Abstract

This paper summarizes the authorities’ stabilization efforts, how these efforts were subsequently reinforced by certain key structural reforms, and other related developments that help explain the remarkable performance of the Dominican Republic’s economy in the 1990s during which the country achieved one of the highest output growth rates in Latin America, combined with low inflation, and a much improved external debt profile. The authorities often resorted to external arrears as a means of financing the external current account deficits of the 1980s. Although rescheduling agreements were reached with the international banking community and with the Paris Club of official creditors in the mid-1980s, they met with limited success until the authorities embarked on their stabilization program of the early 1990s. Large and persistent fiscal deficits represented a significant burden for monetary policy. Although at the beginning of the decade more than half of the public deficit was financed by foreign loans, episodes of default on external and domestic government debt led to a progressive drying up of these sources of financing.

© 2001 International Monetary Fund

Production: IMF Graphics Section

Charts: Sanaa Elaroussi

Typesetting: UpperCase Publication Services, Ltd.

Library of Congress Cataloging-in-Publication Data

The Dominican Republic: stabilization, reform, and growth/by a staff team

led by Philip Young and comprising Jaime Cardoso… [et al.].

p. cm.—(Occasional paper; 206)

Includes bibliographical references.

ISBN 1-58906-046-6

1. Dominican Republic—Economic policy. 2. Dominican Republic—

Economic conditions—1961- I. Young, Philip M. II. Cardoso, Jaime. III.

Occasional paper (International Monetary Fund); 206.

HC153.5.D662 2001

338.97293—dc21

2001039780

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Contents

  • Preface

  • Overview

  • Philip Young

  • I. Stabilization and Structural Reforms

    • Alessandro Giustiniani and Randa Sab

    • The Lost Decade: 1981–90

    • The Initial Phase of the Reform Effort: 1991–95

    • A New Beginning: 1996–2000

    • The Challenges Ahead

  • II. Trade Reform Continues

    • jimmy McHugh and Werner Keller

    • The Trade Regime Prior to the 1990 Reforms

    • Trade Reforms in the 1990s

    • Free-Trade Zones

    • Trade Agreements

    • Conclusion

  • III. Successful External Debt Restructuring

    • Jaime Cardoso and Werner Keller

    • The 1980s—First Round of External Debt Restructuring

    • The 1990s—Second Round of External Debt Restructuring

    • The 1991 Paris Club Debt Rescheduling

    • Non-Paris Club Debt Rescheduling: 1991–97

    • The 1994 Restructuring of Commercial Bank Credits

    • Evolution of Payments Arrears in 1990–2000

    • Past, Present, and Future Debt-Service Payments

    • External Debt Policy

    • Conclusion

  • IV. A Review of Fiscal Policy During the 1990s and Current Policy Considerations

    • David Dunn and Alessandro Giustiniani

    • Contribution of Fiscal Policy to Macroeconomic Stability During the 1990s

    • Tax Reform and Administration

    • Reforming the Budget Process and Redirecting Public Expenditure

    • Conclusion

  • V. Capital Accumulation, Total Factor Productivity, and Growth

    • John Panzer and Raimundo Soto

    • Sources of Growth in the Dominican Republic

    • Sources of Growth Excluding the FTZs

    • Sources of Growth for the FTZs

    • The Role of Public Investment in Growth

    • Conclusion

  • VI. Money Demand in a Small Open Economy: The Case of the Dominican Republic

    • Francisco Nadal-De Simone

    • The Estimated Equations and the Estimation Technique

    • Unit Roots, Cointegration, and Long-Run Elasticities

    • The Long-Run Elasticities of the Model

    • Conclusion and Policy Implications

  • VII. Exchange Market Pressure, Monetary Policy, and Interest Rates; Recent Evidence from the Dominican Republic

    • Evan Tanner

    • Exchange Market Pressure in the Dominican Republic: An Overview

    • EMP and Monetary Policy: A Vector Autoregression Approach

    • Estimation Results

    • Summary and Policy Implications

  • Appendices

  • I. Governance Issues

  • V. Economy-Wide Data

  • VI. A Stylized Open Economy Model

    • Unit Roots and Cointegration

  • Tables

  • I 1. Main Macroeconomic Indicators

    • 2. Structural Reforms

    • 3. Selected Political Risk Components—Comparison with Western Hemisphere Countries

  • II 4. Import Tariff Structure

    • 5. Initial Import Level Before Contingent Tariff Applies

    • 6. Schedule of Contingent Tariffs

    • 7. Index of Trade Restrictiveness

    • 8. Import Tariff Rates

    • 9. Free-Trade Zone Activity

  • III 10. Outstanding External Public Debt Sector

    • 11. Medium- and Long-Term Public External Debt Service

    • 12. Outstanding External Public Sector Arrears

    • 13. Total Rescheduled Debt

    • 14. Summary of the 1994 Restructuring of Commercial Bank Debt

  • IV 15. Summary of the Consolidated Public Sector

    • 16. Summary Operations of the Central Government

    • 17. Tax Revenue by Source

  • V 18. Economic Structure and Growth, 1991–98

    • 19. Production Function Estimates, 1970–98

    • 20. Sources of Growth Estimates

    • 21. Total Factor Productivity Growth of Other Developing Countries

    • 22. Estimates of Sources of Growth in the FTZS

    • 23. Average Productivity in the Economy and the FTZs

    • 24. Composition of Public Expenditures, 1995–98

    • 25. The Determinants of Private Investment, 1979–96

    • 26. Data Sources

    • 27. Data Used in Estimations and Simulations

    • 28. Unit Root Tests

    • 29. Causality Tests

  • VI 30. Unit Root Tests at 5 Percent Level

    • 31. Perron Unit Root Test on the Foreign Interest Rate at 5 Percent

    • 32. The Johansen-Juselius Maximum Likelihood Test for Cointegration

    • 33. The Phillips-Loretan Nonlinear Dynamic Least Squares Estimator

  • VII 34. Exchange Market Pressure and Related Variables

    • 35. Summary of Estimates, Vector Autoregression System Equation

      • A. F-Tests for Exclusion

      • B. Impulse Response Functions

  • Figures

  • I 1. Scatter Diagram of Real GDP Growth Rates and Inflation Rates

  • III 2. Changes in Composition of External Public Sector Debt

  • IV 3. The Overall Public Sector, Net Domestic Bank Credit to Public Sector, and Inflation

  • V 4. Kalman-Filter Estimates of the Share of Capital in FTZ Production Function

  • VI 5. Residuals from Model 1–M1

    • 6. Residuals from Model 1–M2

    • 7. Residuals from Model 2–M1

    • 8. Residuals from Model 2–M2

    • 9. Residuals from Model 3–M1

    • 10. Residuals from Model 3–M2

    • 11. A Transitory Monetary Expansion

    • 12. A Permanent Monetary Expansion

  • VII 13. EMP, Credit Growth, and Interest Rate Differential

    • 14. Response of EMP to Shocks

    • 15. Response of Interest Rate Differential to Shocks

    • 16. Response of Credit Growth to Shocks

The following symbols have been used throughout this paper:

  • … to indicate that data are not available;

  • — to indicate that the Figure is zero or less than half the final digit shown, or that the item does not exist;

  • –between years or months (e.g., 1998–99 or January-June) to indicate the years or months covered, including the beginning and ending years or months;

  • / between years (e.g., 1998/99) to indicate a fiscal (financial) year.

“Billion” means a thousand million;

Minor discrepancies between constituent figures and totals are due to rounding.

The term “country,” as used in this paper, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.

List of Abbreviations

ACP

African, Caribbean, and Pacific countries

ACS

Association of Caribbean States

BCRD

Central Bank of the Dominican Republic

CAFTA

Central American Free Trade Area

CARICOM

Caribbean Community

CCC

U.S. Commodity Credit Corporation

CDE

Companía Dominicana de Electricidad

CEA

Consejo Estatal del Azúcar

CREP

Comisión de Reforma de la Empresa Pública

DGII

Directión General de Impuestos Internos

EMP

exchange market pressure

EU

European Union

FTAA

Free Trade Area of the Americas

FTZ

free-trade zones

IDB

Inter-American Development Bank

LAC

Latin American countries

LIBOR

London interbank offered rate

NAFTA

North American Free Trade Agreement

OLS

Ordinary least squares

ONAPLAN

Oficina Nacional de Planeamiento

ONAPRE

Oficina Nacional de Presupuesto

OPEC

Organization of Petroleum Exporting Countries

TFP

total factor productivity

WTO

World Trade Organization

Preface

Most of the material presented in this Occasional Paper was originally prepared as background for discussions in the IMF Executive Board. It has been updated to take account of developments through early 2001. The authors are grateful to the Dominican authorities for extensive discussions and comments and for their assistance in providing data and other source material.

This Occasional Paper has benefited from the comments of staff in the Western Hemisphere Department as well as the Latin American and Caribbean Region of the World Bank. In particular, the authors would like to thank Patricia Brenner, Eliot Kalter, Saul Lizondo, and Robert Rennhack for their valuable comments. John Panzer works for the World Bank and Raimundo Soto is with the Instituto de Economia, Pontificia Universidad Católica de Chile.

The authors would also like to express their appreciation for the valuable research assistance that was provided by Branko Marie, formerly of the Western Hemisphere Department. Lucy Ulrich of the IMF’s External Relations Department edited the report and coordinated its production for publication.

The opinions expressed are solely those of the authors and do not necessarily reflect the views of the IMF, Executive Directors, or the authorities of the Dominican Republic.

Overview

This Occasional Paper is a compilation of papers that are linked by a common theme—stabilization, structural reform, and economic growth in the Dominican Republic. The papers summarize the authorities’ stabilization efforts, how these efforts were subsequently reinforced by certain key structural reforms, and other related developments that help explain the remarkable performance of the Dominican Republic’s economy in the 1990s during which the country achieved one of the highest output growth rates in Latin America, combined with low inflation, and a much improved external debt profile. The performance is all the more striking when contrasted with the severe imbalances of the previous decade—one of widening external current account and public sector deficits, accelerating inflation, and declining growth.

As a result of these imbalances, by the end of the 1980s, pressures on the balance of payments and prices had reached unsustainable levels. The government suspended certain external debt-service payments, giving rise to large external payments arrears. Conditions deteriorated to such an extent that a drastic reorientation of policies was urgently needed. This is the setting for Chapter I, Stabilization and Structural Reforms, which describes the authorities’ structural reform efforts in the 1990s. The lesson that emerges is that a great deal was accomplished on the structural front, which contributed fundamentally to the extended period of growth observed in the 1990s. The administration of President Hipolito Mejia has continued, if not accelerated, the reform momentum, with the approval of a new hydrocarbons law (removing administration discretion from the setting of domestic fuels prices), substantially reducing the average external tariff rate, and increasing consumption taxes to encourage saving and provide the needed resources for priority social expenditures. Nonetheless, a comprehensive reform agenda (much of which is currently being considered by congress) lies ahead. It includes modernization of the public administration, improving the transparency of economic policies, and strengthening the supervisory and regulatory framework of the financial system.

During the 1980s, in order to protect domestic industries, the authorities often resorted to trade-restricting measures. This resulted in a highly protected domestic industry, which was ill-prepared to enter an increasingly competitive world market. Recognizing that domestic firms risked being unable to keep pace with international conglomerates, the authorities have embarked on a trade reform program. Chapter II, Trade Reform Continues, provides a history of these reforms, which form an integral part of the structural reform agenda. The restrictiveness of the trade regime has been diminishing—for example, congress recently approved several regional trade agreements, lowered tariffs further in 2001, and plans additional reductions in coming years—and this is leading to a harmonization of the Dominican Republic’s trade policies with those of its neighbors.

The authorities often resorted to external arrears as a means of financing the external current account deficits of the 1980s. Although rescheduling agreements were reached with the international banking community and with the Paris Club of official creditors in the mid-1980s, they met with limited success until the authorities embarked on their stabilization program of the early 1990s. Chapter III, Successful External Debt Restructuring, gives an overview of these developments and highlights the improvement in the external debt profile in recent years.

The deepening fiscal imbalances of the 1980s, largely financed domestically, but also with external arrears, led to rapidly accelerating inflation. The economic system was at risk of collapse and it needed a rapid and substantial fiscal adjustment. In just one year, the consolidated public sector balance turned from a deficit of more than 3 percent of GDP in 1990 to near balance in the following year. The underlying theme of Chapter IV, A Review of Fiscal Policy During the 1990s and Current Policy Considerations, is that the subsequent maintenance of fiscal discipline over a number of years has been a key factor behind the exemplary performance of the Dominican economy. The chapter includes a discussion of the major tax reforms and improvements in administration that were implemented during the 1990s, as well as developments in expenditure policy. It concludes with a look ahead to the recently initiated Integrated Financial Management Program, which is expected to yield substantial benefits in terms of transparency and rationalization of the fiscal accounts.

Chapter V, Capital Accumulation, Total Factor Productivity, and Growth, considers trends in capital accumulation, technological change, and economic growth. The restoration of macroeconomic stability and the initiation of structural reforms coincided with strong economic growth and poverty reduction. The chapter shows that this growth was anchored by a resurgence of capital formation and strong productivity growth. Sustaining high economic growth rates requires continuous efforts in fostering investment and productivity growth. This in turn will necessitate continued structural reforms and investment in health and education, the types of investment that help to “crowd in” rather than “crowd out” private sector investment.

In addition to the chapters described above, this paper also includes two technical papers, Chapters VI and VII. The first provides an empirical estimation of money demand in the Dominican Republic. Real money balances are found to be cointegrated with real GDP and interest rates. In the short run, changes in opportunity cost variables (including either domestic interest rates or the differential between domestic and U.S. interest rates) also help explain changes in real money balances. The strength of this relationship holds up over time when money is defined as M2. It dissipates over time, however, when money is measured as M1 (that is, the long-run coefficient is not statistically significant). In the second paper, monetary and exchange rate policies (including reserve movements) are combined in a model of exchange market pressure defined as the sum of exchange rate depreciation and the outflow of official reserves. Consistent with a stable money demand, a reduction in domestic credit results in a decline in the exchange market pressure index. Thus, contractionary monetary policy can be effective in raising official reserves.

Stabilization, Structural Reform, and Economic Growth
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