May 16, 2005

On behalf of our authorities, we would like to thank management and staff for a fruitful policy dialogue. We would also like to express our appreciation for the recent technical assistance missions from MFD and FAD. The recommendations that resulted from the Safeguard Assessment are also appreciated. Fund assistance supports the interim government’s efforts to restore the credibility of public institutions. We agree with the thrust of the papers, and would like to confirm that our authorities consent to their publication.

Haiti’s overall good performance under the EPCA is underscored in the papers. While macroeconomic and financial stability have to a large extent been restored, the reports also note delays in implementing certain structural reforms. We wish to stress the authorities’ determination to carry forward much needed institutional reforms, which for the most part have been delayed due to factors beyond their control. The government is faced with the daunting task of fostering financial stability and trying to re-build institutions that are critical for growth and poverty alleviation, in the context of an unstable security situation and with the political complexities that a transitional government inevitably confronts.

Recent developments in public finance

The supplementary budget for April-September 2005 has been voted by the Council of Ministers and is due to be published shortly. It aims mostly at re-orienting expenditures to stimulate economic activity, taking into account delayed disbursements of donor assistance and additional necessary expenditures. These relate mainly to the elections, the funding of the power company’s (EDH) purchases of fuel, and the increased cost of the SGS service contract to cover the pre-shipment inspection of imports. Additional funds have been allocated to EDH to replace the concluded external funding of its purchases of fuel, which are indispensable to maintaining a minimum electricity supply of 12 hours per day. The costs of SGS inspections have quadrupled as more physical inspections have been requested, in addition to paper verifications in order to improve taxation at customs and discourage fraud, particularly in the case of imports through the border with the Dominican Republic.

The public sector is being depleted of a significant number of its skilled staff, who is either emigrating or being pulled by the private sector and international organizations in Haiti through more competitive salaries. This has further weakened the public sector’s capacity to carry out reforms and execute projects. To halt the hemorrhage of qualified staff, two general wage increases were granted, cumulating to 45 percent. Nevertheless, this increase corrected only partially the significant reduction in real wages during the past decade.

The census of employment and payments arrears in public entities is a complex process, which is being completed. The methodology retained was to have an ad hoc committee do a census within each institution and to subsequently have the Ministry of Economy and Finance (MEF) carry a verification of the findings. The census at the National Police Force will be shortly completed by the MEF. The case of the Education Ministry is noteworthy as it is the single most important employer in the public sector, and a particularly problematic case given past disorderly hiring practices and accumulated arrears. Arrears in this Ministry are being reviewed by the MEF. The census for 43 public institutions is already complete. The ad hoc committee responsible for the census of employment for the 23 other public institutions has been reinstated after a temporary suspension of its work. The final report of the census of employment is scheduled for the end of June.

The government had projected zero financing from the central bank (BRH). With fiscal receipts lagging and in the absence of expected donor disbursements, important cuts in expenditures were operated and certain budgeted outlays delayed. Nevertheless, the government kept current with its debt service. The reduction in investment contributed to depressing further economic activity in the context of low business confidence. The government shared with Fund staff its concern that failure to invigorate the economy would have a significant impact on the democratic building process, and discussed the possibility of undertaking budget reallocations and of using BRH credit to cover exceptional outlays for the elections and to offset the end of USAID support to the electricity sector.

The government is redoubling efforts to increase tax collection. Revenues have picked up during the last three months, mostly due to the strengthened administrative controls and recovery of arrears by the internal revenue service. Customs receipts have also improved recently, even if the administration is having difficulties controlling fraud at the border with the Dominican Republic. With the support of the U.S. Treasury, the IADB, and the Fund, an improvement of tax administration is expected in the short term. The strengthening of the infrastructure of provincial custom offices is being undertaken with help from UNCTAD.

The interim government believes that improved budget management and expenditure control are paramount to sustainable fiscal consolidation. The expenditure approval process has been rationalized, allowing for observance of regular budget processes and a very significant reduction of current account use. Modernization efforts are being undertaken with the help of the IADB and the World Bank. The annuity of the budget process has been reinstated and preparation of the budget for FY 2005-06 is on track. Two weeks ago the budget process was officially launched with the publication by the Prime Minister of the broad orientations for its preparation, including the request for investment budgets from sector ministries. The draft budget will be ready for discussion with civil society in July. The pre-audit of TELECO, the state-owned communications company, has been completed and the modernization of its accounting system is underway. Terms of reference for the audit of EDH, the electricity company, are being drawn and the audit will be carried soon, with financial assistance from the World Bank and the Canadian government.

The motto behind public sector reforms is accountability, transparency and efficiency. The Table of Operations of the Central Government is distributed monthly by e-mail to a wide list of members of civil society, the private sector, international organizations, and to scholars and interested parties. The MEF has announced the launching at the end of this month of its website. It is to be an important medium for informing on budget execution and reform implementation. The anti-corruption unit created in September 2004 has been fully operational since December.

Monetary policy and the BRH’s balance sheet

With the strengthened fiscal position, the BRH was able to reduce inflation sharply, enhance official reserves and ensure exchange rate stability. Nevertheless, challenges remain, in particular the high level of dollarization of the banking sector, the pass-through of international fuel prices, the limited scope for diversification of monetary policy instruments, and the vulnerability of the BRH’s balance sheet.

During the past fiscal year interest paid by the government to service its debt to the BRH did not cover the cost of interest paid to commercial banks on central bank paper. Recently, however, the BRH has been able to decrease interest rates on bonds while still maintaining an adequate stock of bonds. Interest on government debt, which represents close to 60 percent of BRH receipts, now covers the cost of the central bank paper issued. In spite of this, the BRH feels that it needs more room to carry out its operations without endangering its balance sheet. An agreement has been reached with the MEF to raise the monthly interest payments to the BRH. The conversion of outstanding credit to the central government into interest-bearing bonds is being contemplated for the medium term and should significantly improve central bank revenue. Fund TA has been looking at the different functions of the central bank, particularly its fiscal role as collector of taxes for the government. While unusual and costly to the bank, the BRH cannot be alleviated of this function without taking into consideration the actual capacity of the fiscal administration, its needs to be modernized and strengthened, and the imperative necessity to raise fiscal revenue significantly.

Staff mentions problems of excess liquidity and suggests that interest rates on bonds be increased. Although sensible, this suggestion fails to fully take into account the operational framework of bond market operations. Since mid-August 2004 the BRH sold in its weekly auction just enough bonds to replace those coming due during that week, keeping thus the bond stock constant at around 3.5 billion gourdes. This meant that the BRH fixed both prices and quantities. In turn, banks started overbidding. Recently, the BRH issued an administrative order forbidding banks to bid beyond their excess liquidity. Simultaneously, because of signs of nervousness in the exchange rate market, the BRH has decided to increase weekly volumes sold. As a result, outstanding bonds now reach 4.8 billion gourdes. Without raising interest rates, the BRH was able to mop up an important portion of excess liquidity and stabilize the exchange rate market. The BRH stands ready to change posture if the situation so warrants.

The BRH is thankful for the Safeguard Assessment report, showing no imminent vulnerabilities. BRH officials consider the conclusions and recommendations of the assessment a useful tool in framing its reform agenda. The mission concluded that many elements of an adequate safeguard framework are present at the BRH, including a well-functioning external auditing mechanism, a legal framework that guarantees its operational independence, and well-managed operations and foreign reserves. However, the report underlined certain vulnerabilities, some of which the bank was already addressing. They concerned a lack of written guidelines relative to the process of generating and exchanging information within and between departments and potentially conflicting functions of the internal audit department. The interim audit report will, as usual, be published on the BRH’s web site and later in its annual report.

The banking sector has been under constant scrutiny and the BRH board is confident that the financial system’s vulnerabilities are modest. The BRH does not intend to relax prudential regulations and reserve requirements on foreign currency deposits, given the vulnerability of the dollarized banking system to an external shock. The authorities believe that an FSAP would be beneficial and hope that the Fund will be able to attend to this request promptly.

Debt sustainability

The latest DSA suggests that Haiti could potentially be eligible for assistance under the HIPC Initiative. The ratio of NPV of debt to exports at end-September 2003 and 2004 after full use of traditional debt relief mechanisms was estimated to be 200 and 199 percent respectively. This ratio is projected to be around 189 percent this year, well beyond the threshold adopted under the operational framework. We are hopeful that the assessment of eligibility being carried out by the World Bank and the Fund will be concluded soon. Debt relief is urgently needed to break the cycle of low growth, poverty, and political instability. Given Haiti’s large debt, our authorities hope that additional support will be provided primarily in the form of grants.

Conclusions

Looking forward, Haiti faces a number of challenges and downside risks. The recent elimination of the ATC quotas and the expiration of the benefits under the CBTPA (Caribbean Basin Trade Partnership Act) in 2008, will affect growth and employment. A compensating factor would be the passage of the HOPE bill by the United States Congress. The authorities are hopeful that this will in fact happen.

Donor commitment to timely disbursement of pledged resources and donor coordination are paramount for an efficient use of scarce resources. Staff has identified a US$50 million financing gap for FY06. Our authorities are convinced that once a new government is elected, the donor community will be able to move fast and the financing gap will be closed.

The development of a medium-term development and poverty reduction strategy I-PRSP in the course of the next twelve months is important in order to reduce delays in embarking on a PRGF arrangement, which will be instrumental in changing the long-standing negative trend of social and economic indicators and vital to mobilizing adequate funding for achieving the MDG goals.