imf.org/-/media/files/publications/cr/2019/1hndea2019002.pdf*

### References ______________________________________________________________________________ 7

### 1hndea2019002 - References ______________________________________________________________________________ 7

### Revenue Mobilization (REVENUE MOBILIZATION)
- Scope: Assessment of Honduras’ revenue mobilization progress, benchmarking, and prospects for tax expenditure rationalization.
- Key findings:
  - Revenue mobilization contributed to reducing the NFPS deficit by 6½ percentage points of GDP between 2013 and 2018.
  - Tax revenue increased by 3.3 percent of GDP during this period, mainly driven by the December 2013 fiscal package (VAT rate increase and introduction of a minimum corporate income tax).
  - Creation of Servicio de Administración de Rentas (SAR) in 2015 and use of AML legislation helped prosecute tax fraud.
  - Real GDP growth averaged 3.8 percent over 2010-18.
  - Honduras was the country with the second highest private investment-to-GDP ratio in CAPDR in 2018, at 20.8 percent. During 2014-17, private investment averaged 13.3 percent of GDP.
  - Inbound FDI flows to Honduras have outpaced the average level registered in comparators in Latin America since the early 2000s.
  - Benchmarking using an output-oriented bootstrapped DEA model (Simar and Wilson, 2000) on 93 emerging or low-income countries indicates Honduras’ efficiency gap is positive but considerably lower than in Latin American countries.
  - If all inefficiencies were removed, Honduras could increase tax collection by about 4 percentage points of GDP.
- Comparative statutory and collection metrics (as reported):
  - Statutory tax rates are comparable to regional peers for PIT, CIT, and VAT.
  - Honduras is top performer among CAPDR countries in revenue from corporate income and consumption taxes; relatively high collection of personal income tax.
  - Honduras has a marginal corporate tax rate of 30 percent for high-profit companies (the “Aportación Solidaria”), applying to 15 percent of the corporate taxpayer base and contributing slightly above 10 percent of total collection.
  - Minimum CIT (MIT) originally applied to companies with gross income above US$0.5 million; limit increased to US$12 million in 2018, to US$24 million in 2019, and to US$40 million in 2020.
- Policy implications and recommendations:
  - Sustain medium-term revenue mobilization to finance poverty reduction, infrastructure investment, and achieve public debt reduction envisaged in the MTFF.
  - Strengthen revenue mobilization to secure fiscal space for contingent liabilities (nonfinancial SOEs, public banks, PPPs).
  - Prioritize reforms that increase efficiency and compliance: base broadening (reduce tax exemptions), strengthen tax administration/enforcement to mitigate evasion.
  - Anti-evasion and base-broadening reforms are key to improving efficiency and equity; widespread exemptions and tax amnesties incentivize informality and evasion.
- Tax expenditures:
  - Honduras’ tax expenditures are reported at 6.8 percent of GDP — characterized as one of the highest levels in the world.
  - Bulk of tax expenditures attributable to special CIT regimes and VAT exemptions.
  - Large tax incentives induce revenue leakage through increased avoidance and evasion and favor unfair competition.
  - Cost-benefit assessment principles for prioritizing exemption reforms:
    - Reduce expenditures on less elastic bases (e.g., fuel consumption).
    - Target those with negative externalities (e.g., unhealthy food items).
    - Target those with small macroeconomic effects (e.g., higher income individuals with lower marginal propensity to consume; financially unconstrained firms).
    - Reassess CIT holidays aimed at increasing exports and/or employment that have failed to deliver.
  - Over the medium term, base broadening can enable lowering corresponding statutory rates.

### Electricity Reform: International Experiences (ELECTRICITY REFORM: INTERNATIONAL EXPERIENCES)
- Objective: Summarizes common components of successful electricity sector reforms to improve solvency; draws on FAD (2013) and Albania (2009-17).
- A. Key reform components (three-pronged approach):
  - Cost reduction in energy production: private sector participation and liberalization across the value chain to foster competition and reduce generation costs.
  - Reduction of distribution losses: infrastructure investment to limit technical losses; credible enforcement to limit non-technical losses (criminal penalties for theft, forced disconnections, reduce collusion between meter readers and consumers).
  - Cost-recovery tariffs: scale back implicit/explicit subsidies to guarantee operational solvency; accompany tariff increases with improved targeting of social welfare, a single compensatory cash transfer at reform time, and dual-rate electricity meters; public awareness campaigns linking bill payments to service reliability.
- B. Albania (2009-17) case study (parallels with Honduras):
  - Pre-reform problems: net energy importer, volatile electricity costs, frequent prolonged blackouts, distribution losses reached 46 percent in 2012.
  - Burden of electricity companies accounted for 0.9 percent of GDP in 2014; outstanding debt of public electricity companies over 9 percent of GDP.
  - Reform outcomes: losses reduced by 14 percent in three years; quasi-fiscal burden curtailed to 0.1 percent of GDP in 2017.
  - Short-term measures employed:
    - Criminal penalties for electricity theft.
    - Forced service disconnection for nonpayment.
    - Provisionally fixed tariff for consumers without a meter.
    - Tariff increases for commercial clients between 10-39 percent.
    - Elimination of subsidized lower block tariff for residential consumers; one-off partial subsidy to low-voltage consumers receiving social assistance.
    - Removal of commercial high-voltage consumers from regulated tariffs to a liberalized market.
  - Medium-term measures:
    - Investment in infrastructure to reduce technical distribution losses (World Bank support).
    - Sound regulatory framework with more frequent and automatic tariff updates to ensure cost recovery.
- C. Key take-aways for Honduras:
  - Strong political will and an independent, reliable regulatory framework are critical.
  - Critical reform elements: credible sanctions for noncompliance (including criminal penalties), reduce technical losses, improve generation efficiency, regularly updated cost-recovery tariffs, and coverage for poor consumers during reform.
  - Privatization of distribution is complex and may not be effective in reducing losses.

### The Buffering Role of Exchange Rate Flexibility (THE BUFFERING ROLE OF EXCHANGE RATE FLEXIBILITY)
- Purpose: Discusses benefits of greater exchange rate flexibility to support adjustment to external shocks, notably negative terms of trade shocks.
- Mechanism:
  - Exchange rate flexibility supports adjustment through expenditure switching: depreciations foster exports and import substitution.
  - Evidence suggests the export channel of expenditure switching is particularly strong in CAPDR countries, especially Honduras.
- Supporting evidence and figures referenced:
  - Figures include: Exposure to Real External Shocks in Latin America; Terms of Trade Changes and Contributions to REER Changes; Trade-Imputed Elasticity of Export Market Shares for CAPDR Countries.
  - Note highlights high sensitivity of exports to exchange rate movements in CAPDR countries.

### References (as listed)
- Estevão, M. and I. Samake, 2013, “The Economic Effects of Fiscal Consolidation with Debt Feedback”, IMF Working Paper 13/136.
- Fenochietto, R. and C. Pessino, 2010, “Determining Countries’ Tax Effort”, Revista de Economía Pública, 195-(4/2010): 65-87.
- Fenochietto, R. and C. Pessino, 2013, “Understanding Countries’ Tax Effort”, IMF Working Paper 13/244.
- Gupta, Abhijit, 2007, “Determinants of Tax Revenue Efforts in Developing Countries,” IMF Working Paper 07/184.
- Kapsoli, J. and I. Teodoru, 2017, “Benchmarking Social Spending Using Efficiency Frontiers”, IMF Working Paper 17/197.
- Simar, L. and P. W. Wilson, 2000, “A General Methodology for Bootstrapping in Non-Parametric Frontier Models,” Journal of Applied Statistics, Vol. 27, N°6, pp. 779-802.

*Prepared by Maria Coelho, Javier Kapsoli, and Catherine Koh; prepared by Maria Coelho for electricity reform note.*

### 1.      Like other countries in the region, Honduras is exposed to real external shocks. CAPDR

### 1hndea2019002 - 1.      Like other countries in the region, Honduras is exposed to real external shocks. CAPDR

### Exposure to real external shocks
- CAPDR countries, and Honduras in particular, are exposed to similar terms of trade (ToT) shocks as many other Latin American countries.
- ToT shocks are typically associated with the volatility of commodity prices.
- In LA5 and other South American commodity-exporting countries, shocks mainly reflect variations in export prices.
- In CAPDR countries, shocks tend to be driven by fluctuations in import prices, reflecting:
  - Larger shares of commodity exports—fuels and metals—in South American peers.
  - CAPDR exports dominated more by manufactures, including textiles, typically with less volatile prices.
  - CAPDR countries tend to have higher shares of fuel and food imports.

### Exchange rate flexibility
- Evidence from Latin America suggests exchange rate flexibility can buffer external shocks, reducing their impact on international reserves and domestic demand.
- Findings from Chapter 3 of the May 2017 Regional Economic Outlook:
  - Countries with less exchange rate flexibility lose more international reserves and experience greater compression in domestic demand and imports following negative ToT shocks.
  - Countries with more flexible exchange rate regimes experience much more limited reserve losses and stronger export recovery and import substitution via exchange rate depreciation (expenditure switching effects), reducing the sacrifice ratio of falling domestic demand to support external adjustment.
- Honduras’s current arrangement:
  - The country’s crawling peg arrangement is designed to keep the multilateral real exchange rate (REER) roughly constant by pairing nominal bilateral depreciations of the Lempira vis-á-vis the U.S. dollar with inflation differentials and exchange rate adjustments vis-à-vis the U.S. dollar in trading partners.
- Empirical contrast (2013–16 and 2016–18 episodes):
  - During falling commodity export prices in 2013-16, LA5 countries with more flexible regimes experienced REER depreciations similar or larger than the reduction in their ToT.
  - During rising imported oil prices between 2016 and 2018, Honduras showed just a slight REER adjustment despite one of the greatest declines in ToT in CAPDR.
- Policy-relevant consideration:
  - While exchange rate adjustments can have pass-through and balance sheet effects that must be considered, the evidence suggests Honduras could benefit from greater exchange rate flexibility to harness expenditure switching effects that buffer external shocks.

### Export channel of adjustment
- Sensitivity of Honduran exports to the REER indicates expenditure switching would operate mainly through the export channel.
- Estimated elasticities:
  - CAPDR export elasticities to the REER are significantly larger than in the rest of Latin America and emerging Asia, reflecting a smaller role for commodities and a larger role for textiles in the regional export basket.
  - El Salvador and Honduras have particularly high implied REER elasticities because they have the highest share of textiles in their total exports.
- Quantified effect for Honduras:
  - A 10 percent depreciation of the REER would lead to an approximately 2½ percent increase in total exports.
- Caveat and research need:
  - Additional research is needed to assess the strength of the import substitution channel in CAPDR countries, where greater dependency on imports due to limited local productive capacity is a policy concern.

*Source: https://www.imf.org/-/media/files/publications/cr/2019/1hndea2019002.pdf*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1hndea2019002.pdf_