## _cr16342 — IMF staff report excerpts ## Source details **Canonical URL:** [_cr16342 — IMF staff report excerpts](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16342.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16342.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16342.pdf.json) --- ### Restructuring of the Petrocaribe Debt - Summary of operation: - Government bought back US$4 billion of Petrocaribe debt at a discount of about 52 percent (January 2015). - Operation financed with sovereign bond placement of US$2.5 billion (10-year and 30-year maturities); US$1.9 billion used to buy back the debt. - New issuance terms cited: US$1 billion 10-year bonds at 5.5 percent interest, and US$1.5 billion 30-year bonds at 6.85 percent interest. - Fiscal and public debt implications: - Buyback reduced public debt by US$2,094 million or 3.1 percent of GDP. - Petrocaribe debt stock prior to operation indicated as 6.0 percent of GDP; bonds issued to finance buyback amounted to 2.9 percent of GDP in the illustration. - Consolidated public sector debt estimated to have increased marginally to 48½ percent of GDP in 2015. - One-off fiscal effect in 2015: capital grant equivalent of 3.1 percent of GDP. - Net present value and cost comparison: - Original Petrocaribe terms: 25-year maturity, 2-year grace period, interest rate of 1-2 percent. - Transaction achieved savings of 12 percent in net present value terms, assuming a 6 percent discount rate. - The country bought back some 98 percent of the debt accumulated with the PDVSA during 2005-14. - Analysis and trade-offs: - Converted concessional, low-interest, long-maturity exposures (1-2 percent interest, 25-year maturity) into market-rate sovereign bonds (5.5 percent for 10-year, 6.85 percent for 30-year). - Immediate nominal stock reduction vs. higher future interest payment obligations; nuanced net effect on medium-term debt dynamics. - Policy considerations (implied): - Incorporate changed maturity and interest-rate profile into medium-term debt sustainability analysis and fiscal planning. - Preserve transparency in reporting one-off receipts and capital grants to distinguish underlying fiscal balances from headline outcomes. - Monitor external financing costs as monetary policy normalizes globally. - Assess contingent exposures and sectoral needs (notably the electricity sector) that could exert upward pressure on public finances. ### Fiscal adjustment needs, tax reforms, and expenditure priorities - Fiscal adjustment scenarios: - Adjustment of around 1½ percent of GDP over one year needed to stabilize debt at current levels. - Adjustment of 2-2½ percent of GDP over the next three years would put debt on a downward path towards reaching 40–45 percent of GDP by 2020. - Tax base and revenue mobilization: - Tax ratio about 14 percent of GDP in 2014 (excluding one-off revenues). - Tax expenditures accounted for 6½ percent of GDP. - Policy priority: widen tax base by eliminating VAT and excise exemptions, rationalizing tax incentives, lowering the personal income tax threshold to boost PIT coverage. - Current PIT coverage: only 14 percent of formal employment pays personal income taxes. - Distributional guidance: eliminate exemptions for upper-income taxpayers while protecting socially vulnerable groups. - Expenditure rationalization and electricity subsidies: - Electricity sector subsidies averaged 2–2½ percent of GDP in recent years, falling to 1½ percent in 2015 due to lower oil prices. - Tariff adjustment recommendation: adjust tariffs to cost recovery levels (at least 11 percent higher than current tariffs according to existing methodologies), or allow automatic tariff adjustment going forward. - Strengthen social safety nets simultaneously to protect the most vulnerable. - Medium-term fiscal framework and institutions: - Use the fiscal pact discussions to strengthen the fiscal policy framework and potentially transition to a rule-based framework with simple rules allowing cyclical flexibility. - Authorities’ stance: - Authorities reiterated commitment to fiscal discipline; fiscal pact deferred to next administration due to elections. - Electricity sector and quasi-fiscal deficit of the central bank highlighted as important drivers of consolidated public sector debt dynamics. ### Monetary policy, exchange rate, and reserves - Monetary stance and outlook: - Current neutral monetary policy stance appropriate; vigilance required against risks of higher inflation. - Inflation expected to return to the target by end-2016; staff welcomed central bank’s tightening bias. - Exchange rate policy and market infrastructure: - Recommend greater exchange rate flexibility to strengthen credibility of inflation targeting and absorb shocks. - Authorities intend to introduce an electronic trading platform in 2016 and develop FX hedging instruments. - Consider a rule-based FX intervention mechanism with gradually widening tolerance thresholds and an asymmetric band allowing more intervention to accumulate reserves. - Central bank quasi-fiscal issues and coordination: - Legacy bank recapitalization bonds around 10 percent of GDP remain managed by the central bank. - Need stronger coordination between fiscal and monetary authorities on debt management and issuance term structure; legal and institutional arrangements for gradual recapitalization need strengthening. - Reserve adequacy: - Reserves cover about 60 percent of the Fund’s implied risk-based adequacy level. - Reserves have risen since the 2003–04 crisis and are broadly sufficient against standard benchmarks (short-term debt and import coverage) though below the Fund’s risk-weighted metric. - Current reserves projected to grow (GIR: 2015: 5,258; 2016: 5,645; 2017: 6,291; 2018: 6,973; 2019: 7,644; 2020: 8,248, in millions of US$). ### External sector, current account, and external debt dynamics - Current account and real exchange rate assessment: - Actual current account (a): -2.0% of GDP; Adjusted current account (b) 1/: -2.7%; Adjusted current account norm (c): -3.4%; Adjusted current account gap (e): 0.7%. - Headline 2.0 percent of GDP for 2015 implies a current account gap of 1.4 percent of GDP; after adjustment gap narrows to 0.7 percent. - Real exchange rate gap (REER): -4.3% (i.e., REER about 4 percent weaker than fundamentals and desired policies). - External debt and financing: - Restructuring with Petrocaribe lowered external debt from 38 percent of GDP in 2014 to an estimated 35 percent in 2015. - Baseline gross external debt (percent of GDP): 2015: 35.1; 2016: 34.2; 2017: 34.1; 2018: 34.6; 2019: 35.1; 2020: 35.7. - Gross financing needs projected to range between 6 and 7 percent of GDP over the medium term. - Non-debt creating flows expected to cover about one third of financing needs; remainder financed by rolling over existing debt and issuing some new debt. - A 30 percent real depreciation shock would raise medium term external debt to 52 percent by 2020. - Key external figures (selected): - Current account (US$ millions): 2015: -1,380; 2016: -1,574; 2017: -1,779; 2018: -2,202; 2019: -2,372; 2020: -2,772. - Exports f.o.b. (US$ millions): 2015: 9,782; 2020: 12,093. - Imports f.o.b. (US$ millions): 2015: -17,042; 2020: -22,398. - Travel receipts (US$ millions): 2015: 6,154; 2020: 8,398. - Gross international reserves (GIR, millions US$): 2015: 5,258; 2020: 8,248. - GIR in months of imports (excl. maquila): 2015: 3.6; 2020: 4.3. ### Electricity sector weaknesses, reforms, and investment needs - Sector problems and fiscal cost: - Distribution losses among highest in the region; tariffs fall short of costs; about half of clients are not metered; about half of electricity generated using fuel oil. - Annual deficits of 2–2½ percent of GDP in public electricity distribution and transmission sector (down to 1½ percent in 2015 due to lower oil prices). - Firms install own generators due to unstable supply, raising costs. - Investment and new plants: - Construction of two new coal plants estimated to cost about US$2 billion (3 percent of GDP), expected to enter operation in 2017. - Completion projected to increase coal share in generation matrix by about 11 percent, mainly by reducing fuel oil share. - Estimated additional investment needs in electricity sector: an additional ⅓–½ percent of GDP per year over the medium term. - Electricity Pact (policy package): - Aims to reduce electricity losses, gradually adjust tariffs to cost recovery, and ensure a stable regulatory framework to facilitate private investment. - National Pact started social consultation in 2015; authorities expect pact to be concluded in early-2016. ### Social inclusion, education, and structural reforms - Social and education priorities: - Per capita income at 25 percent of U.S. levels and 85 percent of average LAC levels (PPP terms). - Potential growth estimated at 4½–5 percent. - National Education Reform Pact (April 2014); pre-university education spending roughly doubled to 4 percent of GDP; teaching hours extended from 4 to 8. - Social safety nets and financial inclusion: - Strengthened targeting and coordination of assistance; major issue remains access to health and social security insurance by the informal sector (about half of the labor force). - Financial inclusion programs: institution of “bank agents” (about 2–3 thousand commercial entities), administration of social benefits through payment cards, public financial education. - Structural reform priorities: - Address electricity sector bottleneck; improve institutional quality and governance; complete Bankruptcy Law implementation; product and labor market reforms (rigid severance pay regulation, high transportation costs tied to unionization). ### Financial sector structure, risks, and AML/CFT considerations - Financial system structure and concentration: - Financial system assets about 55 percent of GDP; private sector credit-to-GDP around 30 percent. - High bank concentration: 78 percent of total assets held by 3 banks; in another summary the three main banks represented 67.7 percent of deposits and 69.0 percent of loans as of June 2015. - Commercial banks: 17 banks representing 85.8 percent of system assets; state-owned Banreservas holds a third of system assets in one boxed summary. - Financial soundness indicators (end-Sept 2015 highlights): - Regulatory capital to risk-weighted assets: 15.1. - NPLs to total loans: 1.5. - Loan growth (twelve-month percent change, 2015): 13.9. - Return on average assets (2015): 2.5. - Liquid funds to deposits (2015): 25.3. - Loan provisions to NPLs (2015): 185.5. - AML/CFT and nonbank supervision: - Supervision of nonbank intermediaries (credit unions) is weak and needs strengthening to meet the 2012 FATF standard. - Dominican Republic scheduled for assessment against the 2012 FATF standard in the second half of 2016. - Interest rate pass-through and policy implications: - Pass-through from policy rate to retail rates is complete; asymmetries exist: short-term lending rates respond faster to hikes; deposit rates respond faster to cuts. - Recommendation: enhance competition to reduce concentration and support symmetric pass-through; maintain coordination to develop domestic bond market. ### Macro-financial linkages, private sector FX positions, and concentration risks - NFPS external and currency positions: - Private sector holds a net creditor position of "6.7 percent of GDP against nonresidents and banks - the only two sectors to which it is exposed." - Position increases to "20.2 percent of GDP" when including multiple banks' claims on central bank reserves. - Short-term FX liabilities limited because short-term FX deposits are significantly larger than short-term FX liabilities. - Banks allowed open FX net position "up to 100 percent of capital." - Concentration and spillovers: - "56 percent" of total domestic lending to the NFPS comes from the largest bank; that bank holds "30 percent" of total system deposits. - A 30 percent depreciation estimated negative impact on NFPS of "1.7 percent of GDP"; larger sectoral losses shown in table excerpts. - Policy implication: monitor cross-sectoral exposures, reassess FX open position limits, and plan for adverse scenarios (e.g., 30 percent depreciation) given quantifiable impacts. - Table excerpts and quantifications preserved verbatim: - Loss/Gain rows (End-2014, in percent of GDP): Central bank 3.700.151.11; Nonfinancial public sector -27.53-1.10-8.26; Financial sector -0.25-0.01-0.07; Private sector Vis-à-vis financial sector 1/2.560.100.77; Vis-à-vis all sectors 2/6.750.272.02. ### Risk Assessment Matrix and past Fund advice - Major risks, likelihood and policy responses (selected): - Tighter or more volatile global financial conditions: Likelihood H; Impact M; Policy Response: fiscal restraint; shift to domestic financing; readiness to tighten monetary policy. - Sharper-than-expected global slowdown: Likelihood H (advanced)/M (emerging); Impact M; Policy Response: build buffers; structural reforms. - Persistently low energy prices: Likelihood H; Impact M; Policy Response: lock in lower electricity transfers; use savings to improve fiscal position and/or investment. - Discontinuation of Petrocaribe agreement: Likelihood H/M; Impact L; Policy Response: continue fiscal discipline. - Large exchange rate depreciation: Likelihood L; Impact H; Policy Response: fiscal consolidation and shift to domestic currency financing. - Past IMF advice and authorities’ actions: - Advice: continue fiscal consolidation; allow more exchange rate flexibility; resume central bank recapitalization per 2007 legislation; address electricity sector bottlenecks. - Authorities’ actions: significant consolidation through tax reform and expenditure restraint; exchange rate crawl of broadly 3-4 percent a year; recapitalization transfers remain below legislated levels; electricity sector efforts focused on diversifying energy matrix and reducing distribution losses. ### Debt Sustainability Analysis (DSA) and stress tests - Baseline realism and projections: - Gross debt estimated at 48.5 percent of GDP at end-2015. - Debt-stabilizing primary balance: 0.7 percent of GDP (not reached by 2020 under staff baseline). - Effective nominal interest rate on sovereign debt projected to increase from 3.7 percent in 2014 to 8.8 percent by 2020. - Sovereign spread (EMBI) as of January 07, 2016: 447 basis points; 10-year local currency bond yield as of October 9, 2015: 568 basis points. - Debt profile and vulnerabilities: - Some 55 percent of total gross debt held by non-residents; some 60 percent of total debt denominated in foreign currency. - Sovereign bond placements in January 2015 lengthened average maturity to around 10 years for total non-financial public sector debt. - Stochastic simulations and stress tests: - 75 percent probability that debt will be below 60 percent of GDP over the medium term under symmetric risk distribution. - Growth shock: debt ratio reaches 60 percent of GDP by end of projection horizon in growth-shock scenario. - Combined shock: debt exceeds 60 percent of GDP in 2019; combined shock yields average gross financing needs of around 11 percent of GDP over the medium term. - Key DSA headline projections (selected): - Nominal gross public debt (percent of GDP): 2013: 37.4; 2014: 48.3; 2015: 48.1; 2016: 48.5; 2017: 49.5; 2018: 50.7; 2019: 51.2; 2020: 52.1 (alternate 2020: 53.1). - Public gross financing needs (percent of GDP): 2013: 9.8; 2014: 8.7; 2015: 8.8; 2016: 8.5; 2017: 7.3; 2018: 8.3; 2019: 8.8; 2020: 9.7 (alternate 2020: 9.1). - PDVSA grant: some 3.1 percent of GDP; share of public debt held by non-residents: some 55 percent. *Italic: IMF staff report text as provided in content unit _cr16342* ### 1. Restructuring of the Petrocaribe Debt ___________________________________________________________7 ### 1. Restructuring of the Petrocaribe Debt ___________________________________________________________7 ### Summary of the restructuring operation - In January 2015, the Dominican Republic restructured its debt with Venezuela’s state-owned oil company PDVSA under the Petrocaribe agreement. - The government bought back US$4 billion of Petrocaribe debt at a discount of about 52 percent. - The operation was financed with a sovereign bond placement of US$2.5 billion of 10-year and 30-year maturities, of which US$1.9 billion was used to buy back the debt. - The new issuance terms cited in the source: US$1 billion 10-year bonds at 5.5 percent interest, and US$1.5 billion 30-year bonds at 6.85 percent interest. ### Fiscal impact and public debt implications - The buyback reduced public debt by US$2,094 million or 3.1 percent of GDP. - The Petrocaribe debt stock prior to the operation is indicated as 6.0 percent of GDP in the illustration. - The bonds issued to finance the buyback amounted to 2.9 percent of GDP in the illustration. - Despite the restructuring operation, the consolidated public sector debt is estimated to have increased marginally to 48½ percent of GDP in 2015 (text reference). - The headline fiscal deficit in 2015 reports a significant fiscal consolidation owing to the capital grant from the restructuring of the Petrocaribe debt (3.1 percent of GDP; Box 1). ### Net present value and cost comparison - Although the terms of the new issuance are not as favorable as the original Petrocaribe agreement (original: 25-year maturity, 2-year grace period at an interest rate of 1-2 percent), the government achieved savings of 12 percent in net present value terms, assuming a 6 percent discount rate. - With the operation, the country bought back some 98 percent of the debt accumulated with the PDVSA during 2005-14. ### Analysis and implications - The operation converted concessional, low-interest, long-maturity Petrocaribe exposures (1-2 percent interest, 25-year maturity, 2-year grace) into market-rate sovereign bonds (5.5 percent for 10-year, 6.85 percent for 30-year), while delivering immediate debt stock reduction and an NPV saving under the assumed discounting. - The restructuring produced a one-off fiscal effect in 2015 (capital grant equivalent of 3.1 percent of GDP), contributing to the reported headline fiscal consolidation for that year. - The net effect on consolidated public sector debt dynamics is nuanced: while the buyback reduced the nominal stock of Petrocaribe debt by US$2,094 million, issuance of sovereign bonds and higher future interest payment obligations imply a trade-off between immediate debt relief and longer-term debt service costs compared with the original Petrocaribe terms. ### Policy considerations and recommended focus areas (implied by the operation and surrounding analysis) - Continue to incorporate the fiscal and debt-service implications of the Petrocaribe restructuring into medium-term debt sustainability analysis and fiscal planning, given the change in maturity and interest-rate profile of public debt. - Preserve transparency in reporting one-off receipts and capital grants linked to such operations to allow clear distinction between underlying fiscal balances and headline fiscal outcomes. - Monitor external financing costs and public debt vulnerabilities as monetary policy normalizes internationally, since higher global rates would affect interest payments on newly issued sovereign debt. - Assess contingent exposures and sectoral needs (notably the electricity sector) that could exert upward pressure on public finances despite one-off debt restructuring gains. *Source: IMF staff report text as provided in content unit _cr16342 - 1. Restructuring of the Petrocaribe Debt ___________________________________________________________7* ### 14. The favorable cyclical conditions provide a good opportunity to pursue a more ### _cr16342 - 14. The favorable cyclical conditions provide a good opportunity to pursue a more ### Fiscal adjustment needs and scenarios - Staff estimates that an adjustment of around 1½ percent of GDP over one year is needed to stabilize debt at current levels. - An adjustment of 2-2½ percent of GDP over the next three years would put debt on a downward path towards reaching 40–45 percent of GDP by 2020. - The larger fiscal effort is desirable to: - Ensure more adequate buffers to safeguard debt sustainability against rising external risks. - Open additional fiscal space needed to reduce poverty, inequality, and infrastructure gaps (especially in the electricity sector). - Charted scenarios (as presented): - Historical, Baseline (Constant debt to GDP), More ambitious adjustment. ### Tax reforms and revenue mobilization - The tax base remains very narrow for the country’s level of income: - Tax ratio was about 14 percent of GDP in 2014 (excluding one-off revenues). - Tax expenditures accounted for 6½ percent of GDP. - Policy priority: widening the tax base with revenue mobilization focused on: - Substantively eliminating VAT and excise exemptions. - Rationalizing tax incentives. - Boosting personal income tax collections through lowering the tax threshold. - Distributional guidance: - Focus initially on eliminating exemptions for upper-income taxpayers, while maintaining exemptions aimed at protecting socially vulnerable groups. - Statistic on PIT coverage: - As a result of the relatively high income tax thresholds, only 14 percent of formal employment pays personal income taxes. ### Expenditure rationalization and electricity sector subsidies - Need to expand fiscal envelope while undertaking consolidation requires expenditure rationalization. - Key expenditure focus areas: - Reducing subsidies to the electricity sector. - Rationalizing spending on inefficient public institutions. - Improving quality of spending. - Electricity sector subsidies: - Averaged 2–2½ percent of GDP in recent years, falling to 1½ percent in 2015 due to lower oil prices. - Tariff adjustment recommendation: - Adjust tariffs to cost recovery levels (at least 11 percent higher than current tariffs, according to existing methodologies), or initially allow automatic tariff adjustment going forward to lock in recent savings. - Strengthen social safety nets simultaneously to mitigate effects on the most vulnerable. ### Medium-term fiscal framework and institutions - A credible medium-term fiscal framework would strengthen fiscal institutions. - Upcoming discussions of the fiscal pact (required by the national development strategy) provide an opportunity to: - Strengthen the fiscal policy framework. - Potentially transition to a rule-based framework as a medium-term fiscal policy anchor. - Design note: - Rule-based framework would need to rely on simple rules allowing flexibility to absorb cyclical fluctuations. ### Authorities’ views on fiscal policy - Authorities reiterated commitment to fiscal discipline and noted considerable consolidation since 2012. - Fiscal pact deferred to next administration due to elections and ongoing electricity pact discussions; authorities view it as important to medium-term fiscal strategy. - Authorities recognize need to increase revenue to address debt sustainability and narrow fiscal envelope. - Electricity sector and quasi-fiscal deficit of the central bank remain important drivers of consolidated public sector debt dynamics. - Authorities emphasize resolving electricity sector challenges and strengthening arrangements for central bank recapitalization and management of the quasi-fiscal deficit. - Authorities affirmed commitment to fiscal discipline and to the targets set out in the 2016 budget. ### Monetary policy stance and framework - Current neutral monetary policy stance is appropriate; vigilance required against risks of higher inflation. - Inflation expected to return to the target by end-2016. - Widening positive output gap, tightening labor markets, and possible depreciation pressures merit vigilance. - Staff welcomed central bank’s tightening bias and readiness to tighten if stronger-than-anticipated inflationary pressures emerge. - Exchange rate policy recommendations: - Allow greater exchange rate flexibility to strengthen credibility of the inflation targeting regime and absorb external shocks. - Authorities intend to introduce an electronic trading platform in 2016 and develop foreign exchange hedging instruments to support a gradual move toward more exchange rate flexibility. - Consider a rule-based foreign exchange intervention mechanism with gradually widening tolerance thresholds and an asymmetric band allowing more intervention to accumulate reserves. - Monetary policy and quasi-fiscal deficits: - Legacy bank recapitalization bonds are around 10 percent of GDP and remain managed by the central bank along with domestic liquidity. - Need for stronger coordination between fiscal and monetary authorities to ensure more efficient public debt management. - Coordination on term structure of bond issuances (including focusing monetary liquidity management issuances on shorter-term instruments) would help deepen maturity buckets, develop domestic bond markets, and reduce financing costs. - Legal and institutional arrangements for gradually recapitalizing the central bank need strengthening to ensure continued transfer of bank recapitalization costs to fiscal authorities and promote unified public debt management. ### Authorities’ views on monetary policy - Authorities broadly agreed with staff’s assessment and reiterated commitment to price stability and strengthening the inflation targeting framework. - Authorities are closely monitoring external and domestic developments and adopting a neutral-to-tight monetary policy bias. - On exchange rate flexibility, current efforts focus on strengthening market infrastructure given fairly dollarized balance sheets. - Both central bank and fiscal authorities recognize current recapitalization arrangements are not effective and are analyzing alternatives, including transfer size consistency with fiscal envelope, speed of recapitalization, and accountability for managing fiscal resources. ### External sector and reserve buffers - Current account and real exchange rate broadly in line with medium-term fundamentals and desired policy setting. - Lower oil prices strengthened the external balance above its predicted value based on medium-term fundamentals and current policies. - Adjusting for partial recovery of oil prices over the medium term and desired policies, the gap between actual current account and predicted value narrows significantly. - EBA-Lite 2015 current account and REER gaps (as presented): - Actual current account (% GDP) -2.0% - Adjusted current account (% GDP) 1/-2.7% - Medium term current account (% GDP) -3.1% - Current account norm (% GDP) -3.4% -3.0% - Current account gap (% GDP) 0.7% - Real exchange rate gap (+ is over-valuation) -4.3% -2.9% 0.6% - (Note: 1/ Adjusted for the partial recovery of oil prices over the medium term.) - Reserve adequacy: - Reserves have risen significantly since the 2003–04 financial crisis and are broadly sufficient against standard benchmarks (short-term debt and import coverage). - Despite improvements, continued foreign exchange interventions prevented faster accumulation of reserves. - Current reserves cover about 60 percent of the Fund’s implied risk-based adequacy level. - Dominant share of public debt in long-term external liabilities (about half owed to official creditors) and diverse foreign exchange inflows mitigate the need for very high reserves. ### Authorities’ views on external resilience - Authorities concurred with staff’s external assessment and committed to continue accumulating reserves and enhancing resilience to shocks. - Authorities noted further reserve accumulation is needed but faster accumulation is constrained by high sterilization costs. ### Reforms for sustainable and more inclusive growth - Rapid improvement in living standards requires sustaining high growth and making it more inclusive. - Per capita income remains at 25 percent of U.S. levels and 85 percent of the average LAC levels, in PPP terms. - Potential growth estimated at 4½–5 percent may not be sufficient for fast convergence and substantial poverty reduction. - Key reform areas to boost potential: - Electricity sector reforms (main bottleneck). - Address infrastructure gaps: investment needs in electricity sector estimated at an additional ⅓–½ percent of GDP per year over the medium term. - Strengthen institutional quality and governance to close gaps with regional peers. - Bankruptcy reform: recently adopted Bankruptcy Law aims to improve business restructuring, reduce time and costs, and improve recovery rates. - Product and labor market reforms: address rigid severance pay regulation and high transportation costs driven by strong unionization. ### Electricity sector: issues, recent actions, and the Electricity Pact (Box 2) - Main points on sector weaknesses: - Distribution losses remain among the highest in the region. - Tariffs fall short of costs. - Contributing factors: insufficient investments in the distribution grid; governance weaknesses at state-owned distribution companies; high share of unbilled energy (about half of clients are not metered); a relatively unfavorable energy matrix with about half of total electricity generated using fuel oil. - Annual deficits of 2–2½ percent of GDP in the public electricity distribution and transmission sector (down to 1½ percent in 2015 due to lower oil prices), covered with fiscal transfers or accumulation of arrears to private generators. - Unstable supply and blackouts lead firms to install their own generators, raising costs. - New power plants: - Construction of two new coal plants estimated to cost about US$2 billion (3 percent of GDP), expected to enter operation in 2017. - Completion projected to increase the share of coal in generation matrix by about 11 percent, mainly by reducing fuel oil share. - Despite collapse in world oil prices reducing expected savings, savings remain under current commodity price outlook and diversified energy matrix provides protection against future oil price volatility. - Electricity Pact: - National Pact to Reform the Electricity Sector started social consultation in 2015; expected to entail a comprehensive package to: (i) reduce electricity losses through distribution investments; (ii) gradually adjust tariffs to cost recovery; and (iii) ensure a stable and predictable regulatory framework to facilitate private energy investments. - Authorities expect the pact to be concluded in early-2016. ### Social inclusion, education, and financial inclusion priorities - Social inclusion and poverty alleviation are government priorities; additional fiscal space needed to safeguard spending. - Education: - National Education Reform Pact agreed in April 2014. - Spending on pre-university education roughly doubled to 4 percent of GDP to support school building, extend teaching hours (from 4 to 8), and improve learning outcomes. - Reforms expected to boost labor participation, particularly for female workers. - Social safety nets: - Strengthened with better-targeted, categorized, and coordinated assistance for the most vulnerable. - Major remaining issue: access to health and social security insurance by the informal sector (including self-employed), which accounts for about half of the labor force. - Financial inclusion: - Gaps pronounced at household level: inadequate number of bank accounts in lower-income segments, low usage of debit cards and ATMs. - Authorities’ programs to promote inclusion: - Institution of “bank agents” (currently about 2–3 thousand commercial entities providing limited services on behalf of financial institutions). - Administration of social benefits through payment cards to promote inclusion. - Programs for financial education of the public and the press. *International Monetary Fund — Dominican Republic staff report excerpt* ### 27. Authorities’ views. The authorities largely concurred with staff’s view on the economy’s ### 27. Authorities’ views ### Authorities’ assessment of the economy and competitiveness - Largely concurred with staff’s view on the economy’s potential and the need to continue structural reforms. - Noted strong foreign direct investment flows as attesting to a favorable business environment. - Reiterated commitment to continue actions aimed at strengthening competitiveness. - Highlighted the setup of the joint private-public Competitiveness Roundtable in May 2014, aimed at identifying policy measures to improve competitiveness and strengthen the overall business environment. - Agreed that key challenges remain in the electricity sector and pointed out that the Electricity Pact will aim to address them. - Emphasized that reducing poverty and making growth more inclusive continues to be one of the key socio-economic challenges and remains very high on their policy agenda. ### Safeguarding financial stability and promoting financial development — staff observations - Staff welcomed the strengthening of the financial system and its supervision but noted that pockets of vulnerability remain. - Authorities have strengthened the bank supervisory and regulatory framework, including: - continued work towards implementation of Basel core principles, - risk-based supervision, - thematic reviews of bank risks, and - institutional reforms; efforts to further advance progress in these areas continue. - While the financial position of banks is strong, pockets of rapid credit growth, especially in foreign currency, merit close monitoring. - Regulation and supervision of nonbank intermediaries, in particular credit unions, is weak; although the system is very small according to available data, it is closely interlinked with banks through ownership channels and some institutions are as large as banks. - The financial system has remained largely unaffected by the withdrawal of certain financial services by global banks (“de-risking”), with only smaller financial services institutions impacted. ### AML/CFT and nonbank supervision risks - Weaknesses in nonbank supervision could create challenges for compliance with anti-money laundering (AML)/combating the financing of terrorism (CFT) standards. - Since the previous FATF assessment in 2006, the authorities have taken steps to strengthen the AML/CFT framework and supervision, and are working to address weaknesses in the supervision of nonbank intermediaries. - These efforts will need to be supported by bringing the AML/CFT supervisory framework in line with the 2012 FATF standard, notably with respect to nonbank supervision, and by strengthening the financial intelligence unit. - The Dominican Republic is scheduled to undergo an assessment against the 2012 FATF standard in the second half of 2016. ### Financial deepening and structure — key statistics and observations - Strong economic growth has not fully translated into development of financial institutions and markets. - The country scores low on financial deepening indicators compared to the region, and is one of the least financially-developed in LAC. - Private sector credit-to-GDP ratio increased only marginally over the past decade and is still well below the 2003 pre-crisis level at 30 percent. - Fall 2015 Regional Economic Outlook findings cited: - High bank concentration: 78 percent of total assets is held by 3 banks. - Poor score on efficiency of financial institutions, as captured through non-interest income and net interest margins. - High concentration is also reflected in asymmetric, albeit well-functioning, pass-through from changes in monetary policy rates to retail rates: short-term lending rates respond faster to policy rate hikes and deposit rates respond faster to policy rate cuts. ### Authorities’ views on financial sector soundness and AML/CFT - Reiterated commitment to safeguarding the soundness of the financial system. - Stated that the intensive supervision program resulted in improved bank capitalization. - Indicated close monitoring of the quality of the loan portfolio and provisioning levels in the context of robust credit growth. - Stressed commitment to further strengthen Banreservas and increase the paid-in capital by capitalizing future profits. - Pointed out that—despite rapid foreign currency credit growth in some sectors—foreign currency loans can only be extended to borrowers with foreign currency earnings, minimizing credit risk. - Indicated consideration of plans to address deficiencies in AML/CFT compliance by nonbanks and other private sector activities in the real sector. ### Boxed summary: Financial system structure since 2003 crisis — selected points - Financial system is small, dominated by banks and highly concentrated; financial system assets account for about 55 percent of GDP. - Commercial banks: - Banking system very concentrated: some 78 percent of total assets in three banks and a third in the state-owned Banreservas. - Presence of foreign banks increased since 2008: now 7 out of 17 banks are foreign-owned; their share remained relatively low at 10 percent of total banking system. - Other deposit-taking institutions represent 10 percent of total financial system (saving banks, saving and loan associations, credit cooperatives). - Pension funds: - Fastest growing segment; reformed in 2003 with mandatory savings. - Funds mostly invest in public debt securities; investment in corporate bonds is only 5 percent of the pension funds’ portfolio. - Current regulations do not allow pension funds to invest abroad. - Insurance sector small and concentrated: system represents only 2 percent of total financial system, with the largest five companies (out of 31) composing 78 percent of the market. - Capital markets underdeveloped: no equity markets; corporate debt market very small; only bond issues from seven companies were traded in the market in 2014; central bank certificates and government papers are the main securities traded. ### Staff appraisal — macroeconomic outlook and policy priorities - Economic activity maintains strong momentum, aided by a favorable external environment and a strengthened policy framework; domestic demand is the main growth engine, supported by employment expansion, robust credit growth, lower oil prices, and U.S. recovery. - Inflation remained low, the current account deficit contracted, and key social indicators improved. - Implementation of sound policies underpinned strong performance; the inflation targeting framework has been successful at maintaining inflation expectations around the official target range in the face of positive supply shocks. - Going forward, as some external tailwinds dissipate, the economy is expected to slow to its potential growth of 4½–5 percent. - Major policy challenges and recommendations: - Fiscal: Fiscal sustainability and social spending pressures require renewed attention. Over the medium-term, public debt is set to rise due to large consolidated deficits; need to expand the narrow tax base eroded by tax exemptions and incentives; tackle inefficient spending, including on generalized electricity subsidies; further strengthen the fiscal framework by anchoring annual policy decision-making to sustainability objectives and improving the quality of spending; reduce reliance on foreign currency borrowing and develop the domestic bond market in coordination with the central bank. - Monetary: Monetary policy stance is appropriate in guiding inflation back to target range; a strengthened framework could further improve policy effectiveness. Tightening bias is appropriate given the strong outlook and waning supply shocks. Transition towards more exchange rate flexibility and continued buildup of reserves will increase resilience. Need increased coordination with fiscal authorities to manage monetary policy and legacy quasi-fiscal debts and to avoid overlap between issuers in developing local bond markets and firming up recapitalization arrangements. - Financial sector: Resilience of the financial system has been strengthened; regulatory reform agenda needs further advancement towards best international practice; pockets of rapid credit growth warrant monitoring; supervision of non-bank financial intermediaries remains weak, and vigilance is needed against risks, especially those related to potential AML/CFT activities. - Structural: Sustaining strong growth and making it more inclusive requires reforms in education, strengthening social safety nets, and promoting financial inclusion; addressing long-standing problems in the electricity sector is key (significant upgrades to public distribution networks, move towards cost recovery pricing, reducing regulatory uncertainty); foster stronger investment climate to narrow infrastructure gaps; increase product market competition and labor market flexibility to strengthen competitiveness. *International Monetary Fund—Staff report extract (content unit: Authorities’ views).* ### 37. Staff proposes that the next Article IV Consultation take place on the standard 12- ### _cr16342 - 37. Staff proposes that the next Article IV Consultation take place on the standard 12- ### Article IV timing - Staff proposes that the next Article IV Consultation take place on the standard 12-month cycle. ### Recent economic developments and activity - Real GDP growth: 2012: 2.6; 2013: 4.8; 2014: 7.3; 2015: 7.0; 2016: 5.4; 2017: 4.5; 2018: 4.5; 2019: 4.5; 2020: 4.5 (annual percentage change). - Monthly Economic Activity Index (IMAE): charted as year-on-year percent change (visual series shown). - Output placed an estimated "1½ percent" above potential levels. - Demand drivers: vibrant consumption and investment. - Supply-side pick-up: services and industries. - Tourism: strong rebound in tourism arrivals, particularly associated with the U.S. recovery. - Real credit growth (rhs in chart) correlated with Real GDP growth (visual). - US tourists arrivals & US Real GDP (RHS): visual series indicating positive relationship. - Contributions to GDP growth (percent) by component (visual series for 2008–2014): Net exports, Investment, Consumption, Real GDP. - Sector contributions (percent) by Services, Industries, Agriculture, Other (visual series for 2008–2014). - Labor market: Employment Rate, Labor Force Participation, Unemployment Rate plotted (2007–2015); unemployment started to decline amid a steady increase in labor participation. - Job creation: central government, services, industry, agriculture job-creation series (number of jobs created in thousands; unemployment in percent) for 2010–2015 (visual). - Shares in world exports and tourism arrivals increased (Share of world exports and Share of tourist arrivals (RHS) 2007–2015 indexed). - Productivity and wages: - Private Sector: Wages and Productivity index (Index=100, 2007) with series through 2015(p). - Public Administration: Real wages increased strongly despite declining productivity (Index=100, 2007; series through 2015(p)). - Cost Competitiveness: Unit labor costs and labor productivity index (Index=100, 2007; series through 2015(p)). ### Monetary developments and policy - Inflation: - Consumer price inflation (end of period): 2012: 3.9; 2013: 3.9; 2014: 1.6; 2015: 2.3; 2016: 4.0; 2017: 4.0; 2018: 4.0; 2019: 4.0; 2020: 4.0 (period average and end-of-period listed in Table 1). - Both headline and core inflation dropped below the target range, mainly as a result of declining oil prices; expectations for end-2016 remain anchored within the target range. - Interest rate policy: - Interest rates were cut by "150bp" in early 2015 in response to softening inflation. - Reserve requirements shown (percentage) and interest rates (15-day moving average) plotted (visual). - FX market: - Interventions in the exchange rate market continued by way of smoothing fluctuations in a thin market (FX market weekly intervention by BCRD in Millions of USD; pesos per USD). - Given the close crawl against the U.S. dollar, the peso appreciated somewhat in real effective terms; series shown with US Nominal Effective Exchange Rate and DR Real Effective Exchange Rate (Indexes, January 2010 = 100). - Financial conditions: - Financial Condition Index components plotted: REER, Interest rate, FCI (visual). ### Monetary and financial sector developments - Gross international reserves (GIR), actual in US$ billion and 12-month average in US$ billion, plotted (Sep-11 to Sep-15); 3-month import coverage and risk-weighted metric shown. - Despite interventions, central bank reserves continued to increase; however, reserves remain below the Fund’s risk-weighted reserve metrics that requires coverage for long-term liabilities. - Banks’ net foreign asset position remained slightly negative in recent years; asset growth offset by rapid increase in borrowing from abroad. - Credit dynamics: - Credit to the private sector (y-o-y percent change) series for Total, Domestic currency, FX (in U.S. dollar terms) for 2010–2015. - Credit to the private sector and deposits (In billions of pesos) series from Nov-02 to Nov-15 (visual). - Credit growth concentrated in foreign currency and largely at the public bank; financial dollarization increased only moderately as bulk of credit growth financed by increase in private deposits. - Banking system summary (Table 4 highlights): - Net foreign assets (in millions of US$) for the banking system (residency basis): 2012: 1,918; 2013: 3,275; 2014: 3,968; 2015: 4,736; 2016(proj): 5,252. - Net foreign assets (alternative series) in millions of US$: 2012: 1,870; 2013: 3,109; 2014: 3,717; 2015: 4,074; 2016(proj): 4,706. - Credit to the private sector (y-o-y percent): 2012: 5.8; 2013: 15.0; 2014: 19.5; 2015: 12.3; 2016(proj): 9.1. - M3: 2012: 9.4; 2013: 13.5; 2014: 11.8; 2015: 11.3; 2016(proj): 9.7 (percent change, y-o-y). - Financial Soundness Indicators (Table 6 highlights, Sep 2008–2015): - Regulatory capital to risk-weighted assets (end-Sept 2015 value): 15.1 (value for 2015 is as of end-Sept). - NPLs to total loans (2015): 1.5. - Loan growth (twelve-month percent change, 2015): 13.9. - Return on average assets (2015): 2.5. - Liquid funds to deposits (2015): 25.3. - Loan provisions to NPLs (2015): 185.5. ### Fiscal developments and public finances - Fiscal stance and revenues: - Controlling for the Petrocaribe grant, fiscal stance expected to be neutral in 2015, partly owing to slowing revenue collection. - Total revenue and grants (percent of GDP): 2014: 13.6; 2015: 14.6; 2016: 15.1; 2017: 14.8; 2018: 14.5; 2019: 14.5; 2020: 14.3 (Table 2). - Tax revenues (percent of GDP): 2014: 13.1; 2015: 13.9; 2016: 14.0; 2017: 13.7; 2018: 13.7; 2019: 13.6; 2020: 13.4. - Marginal revenue gains from the 2012 tax reform charted (In percent of GDP; series for 2013–2015 Proj.). - Expenditure composition and trends: - Central Government Expenditure index (relative to 2012 values) plotted for components including Wages and salaries, Goods and services, Electricity transfers, Other transfers, Capital expenditure, Interest. - Since 2012, expenditure on wages and salaries has grown steadily, exceeding growth of some other countries in the region, despite relatively low levels. - Wages and salaries (percent of GDP): Table 2 shows Wages and salaries 2014: 3.7; 2015: 4.1; 2016: 4.6; 2017: 4.9; 2018: 4.2; 2019: 4.2; 2020: 4.2. - Electricity transfers (percent of GDP): 2014: 1.5; 2015: 1.4; 2016: 1.4; 2017: 0.9; 2018: 1.0; 2019: 1.1; 2020: 0.9. - Balances and debt: - Central government overall balance (percent of GDP): 2014: -6.4; 2015: -2.8; 2016: -2.6; 2017: 0.6; 2018: -2.5; 2019: -3.0; 2020: -3.0. - Consolidated public sector balance (percent of GDP): 2014: -7.7; 2015: -5.0; 2016: -4.5; 2017: -1.3; 2018: -5.0; 2019: -5.1; 2020: -4.6 (Table 1 and Table 2). - Consolidated public sector debt (percent of GDP): 2014: 43.5; 2015: 48.3; 2016: 48.1; 2017: 48.5; 2018: 49.5; 2019: 50.7; 2020: 51.2 (Table 1). - Share of foreign currency debt: significant (chart NFPS Debt by Currency shows US$, RD$, Other; visual for 2009–2015 (June)). - Central government interest expenditure (percent of GDP): 2014: 2.4; 2015: 2.3; 2016: 2.5; 2017: 2.9; 2018: 2.9; 2019: 3.0; 2020: 3.1 (Table 1). - Quasi-fiscal balance of the central bank (percent of GDP): 2014: -1.1; 2015: -1.4; 2016: -1.5; 2017: -1.4; 2018: -1.4; 2019: -1.3; 2020: -1.2. - Fiscal projections in nominal terms (Table 3, In billions of Dominican pesos): - Consolidated public sector debt (mem. item): 2012: 1,034; 2013: 1,236; 2014: 1,341; 2015: 1,474; 2016: 1,640; 2017: 1,824; 2018: 2,003; 2019: 2,215; 2020: 2,456. - Nominal GDP (DR$ billion): 2014: 2,378; 2015: 2,559; 2016: 2,786; 2017: 3,036; 2018: 3,312; 2019: 3,600; 2020: 3,912; 2021: 4,252; 2022: 4,621 (Table 1 and Table 3). ### External sector and balance of payments - Current account (US$ millions): 2012: -3,971; 2013: -2,537; 2014: -2,026; 2015: -1,380; 2016: -1,574; 2017: -1,779; 2018: -2,202; 2019: -2,372; 2020: -2,772 (Table 5). - Current account (percent of GDP): 2012: -6.6; 2013: -4.1; 2014: -3.2; 2015: -2.0; 2016: -2.2; 2017: -2.4; 2018: -2.8; 2019: -2.8; 2020: -3.1. - Trade balance (US$ millions): 2012: -8,738; 2013: -7,377; 2014: -7,369; 2015: -7,260; 2016: -7,724; 2017: -8,378; 2018: -8,881; 2019: -9,577; 2020: -10,306. - Exports f.o.b. (US$ millions): 2012: 8,936; 2013: 9,424; 2014: 9,920; 2015: 9,782; 2016: 10,097; 2017: 10,551; 2018: 10,979; 2019: 11,499; 2020: 12,093. - Of which: gold (US$ millions): 2012: 175; 2013: 1,191; 2014: 1,541; 2015: 1,187; 2016: 1,215; 2017: 1,179; 2018: 1,098; 2019: 1,056; 2020: 1,018. - Imports f.o.b. (US$ millions): 2012: -17,673; 2013: -16,801; 2014: -17,288; 2015: -17,042; 2016: -17,821; 2017: -18,929; 2018: -19,860; 2019: -21,076; 2020: -22,398. - Of which: oil and gas (US$ millions): 2012: -4,810; 2013: -4,352; 2014: -3,866; 2015: -2,452; 2016: -2,133; 2017: -2,537; 2018: -2,871; 2019: -3,193; 2020: -3,449. - Services and transfers (net) (US$ millions): 2012: 3,909; 2013: 4,147; 2014: 4,326; 2015: 4,651; 2016: 4,921; 2017: 5,228; 2018: 5,496; 2019: 5,960; 2020: 6,341. - Travel receipts (US$ millions): 2012: 4,687; 2013: 5,064; 2014: 5,637; 2015: 6,154; 2016: 6,562; 2017: 7,011; 2018: 7,419; 2019: 7,875; 2020: 8,398. - Financial account (US$ millions): 2012: -3,596; 2013: -4,149; 2014: -3,305; 2015: -1,409; 2016: -2,043; 2017: -2,391; 2018: -2,848; 2019: -3,006; 2020: -3,336. - Foreign direct investment, net (US$ millions): 2012: -3,142; 2013: -1,991; 2014: -2,209; 2015: -2,157; 2016: -2,146; 2017: -2,265; 2018: -2,390; 2019: -2,521; 2020: -2,660. - Gross international reserves (GIR in millions of U.S. dollars): 2012: 3,559; 2013: 4,701; 2014: 4,862; 2015: 5,258; 2016: 5,645; 2017: 6,291; 2018: 6,973; 2019: 7,644; 2020: 8,248. - GIR in months of imports (excl. maquila): 2012: 2.6; 2013: 3.4; 2014: 3.5; 2015: 3.6; 2016: 3.7; 2017: 3.9; 2018: 4.1; 2019: 4.2; 2020: 4.3. ### Structural and competitiveness indicators - Global Competitiveness Index (overall, Index 1–7): Dominican Republic trends shown for 2010-11 and 2014-15; competitiveness hampered by insufficiencies in education, infrastructure, and innovation capacity (visual). - Doing Business indicators (Index 0–100): Starting a Business, Dealing with Construction Permits, Getting Electricity, Registering Property, Getting Credit, Protecting Minority Investors, Paying Taxes, Trading Across Borders, Enforcing Contracts, Resolving Insolvency — Doing Business overall DTF and Global Competitiveness Index overall plotted for 2010 and 2015; overall position only marginally improved. - Competitiveness constraints listed textually in visuals: - Insufficiencies in education, infrastructure, and innovation capacity. - Business climate held back by inefficient electricity sector and weak insolvency resolution framework. ### Key socio-economic indicators (Table 1 highlights) - Population (millions, 2014 estimate): 9.9. - GDP per capita 2014 (U.S. dollars): 6,481. - Quota (218.9 millions SDRs / 0.09% of total). - Poverty (2014, share of population): 35.5. - Extreme poverty (2014, % of pop.): 7.2. - Main export products: tourism, textiles, gold. - Key export markets: U.S. and Canada. - Adult literacy rate (percent, 2014): 91. ### Select banking and financial aggregates (Table 4 highlights) - Banking system net foreign assets (in millions of US$) (residency basis): 2012: 1,918; 2013: 3,275; 2014: 3,968; 2015: 4,736; 2016(proj): 5,252. - Credit to the private sector (In billions of pesos, cumulative series): Credit and deposits series plotted (visual). - M3 (In billions of pesos, series): M3 2012: 962.8; 2013: 1,092.7; 2014: 1,222.1; 2015: 1,360.5; 2016(proj): 1,492.9. *Italic: Sources as presented in the content unit (BCRD, WEO database, UN Comtrade, CTO, National Labor Force Survey, IMF Monetary and Financial Statistics database, country authorities, Fund staff calculations and estimates).* ### Annex I. Risk Assessment Matrix and Past Fund Advice ### Annex I. Risk Assessment Matrix and Past Fund Advice ### Risk Assessment Matrix — major risks, likelihood, impact, effect, and policy response - Tighter or more volatile global financial conditions - Likelihood: H - Impact: M - Effect: Reduction in capital inflows or an increase in capital outflows; higher financing costs; pressures on the exchange rate - Policy Response: Fiscal restraint; shift to domestic financing sources; readiness of monetary authorities to tighten policy if needed - Sharper-than-expected global growth slowdown, in particular through structurally weak growth in key advanced and emerging economies - Likelihood: H (advanced economies)/M (emerging markets) - Impact: M - Effect: Reduction in exports, tourism receipts, and remittances. Subsequently, lower economic activity and fiscal receipts - Policy Response: Build external and fiscal buffers to safeguard macroeconomic stability; structural reforms to improve competitiveness - Persistently low energy prices - Likelihood: H - Impact: M - Effect: Higher real income, boosting demand and output - Policy Response: Lock in lower transfers to the electricity sector, use savings to improve fiscal position and/or enhance needed productive public investment - Reopening of U.S.-Cuba relations and geopolitical aspects - Likelihood: H - Impact: M/L - Effect: Stronger relationships between U.S. and Cuba can divert tourism and exports. Ban on overland imports of products to Haiti can result in a decline of exports and output - Policy Response: Structural reforms to improve competitiveness both in the tourism and other export-oriented sectors - Discontinuation of Petrocaribe agreement - Likelihood: H/M - Impact: L - Effect: Reduction in favorable fiscal financing - Policy Response: Continue commitment to fiscal discipline - Large exchange rate depreciation - Likelihood: L - Impact: H - Effect: Deterioration of the net financial position of the public sector arising from large currency mismatches - Policy Response: Fiscal consolidation and shift to domestic currency financing - Note on RAM interpretation: - “low” indicates a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent. - The RAM shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). Non-mutually exclusive risks may interact and materialize jointly. ### Past Fund advice and authorities’ actions - Key areas of past IMF advice: - Continue fiscal consolidation to put debt on a sustainable downward path - Allow additional exchange rate flexibility by limiting interventions only to counter disorderly market conditions - Resume the recapitalization of the central bank at levels envisaged in the 2007 legislation - Address bottlenecks in the electricity sector - Authorities’ actions and outcomes: - Undertook significant consolidation through tax reform and expenditure restraint over the past three years, halving the central government deficit to 2⅔ percent. - The exchange rate continues to depreciate at a broadly 3-4 percent a year crawl vis-à-vis the U.S. dollar, with interventions on both sides of the market. - Recapitalization transfers remain below levels envisaged in the legislation, in part due to the limited fiscal envelope. - Efforts in the electricity sector focused on diversifying the energy matrix and reducing distribution losses; substantive reforms depend on outcomes of ongoing discussions of the electricity pact. *Source: _cr16342 - Annex I. Risk Assessment Matrix and Past Fund Advice* ### Annex II. Macroeconomic Impact of the Decline in Oil Prices ### Overview - The decline in world oil prices since mid-2014 represented a positive terms-of-trade shock for the Dominican Republic as a net oil importer. - Four key areas of macroeconomic gains: stronger economic activity, lower inflation, fiscal savings, and an improvement in the external position. ### Economic activity — channels and estimated impact - Channels: - Domestic demand: Increased real disposable income boosted private consumption to the extent it was not fully saved; a considerable share leaked out through higher imports but net impact estimated positive. - Supply: Lower production and transportation costs boosted corporate profits, expanded productive capacity, increased investment, and indirectly supported credit activity. - External demand: Main export destinations and key tourism source markets are generally net oil importers; thus overall external demand likely improved for Dominican goods and services. - Staff empirical estimates: - Based on regression analysis, VAR, and a structural model, assuming private consumption, private investment, and import shares do not significantly deviate from the last five years’ trend. - Staff estimates suggest that the 47 percent drop in oil prices in 2015 has added about 0.6–0.7 percentage points to economic growth in 2015. - Alternative techniques are typically centered on 0.6–0.7 percentage points higher growth, with the upper bound at 1 percentage point. ### Inflation — estimated effects - Direct transmission through fuels, transport, and household costs where pass-through is fast and substantial. - Second-round effects via retail, logistics, and distribution channels affected core and headline inflation. - Staff estimates: - Drop in global oil prices lowered domestic headline inflation by about 1-1¼ percentage points through end-2015, mainly through lower fuel, transport, and household costs. - Core inflation about 0.4 percentage points lower due to second-round effects. - Pass-through note: - The pass-through from international fuel prices to the reference fuel import prices used in final consumer fuel price calculation is almost complete with a lag of less than two weeks. - Reference fuel import prices represent about 40 percent of overall final consumer fuel prices; the rest is determined mainly by fixed taxes, charges, and margins. ### Fiscal position — channels and quantified effects - Exposure channels: - Ad valorem components of fuel taxes - Financing under the Petrocaribe agreement - Overall deficit of the public electricity sector - Net effect in 2015: - Overall improvement of the fiscal position of about 0.4 percent of GDP in 2015 (electricity sector savings more than compensated for revenue and interest losses). - Details: - Ad valorem fuel taxes: - Ad valorem fuel taxes represent about 16 percent of the import fuel price. - Staff estimates direct fiscal revenue loss in 2015 was about 0.2 percent of GDP. - Petrocaribe financing: - Dominican Republic has received long-term financing at interest rates significantly below market levels under Petrocaribe since 2005. - Petrocaribe financing has been considerably less important for the Dominican Republic than for other countries in the region and has not been earmarked for specific social projects. - Staff estimates substituting Petrocaribe financing with costlier sources may imply higher annual interest costs for the public sector of up to 0.03–0.04 percent of GDP. - Electricity sector savings: - Oil fuels account for about half of total electricity generation. - Staff estimates the 47 percent drop in oil prices in 2015 reduced the deficit of the electricity sector by about 0.6 percent of GDP. - Lower deficit allowed avoidance of further accumulation of arrears to private generators, reduction of current arrears, and lower expected fiscal transfers in 2015. ### External position — quantified effects - Oil import bill: - Higher oil import volumes in H1 2015: 18 percent jump in volumes (higher-than-initially-projected). - Staff estimates a decline in the value of oil imports from 5.6 percent of GDP in 2014 to 3.4 percent of GDP in 2015. - Current account: - Oil import bill savings are estimated to have directly contributed to an improvement in the current account of about 2.2 percent of GDP. *Source: _cr16342 - Annex II. Macroeconomic Impact of the Decline in Oil Prices* ### Annex III. External Sector Assessment — summary findings - Current account and real exchange rate: - The current account and real exchange rate are broadly in line with medium-term fundamentals and desired policy settings. - While recent current account improvements have strengthened the external balance, the cyclically adjusted current account balance is close to its norm. - According to the EBA-lite current account panel regression the estimated adjusted current account norm for 2015 is -3.4 percent of GDP which accounts for a slight policy gap of -0.4 percent of GDP. - External financing and reserves: - Persistent current account deficits, financed through foreign direct investment (FDI) flows and to a lesser extent public external debt accumulation, continue to deteriorate the net international investment position. - Reserves remain well below the Fund’s risk-weighted adequacy metric. *Source: _cr16342 - Annex III. External Sector Assessment* ### 2.0 percent of GDP for 2015 suggests a current account gap of 1.4 percent of GDP. However, most ### _cr16342 - 2.0 percent of GDP for 2015 suggests a current account gap of 1.4 percent of GDP. However, most ### Current account assessment - Actual current account (a): -2.0% - Adjusted actual current account (b) 1/: -2.7% - Fitted current account (g): -3.8% - Residual = (a)-(g) (h): 1.8% - Adjusted current account norm = (g) - (i) -3.4% (c) - Adjusted current account gap = (b)-(c) (e): 0.7% - Combined policy gap (i)/(j)+(k)+(l): -0.4% - Policy components: - Fiscal policy (j): -0.6% - Change in GIR (k): -0.1% - Private credit to GDP (l): 0.2% - Assuming an exchange rate elasticity of 16 percent (f): -15.7% - Real exchange rate gap = (e)/(f): -4.3% - Narrative findings: - The headline 2.0 percent of GDP for 2015 implies a current account gap of 1.4 percent of GDP; after adjusting for the partial recovery of oil prices over the medium term the estimated gap narrows to 0.7 percent of GDP, indicating the actual current account is broadly in line with fundamentals and desired policy settings. - The adjusted current account gap implies the real exchange rate is 4 percent weaker than fundamentals and desired policies (text: "the real exchange rate is 4 percent weaker"), consistent with the EBA-lite current account approach. 1/ Adjusted for the projected increase in oil prices over the medium term. ### Real effective exchange rate (REER) - REER movements: - The peso has appreciated against other major currencies while the nominal exchange rate was allowed to only gradually depreciate against a stronger U.S. dollar. - The REER has appreciated by approximately 3 percent over the past year. - EBA-lite REER panel regression result: - The real rate is 3 percent weaker than the level consistent with fundamentals and desired policies. - Consistency: - This REER assessment is largely consistent with the EBA-lite current account approach. ### Current account projection and sustainability - Projected current account deficit: - Projected to increase to 3.1 percent by 2020. - Financing composition: - Primarily financed through FDI flows and government borrowing. - External sustainability benchmark: - Stabilizing the net IIP at the 2014 level would require a current account deficit of 3.0 percent of GDP, indicating the underlying deficit is only marginally weaker than its norm. ### International Investment Position (IIP) and external debt - Net IIP dynamics: - Net foreign liabilities doubled between 2005 and 2014, from 32 present of GDP to 61 present of GDP. - Two-thirds of the increase reflected non-debt creating flows in terms of foreign direct investment in the tourism, manufacturing and mining industries. - Net IIP is projected to stabilize at around 60 percent of GDP over the medium term (consistent with the external sustainability analysis). - Gross external debt: - Rose from 28 to 38 percent, mainly due to increased public external borrowing. - Restructuring with PetroCaribe and increased issuance of dollar denominated bonds in 2015: external public debt securities estimated to account for more than half of total external debt in 2015 compared to only a quarter in 2008. - Share of short-term public debt estimated to have fallen from approximately one third in 2008 to a projected less than a one tenth in 2015. - Projections and sensitivity: - Restructuring with PetroCaribe lowered external debt from 38 percent of GDP in 2014 to an estimated 35 percent in 2015. - Over the medium term gross financing needs will range between 6 and 7 percent of GDP. - Non-debt creating flows expected to cover about one third of financing needs; remainder financed by rolling over existing debt and issuing some new debt. - Gross external debt projected to rise moderately to 36 percent of GDP by 2020. - External debt profile resilient to one-half standard deviation shocks to interest rate, growth rate and non-interest current account; a 30 percent real depreciation shock would raise medium term external debt to 52 percent by 2020. ### Reserve adequacy - 2015 reserves: - Reserves projected to grow by 0.4 US$ billion in 2015. - Risk-weighted adequacy metric: - Reserve adequacy improved relative to some standard benchmarks but remains well below the Fund’s risk-based metric which requires coverage against medium and long-term external debt. - Mitigating factors: - Majority of long-term external liabilities are public borrowings, about half owed to official creditors with a protracted amortization schedule. - Diverse sources of foreign exchange: tourism, remittances and gold. - Projection: - Reserve adequacy projected to further improve over the medium term, albeit still below the Fund’s risk-weighted metric. - Reserve adequacy: risk-weighted metric, 2012-2015 (in percent of metric, using quarterly average of GIR) values shown in chart: 49.1, 58.6, 54.8, 60.5, 62.4, 66.1, 68.3, 70.6, 71.8 (series across 2012–2015 and projections 2016–2020 in chart). - Suggested adequacy range (table): - Months of imports: 3.0 2012; 2.6 2015(p); 3.6 2020 (p); 4.3 suggested - Broad money: 20% 2012; 15% 2015(p); 18% 2020 (p); 20% suggested - Short-term debt: 100% 2012; 152% 2015(p); 177% 2020 (p); 259% suggested ### External Debt Sustainability Framework — key table highlights (2010–20) - Baseline: External debt (percent of GDP) - 2010: 30.9 - 2011: 31.2 - 2012: 33.2 - 2013: 36.3 - 2014: 37.7 - 2015: 35.1 - 2016: 34.2 - 2017: 34.1 - 2018: 34.6 - 2019: 35.1 - 2020: 35.7 - Change in external debt (line 2) - 2010: 1.4 - 2011: 0.3 - 2012: 1.9 - 2013: 3.1 - 2014: 1.4 - 2015: -2.6 - 2016: -0.9 - 2017: -0.1 - 2018: 0.5 - 2019: 0.5 - 2020: 0.6 - Identified external debt-creating flows (3) - 2010: -0.2 - 2011: 1.2 - 2012: 0.2 - 2013: 0.5 - 2014: -1.9 - 2015: -3.7 - 2016: -2.6 - 2017: -2.1 - 2018: -1.7 - 2019: -1.7 - 2020: -1.4 - Current account deficit, excluding interest payments (4) - 2010: 6.3 - 2011: 6.2 - 2012: 5.1 - 2013: 2.7 - 2014: 1.8 - 2015: 0.5 - 2016: 0.4 - 2017: 0.5 - 2018: 0.8 - 2019: 0.8 - 2020: 1.1 - Deficit in balance of goods and services - 2010: 11.4 - 2011: 10.3 - 2012: 9.1 - 2013: 6.0 - 2014: 4.9 - 2015: 4.2 - 2016: 4.2 - 2017: 4.4 - 2018: 4.4 - 2019: 4.5 - 2020: 4.7 - Exports (percent of GDP) - 2010: 22.8 - 2011: 24.2 - 2012: 24.8 - 2013: 25.9 - 2014: 26.5 - 2015: 25.5 - 2016: 25.2 - 2017: 25.2 - 2018: 25.0 - 2019: 25.0 - 2020: 25.0 - Imports (percent of GDP) - 2010: 34.3 - 2011: 34.5 - 2012: 33.9 - 2013: 31.9 - 2014: 31.4 - 2015: 29.7 - 2016: 29.4 - 2017: 29.6 - 2018: 29.5 - 2019: 29.5 - 2020: 29.8 - Net non-debt creating capital inflows (negative) (8) - 2010: -4.5 - 2011: -3.9 - 2012: -5.2 - 2013: -3.3 - 2014: -3.5 - 2015: -3.2 - 2016: -3.0 - 2017: -3.0 - 2018: -3.0 - 2019: -3.0 - 2020: -3.0 - Automatic debt dynamics (1/) (9) - 2010: -1.9 - 2011: -1.1 - 2012: 0.3 - 2013: 1.0 - 2014: -0.2 - 2015: -0.9 - 2016: 0.0 - 2017: 0.4 - 2018: 0.5 - 2019: 0.5 - 2020: 0.6 - Residual, incl. change in gross foreign assets (2-3) (13) - 2010: 1.6 - 2011: -0.9 - 2012: 1.7 - 2013: 2.6 - 2014: 3.3 - 2015: 1.1 - 2016: 1.7 - 2017: 2.0 - 2018: 2.2 - 2019: 2.1 - 2020: 2.0 - External debt-to-exports ratio (in percent) - 2010: 135.6 - 2011: 129.2 - 2012: 133.9 - 2013: 140.1 - 2014: 142.4 - 2015: 137.6 - 2016: 135.7 - 2017: 135.5 - 2018: 138.4 - 2019: 140.5 - 2020: 142.8 - Gross external financing need (in billions of US dollars) (4/) - 2010: 6.3 - 2011: 7.7 - 2012: 6.6 - 2013: 4.9 - 2014: 5.6 - 2015: 6.6 - 2016: 4.6 - 2017: 4.6 - 2018: 4.8 - 2019: 5.7 - 2020: 6.0 - Gross external financing need (in percent of GDP) - 2010: 11.8 - 2011: 13.3 - 2012: 10.8 - 2013: 8.0 - 2014: 8.8 - 2015: 9.8 - 2016: 6.4 - 2017: 6.1 - 2018: 6.1 - 2019: 6.8 - 2020: 6.8 ### Key macroeconomic assumptions underlying the baseline (selected) - Real GDP growth (in percent) - 2010: 8.3 - 2011: 2.8 - 2012: 2.6 - 2013: 4.8 - 2014: 7.3 - 2015: 7.0 - 2016: 5.4 - 2017: 4.5 - 2018: 4.5 - 2019: 4.5 - 2020: 4.5 - GDP deflator in US dollars (change in percent) - 2010: 3.2 - 2011: 5.4 - 2012: 1.2 - 2013: -3.4 - 2014: -2.6 - 2015: -1.4 - 2016: 0.5 - 2017: 1.0 - 2018: 1.0 - 2019: 1.0 - 2020: 1.0 - Nominal external interest rate (in percent) - 2010: 4.5 - 2011: 4.6 - 2012: 4.8 - 2013: 4.3 - 2014: 3.8 - 2015: 4.4 - 2016: 5.5 - 2017: 5.8 - 2018: 6.0 - 2019: 6.1 - 2020: 6.2 - Growth of exports (US dollar terms, in percent) - 2010: 19.0 - 2011: 14.8 - 2012: 6.4 - 2013: 5.9 - 2014: 6.9 - 2015: 1.7 - 2016: 4.6 - 2017: 5.4 - 2018: 4.8 - 2019: 5.3 - 2020: 5.7 - Growth of imports (US dollar terms, in percent) - 2010: 30.3 - 2011: 9.1 - 2012: 2.1 - 2013: -4.7 - 2014: 2.8 - 2015: -0.2 - 2016: 4.8 - 2017: 6.3 - 2018: 5.0 - 2019: 5.7 - 2020: 6.4 - Current account balance, excluding interest payments (percent of GDP) - See table line (4) above: values from -6.3 (2010) to -0.5 (2015) to -1.1 (2020) - Net non-debt creating capital inflows (see table): 4.5 (2010) to 3.2 (2015) to 3.0 (2020) ### Scenario and sensitivity test highlights - Debt dynamics under shocks (Figure 1 summary): - Baseline external debt around mid-30s percent of GDP through 2020 (36 baseline). - Interest rate shock raises projected external debt modestly (example box values: 37 baseline, 36 scenario). - Growth shock, non-interest current account shock and combined shocks increase debt; a 30 percent real depreciation shock raises external debt to 52 by 2020. - Gross financing needs under baseline (right scale) and scenario values shown in chart: baseline and scenario gross financing need values and historical comparisons indicate vulnerability primarily to large real depreciation shocks. *Source: Fund staff calculations and IMF country material provided in the content unit.* ### Annex IV. Updated Debt Sustainability Analysis ### Annex IV. Updated Debt Sustainability Analysis ### A. Realism of Baseline Scenario - Gross debt estimated at 48.5 percent of GDP at end-2015. - Gross financing needs remain below 10 percent of GDP over the entire forecast horizon. - Large share of foreign-currency denominated debt (some 60 percent of total debt) implies that large and sudden exchange rate depreciation could raise the public debt-to-GDP trajectory. - PDVSA debt buy-back operation largely explains the modest increase in gross debt levels in 2015 relative to 2014. - PDVSA grant classification: discounted portion of the PDVSA debt is treated as a grant in central government accounts, amounting to some 3.1 percent of GDP; without this grant the projected adjustment in the cyclically-adjusted primary balance would not be considered infeasible. - Primary balance trajectory: - The primary balance is projected to improve in 2018 but does not reach the debt-stabilizing level—0.7 percent of GDP—by 2020 under staff baseline. - As a result, debt remains on a rising trajectory over the forecast horizon. - Growth and forecast errors: - Past projections show a tendency for pessimistic forecasts; example: actual 2014 GDP growth was 7.3 percent. - Debt dynamics are sensitive to sudden changes in GDP growth; growth shocks are important under DSA stress tests. - Sovereign yields and market perception: - As of January 2016, Dominican Republic’s sovereign bonds have a credit spread of 447 basis points relative to U.S. Treasury Bonds. - Comparison: emerging-market and Latin-American average spreads of 669 and 515 basis points, respectively. - 10-year local currency bond yield at 568 basis points as of October 9, 2015 (noted upward since July 2015). - Effective nominal interest rate on sovereign debt projected to increase from 3.7 percent in 2014 to 8.8 percent by 2020. - Ratings developments: Standard & Poor’s upgraded to BB- (May); Fitch affirmed B+ and revised outlook from stable to positive. ### B. Debt Profile - Maturity and rollover: - Sovereign bond placements in January 2015 lengthened average maturity to around 10 years for total non-financial public sector debt and lowered variable rate risk. - Some 55 percent of total gross debt is held by non-residents, making rollover risk sensitive to market sentiment; most non-resident holdings are at maturities longer than one year, so rollover risks are deemed reasonable at present. - Currency composition: - Some 60 percent of total debt is denominated in foreign currency; exchange rate depreciation could have a significant effect on debt dynamics. - Other profile indicators: - With the exception of the share of debt held by non-residents and public debt held in foreign currency, public debt profile indicators remain below the upper early warning benchmarks. ### C. Stochastic Simulations - Fan-chart results: - Under a symmetric distribution of risk, there is a 75 percent probability that debt will be below 60 percent of GDP over the medium term. - Under an asymmetric scenario restricting positive primary balance shocks, the debt path is still projected to remain below 60 percent of GDP over the projection horizon. ### D. Stress Tests - Real GDP growth shock: - Debt ratio remains under 55 percent of GDP under all scenarios except the growth shock, where it reaches 60 percent of GDP by the end of the projection horizon. - The growth shock produces a drastic increase in public gross financing needs in 2017; all scenarios show an increase in 2019 related to a large principal payment due on external debt. - Combined shock: - The combined shock (largest effects of individual shocks on real GDP growth, inflation, primary balance, exchange rate and interest rate) produces the most extreme debt trajectory. - Under the combined shock, debt exceeds 60 percent of GDP in 2019. - Combined shock results in average gross financing needs of around 11 percent of GDP over the medium term. ### Key projections and indicators (as presented in the DSA tables and figures) - Nominal gross public debt (in percent of GDP), 2013–2020: - 2013: 37.4 - 2014: 48.3 - 2015: 48.1 - 2016: 48.5 - 2017: 49.5 - 2018: 50.7 - 2019: 51.2 - 2020: 52.1 - 2020 (alternate figure in chart): 53.1 - Public gross financing needs (in percent of GDP), 2013–2020: - 2013: 9.8 - 2014: 8.7 - 2015: 8.8 - 2016: 8.5 - 2017: 7.3 - 2018: 8.3 - 2019: 8.8 - 2020: 9.7 - 2020 (alternate): 9.1 - Other headline figures: - Share of public debt held by non-residents: some 55 percent of total gross debt. - Share of public debt in foreign currency: some 60 percent of total debt. - PDVSA grant: some 3.1 percent of GDP. - Debt-stabilizing primary balance: 0.7 percent of GDP (not reached by 2020 under baseline). - Sovereign spread (EMBI) as of January 07, 2016: 447 basis points. - 10-year local currency bond yield as of October 9, 2015: 568 basis points. *Source: Fund staff calculations and estimates.* ### Annex V. Interest Rate Pass-Through ### Annex V. Interest Rate Pass-Through ### Background - The Monetary and Financial Law of 2002 established price stability as the central bank’s main mandate. - From 2004 the central bank moved away from exchange rate targeting to monetary targeting, introducing an overnight deposit window and a Lombard facility to create a corridor for the interbank rate; the overnight rate served as the signal of the monetary policy stance. - The central bank adopted an inflation targeting regime in January 2012; starting in February 2013 the authorities introduced the monetary policy rate as the benchmark rate, which is in the middle of a corridor bounded by the one-day deposit and expansion facilities. - Empirical coverage: monthly data over the period June 2006-June 2015. ### Financial System Concentration and Structure - As of June 2015 the financial system: - Is composed of 65 financial entities with assets over 45 percent of GDP and a loan portfolio of about 27 percent of GDP. - Loan composition: 58.7 percent commercial, 24 percent personal consumption, 17.3 percent mortgage. - System composition (percent of system assets): 17 commercial banks (85.8 percent), 10 saving and credit institutions (11.1 percent), 19 credit unions (1.9 percent), several credit corporations (0.3 percent), and a development bank (0.9 percent). - Concentration dynamics: - June 2006: the three main banks represented 57.5 percent of deposits and 58.2 percent of loans. - June 2015: the three main banks represented 67.7 percent of deposits and 69.0 percent of loans. - Collateral use: commercial and mortgage loans are usually backed by collateral, contributing to lower interest rates. - Spreads: spreads are high at all maturities, with 6.5 percent on average for three-month spread over 2006–15. ### Completeness, Speed of Adjustment, and Asymmetries (Empirical Findings) - Econometric approach: - Models used: error correction and momentum-threshold autoregressive models. - Data period: June 2006-June 2015. - Pass-through completeness: - The pass-through from the monetary policy rate to retail rates is complete, confirming effectiveness of the monetary policy transmission mechanism. - Speed and asymmetry: - The pass-through to lending rates is generally faster than to deposit rates. - Short-term rates adjust asymmetrically: - Short-term deposit rates respond faster to monetary policy rate cuts than to hikes. - Short-term lending rates respond faster to monetary policy rate hikes than to cuts. - Loan-category timing: - The analysis includes three-month, six-month, one-year, weighted average, and loan-category (commercial, personal consumption, mortgage) rates; charts show timing of a one-percentage point change in monetary policy rate and asymmetric pass-through by category and maturity. - Banking margins and timing: - Charts and figures indicate banks' margins at all maturities and banks' margins on three-month deposits/loans over the sample period, evidencing variation in spreads when the monetary policy rate changes. ### Policy Implications and Recommendations - Enhancing competition: - Reducing bank concentration by fostering competition in the financial system could help achieve a more symmetric adjustment of retail rates and strengthen monetary policy transmission. - Relevance for inflation targeting: - With the recent adoption of an inflation targeting regime, ensuring that changes in the monetary policy rate are quickly and fully reflected in retail rates is critical to influence aggregate demand and inflation. *Source: Annex V. Interest Rate Pass-Through (June 2006–June 2015 data), _cr16342 - Annex V. Interest Rate Pass-Through_* ### 6.7 percent of GDP against nonresidents and banks - the only two sectors to which it is exposed. ### _cr16342 - 6.7 percent of GDP against nonresidents and banks - the only two sectors to which it is exposed. ### Nonfinancial private sector (NFPS) external and currency positions — key findings - The private sector holds a net creditor position of "6.7 percent of GDP against nonresidents and banks - the only two sectors to which it is exposed." - Households are net creditors vis-à-vis banks, whereas firms are net debtors. - Maturity risks in foreign currency positions are minimal because short-term foreign currency deposits are significantly larger than short-term foreign currency liabilities. - The private sector’s creditor position makes it the main potential beneficiary from currency depreciations; however, the estimated benefit to the NFPS is small compared to the negative impact on the NFPS cited elsewhere (1.7 percent of GDP in the case of 30 percent depreciation; see table 2). - Footnote: "The position increases to 20.2 percent of GDP once multiple banks claims on central bank reserves –related to required reserves on FX deposits- are also taken into account." - Regulatory note: "The current financial regulation on the limits on foreign currency open position is relatively relaxed, allowing banks to have an open foreign currency net position of up to 100 percent of capital." ### Intersectoral linkages, vulnerabilities, and spillovers - Network-map interpretation: - Nodes represent size of net financial position of each sector; thickness of links represents exposure size. - NFPS could be an important source of vulnerability and spillover: a shock related to external funding to the government could adversely affect balance sheets of other sectors, particularly the financial sector. - An adverse impact on banks could reduce credit supply to the rest of the economy and produce an overall economic slowdown. - Concentration risks in the banking system: - Around "56 percent of total domestic lending to the NFPS is coming from the largest bank in the system -which also holds 30 percent of total system deposits." - Fiscal and monetary transmission channels: - Distress in the NFPS would increase the central bank’s quasi-fiscal deficit and further weaken the central bank’s financial position, thus affecting monetary policy. - Pension funds invest a large portion of households’ savings in government bonds; increased indirect exposure of households to the sovereign could compromise pension fund solvency. ### Quantified sectoral positions and shock impacts (selected figures preserved exactly as in source) - From the main text: - "6.7 percent of GDP against nonresidents and banks" - "1.7 percent of GDP in the case of 30 percent depreciation" (negative impact on the NFPS; referenced) - "20.2 percent of GDP" (position including multiple banks claims on central bank reserves) - Banks allowed open FX net position "up to 100 percent of capital." - "56 percent" of total domestic lending to NFPS from the largest bank; that bank holds "30 percent" of total system deposits. - Excerpt from Table 2 (Net Foreign Currency Debt Positions and Exchange Rate Stock — layout and numbers preserved verbatim as in source): - Table headings and lines as shown in the source (selected rows shown exactly): - "Central bank-16.09.95.44.1-6.3" - "In domestic currency-16.18.05.44.1-0.6" - "In foreign currency 0.11.90.00.0-5.7" - "Nonfinancial public sector16.02.16.7...26.8" - "In domestic currency16.11.26.7...0.0" - "In foreign currency -0.10.80.0...26.8" - "Other depository corporations 1 -10.1-2.1 3.4 4.40.4" - "In domestic currency-8.2-1.23.41.80.1" - "In foreign currency -1.9-0.80.02.60.3" - "Other financial corporations-5.4-6.7-2.99.80.0" - "In domestic currency-5.4-6.7-2.79.80.0" - "In foreign currency 0.00.0-0.10.00.0" - "Nonfinancial private sector-4.1...-4.4-9.8-4.2" - "In domestic currency-4.1...-1.8-9.80.0" - "In foreign currency 0.0...-2.60.0-4.2" - "Nonresidents6.3-26.8-0.40.04.2" - "In domestic currency0.60.0-0.10.00.0" - "In foreign currency 5.7-26.8-0.30.04.2" - Loss/Gain rows (End-2014, in percent of GDP) reproduced as in source: - Header: "From 2015 depreciation From large exchange rate shock (30 percent)" - "Central bank3.700.151.11" - "Nonfinancial public sector-27.53-1.10-8.26" - "Financial sector-0.25-0.01-0.07" - "Private sector Vis-à-vis financial sector 1/2.560.100.77 Vis-à-vis all sectors 2/6.750.272.02" - Footnotes attached in the source: - "1/ Includes FX bank credit and deposits." - "2/ Includes FX bank credit and deposits, and net foreign assets of the private sector." ### Implications and policy-relevant considerations (as stated or implied in the source) - Monitoring and macrofinancial surveillance priorities: - Closely monitor cross-sectoral exposures between NFPS, banks, central bank, and government given the network of linkages and potential spillovers. - Watch concentration in the banking system (single large bank supplying "56 percent" of domestic lending to NFPS and holding "30 percent" of system deposits). - Track central bank quasi-fiscal exposure tied to government distress and required reserves on FX deposits. - Assess pension funds’ indirect sovereign exposure because of large investments in government bonds and potential solvency implications for households. - Regulatory considerations: - Reassess the adequacy of existing limits on foreign currency open positions (currently allowing up to "100 percent of capital") in light of potential FX shocks and system concentration. - Risk management and contingency planning: - Ensure readiness for adverse scenarios involving large exchange rate shocks (e.g., "30 percent" depreciation) given quantifiable impacts in Table 2 and the network spillovers described. *Prepared from the IMF staff report excerpted in the provided content unit.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16342.pdf_