Honduras
Request for Stand-By Arrangement-Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Honduras
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International Monetary Fund
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Publication Date:
23 Jul 2008
eISBN:
9781451817201
Language:
English
Keywords:
ISCR; CR; staff appraisal; IMF staff representative; program; statement; debt relief; debt service; IADB budget-support loan; financing gap; nominal exchange rate; International reserves
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This paper discusses request from Honduras’ authorities for a Stand-By Arrangement (SBA). Honduras has had three previous Poverty Reduction and Growth Facility (PRGF) arrangements, the last of which ended in February 2007. The most recent PRGF program focused on fiscal consolidation and structural reforms. However, the program went off track owing to large wage increases granted in 2006, including a four-year agreement with teachers. The authorities are now requesting a 12-month SBA covering economic policies through December 2008. In IMF staff’s view, the authorities’ program appropriately addresses emerging imbalances.

Abstract

This paper discusses request from Honduras’ authorities for a Stand-By Arrangement (SBA). Honduras has had three previous Poverty Reduction and Growth Facility (PRGF) arrangements, the last of which ended in February 2007. The most recent PRGF program focused on fiscal consolidation and structural reforms. However, the program went off track owing to large wage increases granted in 2006, including a four-year agreement with teachers. The authorities are now requesting a 12-month SBA covering economic policies through December 2008. In IMF staff’s view, the authorities’ program appropriately addresses emerging imbalances.

Executive Summary

Background

  • Honduras has had three previous PRGF arrangements, the last of which ended in February 2007. The most recent PRGF program focused on fiscal consolidation and structural reforms to strengthen growth and reduce vulnerabilities in the financial sector. However, the program went off track due to large wage increases granted in 2006, including a 4-year agreement with teachers.

  • Over the last year, expansionary policies led to emerging imbalances. While growth remains robust and macroeconomic stability has been maintained, in 2007 inflation increased, bank credit expanded rapidly and led to a boom in imports, a sharp weakening in the external current account deficit, and a loss of net international reserves. At the same time, the overall fiscal deficit deteriorated, partly reflecting the weakening finances of the public electricity company (ENEE).

  • The authorities are requesting a 12-month SBA covering economic policies through December 2008. They consider that Fund support for their program will help anchor economic policymaking ahead of primary elections, reinforce confidence and unlock donor financing. They do not intend to draw under the arrangement, and view it as a bridge to a PRGF to be negotiated before end-year.

Program objectives and staff appraisal

  • The authorities’ program is centered on strengthening macroeconomic stability through policies in three key areas:

    • ➢ Fiscal consolidation and reorientation. The overall fiscal deficit will be reduced to 1½ percent of GDP in 2008, from 2¼ in 2007. This is consistent with a stable wage bill, a recovery in priority spending, and a stable debt-to-GDP ratio.

    • ➢ Containing inflation and safeguarding external stability. The monetary program seeks to maintain single digit inflation, bring credit growth to sustainable levels, and build up net international reserves. The program also envisages prudential measures to encourage banks to internalize risks from rapid credit expansion. The existing exchange rate band will be used more actively to help maintain external competitiveness and an adequate level of foreign reserves.

    • ➢ Strengthening the energy sector. In collaboration with the World Bank and the IADB, the program envisages the implementation of a tariff policy that covers operational costs of the electricity company and the clearance of arrears with private generators.

  • In the staff’s view, the authorities’ program appropriately addresses emerging imbalances. Risks include a less favorable external environment and pressures for domestic expansionary policies ahead of primary elections scheduled for late 2008. Staff welcome the authorities’ prior actions, which are an important signal of the government’s commitment to the program, but underscore the need to react promptly to changes in the external environment and resist pressures for a loosening of policies.

I. Introduction

1. Honduras is among the poorest countries in the region and has historically experienced low and volatile growth. Long-standing institutional problems have weakened economic growth, and policymaking has been constrained by short political cycles, pressure from vested interests, governance challenges, and intermittent social unrest. At the same time, external shocks, including hurricanes and terms-of-trade changes, have contributed to the volatility of output. As a result, social indicators remain among the weakest in Latin America, with an unequal distribution of income and a third of the population living on under US$2 a day.

uA01fig01

Honduras is among the poorest countries in the region.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

2. The previous PRGF, approved in 2004, focused on fiscal consolidation and structural reforms to strengthen growth and reduce vulnerabilities in the financial sector. A key to restoring sustainability to the public finances was the reduction in the civil service wage bill in terms of GDP, a tax reform, and improved tax administration. To address bank fragilities resulting from the devastation of Hurricane Mitch in 1998, the financial sector was strengthened through an upgrading of the legal, prudential, and supervision frameworks. Key medium-term reforms were oriented at strengthening the central bank and monetary policy operations, the banking commission (CNBS), and the tax administration office (DEI). In addition, Honduras obtained debt relief from the Enhanced HIPC Initiative, Paris Club creditors, the MDRI, and the IADB, bringing its external debt down from 78 percent of GDP in 1999 to 16 percent in 2007.

3. Social pressures, however, led to an unwinding of key fiscal reforms and the introduction of procyclical policies in 2006. Having won the end-2005 elections by a small margin, the new government took office without a congressional majority and with difficulties in forging political alliances. Against a backdrop of social unrest fueled by rising oil prices and the expectation of higher spending following debt relief, the government granted substantial concessions on public wages (including a 4-year agreement with teachers), reinstated fuel subsidies, and froze fuel and electricity prices. Moreover, the central bank eased monetary policy by lowering interest rates and reducing liquidity requirements on dollar bank deposits. As a result, the fourth review of the PRGF, scheduled for April 2006, was not completed due to the lack of agreement on key policies, and the program expired in February 2007.

II. The Emerging Economic Imbalances

4. Economic imbalances grew over the last year. While growth remains robust and macroeconomic stability has been maintained, inflation increased to near 9 percent last December (from 5.3 percent in 2006), among the highest in the region and above the authorities’ target range (5–6 percent), boosted by rising oil and food prices. Also, despite an improvement in the terms of trade and good export performance in 2007, the external current account deficit almost doubled (reaching 10 percent of GDP) due to the rapid growth of imports, and net international reserves began to decline (Figure 1).

Figure 1.
Figure 1.

Honduras: Macroeconomic Performance—Imbalances are Growing

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Sources: Central Bank of Honduras; and Fund staff estimates.
uA01fig02

Inflation is among the highest in the region.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

5. These imbalances have largely reflected expansionary macro policies. In particular:

  • Fiscal policy. The overall fiscal deficit has deteriorated since 2005 and the quality of public spending weakened. Although tax revenue has been buoyant, the rapid rise in the wage bill and untargeted subsidies have crowded out public investment and social spending, posing risks to fiscal sustainability. Reflecting rising employment and large wage increases granted in 2006, the central government wage bill increased 25 percent in 2007 (33 percent for teachers). The combined public sector wage in 2007 is estimated at 11.7 percent of GDP, one of the highest in the region. Net lending from the public pension institutes also contributed to growth in the overall deficit.

  • Monetary policy. An accommodative monetary policy and competition for market share among domestic banks in response to the entry of foreign banks led to a rapid rise in bank credit (over 30 percent year-on-year) and a boom in imports, posing risks to financial sector health and external stability. In response, the central bank raised policy interest rates by 150 basis points to 7.5 percent in the second half of 2007 and increased reserve requirements, but real interest rates remain negative and the outstanding stock of central bank paper has declined.

  • Exchange rate policy. The official exchange rate regime allows the Lempira to fluctuate within a ± 7 percent crawling band, but it has been pegged at the most appreciated side of the band since 1999, and the band has been fixed since October 2005. With a de facto fixed exchange rate and expansionary fiscal and monetary policies, net international reserves fell by US$102 million in 2007. While the real effective exchange rate appreciated marginally in the context of a fixed nominal exchange rate, staff estimates of the real exchange rate suggest there is no significant misalignment.

uA01fig03

The deficit is increasing and the quality of spending is deteriorating.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Sources: Ministry of Finance; and Fund staff calculations.
uA01fig04

The wage bill is the highest in the region.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Source: Fund staff estimates (estimates 2007).
uA01fig05

The monetary stance is expansionary, and the stock of open market bills has fallen.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Sources: Central Bank of Honduras; and Fund staff estimates.
uA01fig06

The REER has appreciated in the context of a stable nominal exchange rate…

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Sources: Country authorities; and Fund staff calculations.
uA01fig07

…but there is no evidence of significant misalignment.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

1/ Based on cointegration analysis of the RER with country fundamentals.

6. Emerging imbalances are also associated with weaknesses in the energy sector, which pose risks to the public finances, the financial system, and growth. From April 2006 to December 2007 electricity tariffs remained fixed, while fuel costs rose by 50 percent (to US$75 per barrel of bunker, from about US$50). As a result, the losses of the public electricity firm ENEE increased and led to a significant weakening of the overall operating balance of state enterprises. The losses of ENEE were financed with payment arrears to private generators, and contractors (about 1.6 percent of GDP), as well as transfers from the government, and short-term bank credit. Moreover, subsidies have kept domestic fuel prices fixed at below international prices and have been financed by squeezing importers’ profit margins and with direct transfers from the budget. Overall energy subsidies in 2007, including losses of ENEE, are estimated at over 2 percent of GDP. At the same time, the two largest banks (about 30 percent of financial sector assets) and a medium-sized bank each had over 30 percent of capital exposed to the energy sector.

uA01fig08

The finances of state enterprises have weakened.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Sources: Ministry of Finance; and Fund staff calculations.

III. The Stabilization Program: Addressing Economic Imbalances

A. Overview

7. The authorities’ program for 2008 aims at strengthening the conditions for sustained growth and poverty reduction through the consolidation of macroeconomic stability. The program focuses on policies in three key areas: fiscal policy will be tightened and the public sector wage bill stabilized to help keep public debt broadly constant and redirect spending to priority sectors; monetary policy will be geared to contain inflation and achieve the NIR target, while bringing credit growth down to more sustainable levels. Exchange rate policy will use the existing band more actively to support monetary policy and help maintain external competitiveness; the energy sector will be strengthened in collaboration with the World Bank and the IADB, by implementing electricity tariff reform to cover the operational costs of ENEE and clearing ENEE arrears with private generators.

8. The authorities believe that a 12-month precautionary SBA would reinforce confidence and support their economic program for 2008, while providing a bridge to a Poverty Reduction and Growth Facility (PRGF) later in the year.1 With a precautionary SBA in place, the existing financing gap is expected to be covered by concessional flows. At the same time, acknowledging that a PRGF is better suited to address Honduras’ structural challenges, the authorities intend to develop the political consensus needed to finalize a medium-term plan with policies for poverty alleviation and growth. The plan is expected to include a medium-term fiscal framework, a comprehensive civil service reform, and polices to enhance the transparency of the budgetary process, continue strengthening the energy and financial sectors and public institutions, and improve the business climate. A successful transition to a new PRGF will require satisfactory performance under the SBA, budget discipline and expenditure control, an appropriate mix of monetary and exchange rate policies, an updated Poverty Reduction Strategy Paper (PRSP), and clarity about a medium-term expenditure framework. In coming months, the authorities plan to update the July 2001 PRSP through 2015 to ensure progress towards the poverty-reduction goals. The updated PRSP will give priority to developing a medium-term macroeconomic framework, and improving the alignment between public expenditure and poverty reduction.

9. The authorities’ program is designed to preserve growth and contain inflation within a less favorable external environment. Growth is projected to abate from over 6 percent in 2007 to 4¾ percent in 2008, largely reflecting a slowdown in the world economy, with monthly indicators pointing to a deceleration in economic activity since late 2007. Inflation is expected to remain at about 9 percent, driven by increases in electricity tariffs, a decline in fuel subsidies, and rising wages (e.g. the minimum wage was increased by 11 percent). Despite an expected deterioration in the terms of trade, the external current account deficit would start declining gradually and gross international reserves would be maintained at 4 months of nonmaquila imports.

Prudent macro policies will help address emerging imbalances

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Sources: Central Bank of Honduras; Ministry of Finance; and Fund staff estimates.

10. Near-term risks are somewhat tilted to the downside. While a Fund-supported program could reinforce confidence and help anchor economic policy making, a higher-than-anticipated slowdown in the U.S. economy could adversely affect remittances and exports. Staff research suggests that a 1 percent deceleration in the U.S. would lead to a similar slowdown of the Honduran economy. Other downside risks include higher fuel prices and pressures for expansionary policies in the run-up to primary elections scheduled for late 2008. It will be important to monitor economic developments closely and strengthen the program, if necessary, to help ensure macroeconomic imbalances are reduced.

B. Fiscal Consolidation and Reorientation

11. Under the program, the overall deficit of the combined public sector will decline from 2¼ percent of GDP in 2007 to 1½ percent in 2008. This represents an underlying adjustment of about 2 percent of GDP, compared to a passive scenario in which no measures are taken. The deficit target is expected to be in line with the budget to be approved by congress in April (prior action) and will help keep public debt broadly stable at about 22½ percent of GDP (MEFP ¶ 5). The authorities’ intention to redirect spending to priority sectors, particularly public investment, will be instrumental to sustain growth and reduce poverty.

Despite fiscal consolidation, public investment will increase

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Sources: Ministry of Finance; and Fund staff estimates.

12. Fiscal consolidation is being achieved through a mix of revenue and expenditure measures. On the revenue side, tax administration and policy are being strengthened and the decision to make the solidarity tax permanent has prevented a decline in tax revenues; new services charges in the public telecommunication company will increase nontax revenues; electricity tariffs were raised in January and a new tariff structure will come into effect in April (see section on energy policy), which fully covers the operational cost of the electricity company (ENEE) (structural performance criterion). On the expenditure side, the authorities are committed to keep a tight lid on current primary spending of the central government (indicative ceiling) and increase public investment in infrastructure projects to reduce bottlenecks in the electricity sector and improve transport infrastructure. Conscious of the need to protect the poor, the authorities are improving the targeting of electricity and direct fuel subsidies while reducing their overall level. Staff encouraged the authorities to strengthen further the targeting of subsidies, including through a gradual lifting of price ceilings on gasoline and diesel, while continuing to subsidize cooking gas and kerosene, in line with recent Fund TA advice. The policy of no new net lending by public pension funds will help curtail spending, limit risk in their portfolios, and protect their financial integrity.

13. The stabilization of the wage bill is a key objective of the program. Containing the rapid rise in the wage bill will help attain the inflation objective, create space for priority spending, and support fiscal sustainability. In collaboration with the World Bank, structural reform measures will need to be implemented to bring the wage bill under better control in the medium term. In the meantime, there was agreement to stabilize the central government wage bill at 9.2 percent of GDP in 2008 and to reduce it to 9.1 percent of GDP in 2009 (indicative target), with the overall public sector wage bill contained at 11.4 percent of GDP in 2008, below 2007 levels. In order to achieve these goals, the authorities will:

  • Implement moderate wage increases. There will be no further wage or benefit increases for teachers beyond the 2006 agreement (which stipulates fixed nominal wage and benefit increases for 2008–09)—and nominal wage increases for other civil servants will be in line with projected inflation.

  • Control public employment. There will be no increase in net employment at the central government, with the planned hiring of teachers, policemen, and health workers fully compensated by retirements and other separations. Actions will be taken to tighten payroll control, including: establishing a centralized unit for payroll management at the ministry of finance; incorporating payroll management systems into the integrated financial management system (SIAFI); acting on irregularities revealed by a census and audit of teachers (including stopping payment and initiating legal actions), and extending the audit to the rest of the central government. Also, restructuring plans for the two largest state enterprises will be completed in late 2008.

14. The budget is financed entirely through concessional foreign lending. External concessional loans and proceeds from the sale of a cellular license band will exceed budgetary financing needs, allowing for negative domestic financing, reducing budgetary costs and supporting monetary policy. It will also help ensure a stable debt-to-GDP ratio over the medium term as external financing will be contracted only on concessional terms. After receiving over US$3 billion of debt relief, the NPV of Honduras’ external public debt is about 12 percent of GDP and is expected to remain below 14 percent in the medium-term—well below distress thresholds (50 percent of GDP) (Appendix II). Key sources of financing include:

uA01fig09

Reliance on domestic financing will be substantially reduced.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Sources: Ministry of Finance; and Fund staff calculations.

  • Petrocaribe. Concessional financing for US$350 million in 2008–09 is expected (about 2.8 percent of 2007 GDP), with about US$80 million earmarked in the 2008 budget to finance hydroelectric projects and upgrade transmission and distribution infrastructure. The authorities plan to earmark the rest for energy projects over 2009–12 and seek advice from the World Bank and IDB in the selection and monitoring of the projects. By investing in hydroelectric projects, the plan will help reduce fuel imports and the external current account deficit over the medium term. The creation of a trust fund at the central bank to hold the proceeds from Petrocaribe will help ensure that the resources are managed and recorded in a transparent manner and used for infrastructure only. Staff encouraged the authorities to resist pressures to use these funds for current spending.

  • Proceeds of a cellular license sale. The 2008 budget earmarks these one-time proceeds (0.6 percent of GDP) for already identified infrastructure projects, mostly roads. Since these resources are not debt creating, there are no risks for fiscal sustainability.

C. Containing Inflation and Safeguarding External Stability

15. Supported by fiscal policy, the monetary program for 2008 aims to contain inflation while reversing the declining trend in international reserves. Key priorities are to keep inflation within a range of 8–10 percent by containing the second-round effects of food and energy price and wage increases, while reducing the growth of bank credit to more sustainable levels. The program targets a build up of net international reserves of US$253 million to stabilize nonmaquila import coverage at 4 months.

Aided by fiscal policy, monetary policy is geared to achieve the reserve target while maintaining the stock of open market bills

article image
Source: Central Bank of Honduras.

16. Consistent with these goals, the central bank took some initial steps to tighten monetary policy. It raised the policy interest rate by 25 bps to 7¾ percent in February and is implementing additional measures equivalent to 2 percentage points of reserve requirements in March through a combination of higher obligatory investments and the placement of open market bills (prior actions). At the same time, the central bank introduced changes to obligatory investments and reserve requirements to bring them in line with levels in neighboring countries (particularly for reserve requirements on foreign currency deposits) and to discourage consumption lending (MEFP ¶6). In particular:

  • Increase in obligatory investments. These will be raised gradually by 5 percentage points (from 4 to 9 percent of bank deposits), starting in March. Government bonds, which will be used to repay ENEE arrears to private generators, were made eligible to meet these investments to induce banks to hold this paper.

  • Reduction in reserve requirements. These will be lowered gradually from 12 to 7 percent on Lempira deposits (and from 34 to 24 percent on U.S. dollar deposits), in monthly steps starting in March, for banks that increase their share of loans to priority sectors (which exclude consumer loans and retail).

17. While staff understands the rationale for the recent changes in obligatory investments and reserve requirements, it expressed several concerns. The team stressed that the reduction in reserve requirements could have an expansionary impact of up to 1 percent of GDP in 2008; the impact will be small initially, but could get bigger during the second half of the year as banks reconfigure their loan portfolios. Staff advised the authorities to implement uniform reserve requirements, avoid credit rules that could be circumvented, and encouraged them to allow market forces to play a greater role in determining interest rates on government bonds. The authorities argued that their policy of differentiated reserve requirements seeks to shift banks’ credit to priority sectors. They also underscored their intention to mop up any excess liquidity from these measures and to reassess them in the first review of the program, adjusting them as necessary to ensure consistency with program objectives. They also noted that bank collusion and uncompetitive conditions made it necessary to use obligatory investments to avoid excessively high interest rates.

18. Exchange rate policy will be geared to support monetary policy, safeguard external competitiveness and protect the economy against shocks. While the real exchange rate appears to be near its long-run equilibrium, Honduras maintains high price and wage inflation relative to trading partners and remains vulnerable to changes in world oil and food prices, external demand, and workers’ remittances. The authorities have started to satisfy only part of the bids at the foreign exchange auctions, allowing the exchange rate to move marginally away from the most appreciated edge of the band. The team encouraged the authorities to use this flexibility actively to protect external competitiveness and reserve targets were external developments to be more adverse than anticipated. Exchange rate management will be reexamined in the first program review based on a study of the options for the exchange rate system (MEFP ¶7).

uA01fig10

The growth of remittances has decelerated sharply in 2007.

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Sources: Haver analytics, country authorities.

19. Prudential policy will encourage banks to internalize the risks associated with the rapid expansion of bank credit, particularly for consumption. While the soundness of the banking system has improved considerably in recent years, the recent FSAP update noted that the entry of foreign banks and rapid credit expansion (mainly for consumption and commercial real estate) may put stress on the financial system. In this context, the issuance of regulations to tighten loan classification and provisioning is an important step. General provisions have been set for all loans, but with higher provisions for credit card debt and commercial loans with real estate collateral, which have been growing rapidly and are considered particularly risky. The authorities indicated that household mortgages were excluded to avoid restricting mortgage credit to low-income households. Swift implementation will be important to ensure that the regulations begin to take effect this year. The CNBS will also develop a timetable to introduce risk-based supervision, including the issuance of a regulation (MEFP ¶8) (structural performance criterion), and plans to use the recommendations of the recent FSAP update as a blue print to deepen banking reforms.

D. Strengthening the Energy Sector

20. Reforming the electricity sector is essential to safeguard the public finances and support growth. In coordination with the World Bank and the IADB, the strategy to ensure a sustainable energy policy includes putting the electricity company (ENEE) on a sound financial footing, improving its governance, reducing distribution losses and fraud, and reversing the persistent underinvestment in the sector (MEFP ¶9). The authorities named a new ENEE manager in early 2008 and have prepared an investment plan in consultation with the World Bank.

21. Ensuring the electricity company is on a sound financial footing is of key macroeconomic importance. To achieve this goal, the program envisages a tariff structure that fully covers operational costs. According to the World Bank, this implies raising electricity tariffs by 26 percent over end-2007 levels at December 2007 bunker prices (US$74 per barrel). In a decisive move, average tariffs were adjusted up by 15 percent in January and will be increased by a further 11 percent in April, when a new tariff structure comes into effect (structural performance criterion). The authorities intend to adjust tariffs periodically to pass-through any further increase in international fuel prices above their current level to domestic prices, in accordance with the current law, thus helping ensure that ENEE no longer falls into arrears with generators. Furthermore, with the congressional approval of the 2008 budget, all payment arrears of ENEE with generators will be cleared by end-June through the issuance of government bonds.

IV. Financing, Access and Program Modalities

22. The SBA would help unlock financing needed to cover a gap in 2008. This takes into account the need to maintain reserve coverage, with a projected slowdown of import growth through monetary and fiscal tightening and an increase in FDI (particularly in the maquila and telecommunication sectors). The financing gap is estimated at about US$76 million and is projected to be filled by World Bank and IADB budget-support loans and grants, and financing from other bilateral creditors. Swiftly unlocking external financing is important to avoid derailing the authorities’ investment program. Honduras will continue to remain current on its external debt payment obligations.2

23. The proposed precautionary SBA, with low access and minimum risk of failure to repay the Fund, covers the macroeconomic program through end-December 2008. Total access under the arrangement will be 30 percent of quota (SDR 38.85 million), with the first drawing of 25 percent of quota in line with first credit tranche policies, and the remaining 5 percent divided evenly between three purchases after reviews. Honduras is current on its payments toward the Fund and has no GRA purchases outstanding. Repurchase obligations under the proposed SBA will average 1.1 percent of projected gross reserves for 2010–2012.

The program would be financed by an increase in World Bank and IADB disbursements

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Source: Fund staff estimates.

Includes project-financed loans.

Assumes no purchases under the SBA

24. The program envisages three reviews, beginning at end-June 2008. Prior actions include a tightening of monetary policy and congressional approval of the 2008 budget consistent with an overall deficit of 1.5 percent of GDP and in line with the current expenditure indicative targets, including the wage bill. Quantitative performance criteria and indicative targets will be measured on a cumulative basis from January 1 (MEFP, Table 1). Given the importance of prompt action to strengthen the electricity sector and reduce risks in the financial sector, structural conditionality focuses on implementing a new tariff structure that fully covers the operational costs of ENEE; eliminating arrears of ENEE to help reduce the exposure of the financial system to the energy sector; and issuing regulations on risk based supervision to encourage banks to internalize the risks associated with the rapid expansion of credit (MEFP, Table 2).

Table 1.

Honduras: Selected Economic Indicators

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Sources: Central Bank of Honduras; Ministry of Finance; and Fund staff estimates.

Includes adjustments made for NIR and NDA due to Fund MDRI debt relief granted in January 2006 ($155 million).

Refers to the following year’s imports of nonmaquila goods and nonfactor services.

Goods only.

Includes medium and long-term public and publicly guaranteed external debt.

Debt service paid.

Table 2.

Honduras: Operations of the Central Government

(In percent of GDP)

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Sources: Honduran authorities; and Fund staff estimates.

Includes direct electricity subsidy and Bonochenta.

Includes urban transport subsidy and public transport fare stabilization subsidy.

Includes proceeds of the sale of a cellular band license in 2008.

In 2008 discrepancies are due to methodological differences between the Ministry of Finance and the Central Bank.

V. Staff Appraisal

25. During 2007, significant imbalances began to emerge in the Honduran economy. While growth remains robust, expansionary fiscal and monetary policies, in a context of a de facto fixed exchange rate, have led to rising inflation, a sharp increase in the external current account deficit, and a decline in international reserves. Bank credit has been expanding rapidly, fueling imports and posing risks to economic stability and financial health. In addition, weaknesses in the energy sector pose risks to the public finances, the financial system, and growth.

26. Staff considers that a precautionary SBA can play an important role in supporting the authorities’ program over the coming months. While a PRGF is better suited to address Honduras’ structural challenges, a medium-term structural reform agenda that enjoys broad support from all sectors of society still needs to be finalized. In this context, a precautionary SBA is appropriate to promptly address economic imbalances and reinforce confidence in the authorities’ economic program, thereby unlocking donor financing and serving as a bridge to a new PRGF later this year.

27. The authorities’ program appropriately strengthens macroeconomic policies and the energy sector. Reducing aggregate demand pressures and reforming the energy sector will improve public finances and enhance growth prospects. Early actions to date have been generally encouraging, including submission to congress of a prudent 2008 budget, a decisive increase in electricity tariffs, and a tightening of monetary policy, accompanied by a turnaround, since early February, in the declining trend of international reserves.

28. Fiscal consolidation and the redirection of spending to priority sectors is at the core of the authorities’ program. The program includes an underlying adjustment of 2 percent of GDP, which permits a reduction in the overall deficit and a substantial increase in public investment, reversing the trend in recent years. Debt ratios will remain below their indicative thresholds and resilient to shocks over the medium and long term. The pick up in public investment includes hydroelectric projects, supporting growth objectives and helping reduce fuel imports and the external current account deficit over the medium term. Conscious of the need to protect the poor, the authorities are improving the targeting of electricity and direct fuel subsidies. It will be important to strengthen further the targeting of these subsidies and to limit them to agreed ceilings in the context of rising oil prices.

29. Staff welcomes the authorities’ intention to stabilize and then reduce the public wage bill as a percent of GDP. Honduras’ public wage bill is high by regional standards and its sharp rise in recent years has contributed to crowd out anti-poverty spending and public investment and has added to inflationary pressures. Looking forward, it will be key to resist pressures for additional wage increases and develop a comprehensive wage policy for the public sector.

30. In contrast to past years, the budget is expected to be more than financed by concessional external lending, allowing a marked reduction in net domestic financing and supporting monetary policy. To this end, the authorities intend to move swiftly to unlock external financing. Staff welcomes the plan to earmark for hydroelectric projects the resources obtained from Petrocaribe. The creation of a trust fund at the central bank will help ensure that these resources are managed and recorded transparently. Staff encourages the authorities to resist pressures to use these funds for current spending.

31. Monetary tightening is key to the program. Staff welcomes the authorities’ actions to significantly tighten monetary policy ahead of the Board meeting and the steps taken on prudential policy to address the risks associated with the rapid expansion of bank credit. While staff understands the authorities’ rationale for the recent changes in reserve requirements and obligatory investments, it is concerned that these could have an increasingly expansionary impact on liquidity and limited effectiveness in redirecting credit to priority sectors. The impact of these changes on liquidity should be monitored carefully, with excess liquidity promptly mopped up, as the authorities intend, and the measures adjusted as necessary at the time of the first review to ensure that the program targets are met.

32. The authorities’ actions to allow greater flexibility within the existing exchange rate regime are welcomed. While the exchange rate appears to be in line with fundamentals, external conditions are deteriorating significantly and the economy remains highly vulnerable to oil prices and to a slowdown in the U.S. economy which would adversely affect remittances and exports. Staff encourages the authorities to stand ready to allow greater exchange rate flexibility, especially if external developments were to be more adverse than anticipated. The authorities have agreed to reexamine exchange rate management at the first review, in line with a study on the exchange rate system.

33. The program will help ensure that the electricity company is on a sound financial footing. Staff commends the authorities for their decisive increase in electricity tariffs and for their intention to adjust the new tariff periodically to pass-through any further increase in international fuel prices, thus helping avoid new arrears with generators. The expected clearance of all payment arrears with generators through the issuance of government bonds is also a key step. Staff encourages the authorities to continue working closely with the World Bank and the IADB to strengthen further the governance of the electricity company, reduce distribution losses and fraud, and reverse the persistent underinvestment in the sector.

34. The proposed Stand-By Arrangement will provide an anchor for economic policymaking and reinforce confidence, paving the way for an early move to a PRGF. Prior actions taken on the monetary side and the expected congressional approval of the budget are important, underscoring the authorities’ ownership. Looking ahead, it will be key to resist pressures for expansionary policies in the run-up to primary elections scheduled for late 2008, improve implementation of the capital budget and adjust policies promptly were the deterioration in external conditions to be higher-than-anticipated. Given the structural challenges in Honduras, staff urges the authorities to finalize swiftly a medium-term plan with policies for poverty alleviation and growth that could be supported under the Poverty Reduction and Growth Facility before end-2008.

35. In light of these considerations, staff recommends approval of the authorities’ request for a Stand-By Arrangement.

Table 2a.

Honduras: Operations of the Central Government - Quarterly

(in millions of lempiras)

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Sources: Honduran authorities; and Fund staff estimates.

Includes direct electricity subsidy and Bonochenta.

Includes urban transport subsidy and public transport fare stabilization subsidy.

Includes proceeds of the sale of a cellular band license in 2008.

In 2008 discrepancies are due to methodological differences between the Ministry of Finance and the Central Bank.

Table 3.

Honduras: Operations of the Combined Public Sector

(In percent of GDP)

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Sources: Honduran authorities; and Fund staff estimates.

Includes proceeds of the sale of a cellular band license in 2008.

In 2008 discrepancies are due to methodological differences between the Ministry of Finance and the Central Bank.

Table 3a.

Honduras: Operations of the Combined Public Sector - Quarterly

(in millions of lempiras)

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Sources: Honduran authorities; and Fund staff estimates.

Includes proceeds of the sale of a cellular band license in 2008.

In 2008 discrepancies are due to methodological differences between the Ministry of Finance and the Central Bank.

Table 4.

Honduras: Summary Accounts of the Banking System

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Sources: Central Bank of Honduras; and Fund staff estimates.

Includes the revaluation account reflecting changes in the value of assets due to exchange rate fluctuations.

Table 4a.

Honduras: Summary Accounts of the Banking System - Quarterly

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Sources: Central Bank of Honduras; and Fund staff estimates.
Table 5.

Honduras: Balance of Payments

(In millions of U.S. dollars; unless otherwise indicated)

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Sources: Central Bank of Honduras; and Fund staff estimates and projections.

Includes HIPC grants from the FIDA, IDB, IMF (until 2005), and the World Bank (until June 2006).

Equals the sum of reserve assets, reserve liabilities, and IMF.

Table 6.

Honduras: Illustrative Medium-Term Scenario

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Sources: Central Bank of Honduras; Ministry of Finance; and Fund staff estimates.

Refers to the following year’s imports of nonmaquila goods and nonfactor services.

Table 7.

Honduras: Purchase Schedule and Terms under Proposed Stand-By Arrangement

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Table 8.

Honduras: Indicators of Fund Credit

(In units indicated)

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Sources: Central Bank of Honduras; and Fund staff estimates.

End of period.

Expected repayment schedule, assuming a constant 4.38 rate of charge.

Table 9.

Honduras: External Vulnerability Indicators

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Sources: Central Bank of Honduras; and Fund staff estimates.
Table 10.

Honduras: Structure and Performance of the Banking Sector

(In percent, unless otherwise indicated)

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Sources: National Commission of Banking and Insurance;

Preliminary

Includes contingent assets.

NPLs exclude restructured loans, mostly to the agricultural sector.

Assets include off-balance sheet items.

Includes cash, public sector securities, and other liquid assets.

Attachment I. The Authorities’ Letter

Tegucigalpa, March 24, 2008

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington DC, 20431

Dear Mr. Strauss-Kahn,

1. In recent years, the Honduran economy has enjoyed robust economic growth and declining poverty. To preserve these gains, within the context of a slowing global economy, the Government of Honduras intends to strengthen policies to address emerging economic imbalances. In support of its macroeconomic program for 2008, the Government is requesting a precautionary 12-month Stand-By Arrangement with the International Monetary Fund, in the amount of SDR 38.85 million, equivalent to 30 percent of Honduras’ quota at the Fund.

2. In the enclosed Memorandum of Economic and Financial Policies (MEFP), we set out the goals and policies of the Government for 2008. These policies reflect the Government’s commitment to high growth and macroeconomic stability, which are key conditions for further reducing poverty. The Government believes that the policies set forth in the attached MEFP are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for the purpose. We will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund’s policies on such consultation. During the program, the Government will not introduce or intensify any exchange rate restrictions, multiple currency practice, and import restrictions for balance of payments purposes, nor conclude any bilateral payment agreements that are inconsistent with Article VIII of the Fund’s Articles of Agreement.

3. Program implementation will be monitored through quarterly quantitative and structural performance criteria set forth in Tables 1 and 2 of the MEFP, and through quarterly reviews with the Fund, with the first review to be completed by August 2008. Consistent with the intention to keep the public informed, the Government will publish the MEFP and will report periodically on progress under the program.

Table 1.

Honduras - Performance Criteria and Indicative Targets

(Cumulative flows from end-2007; millions of Lempiras, unless specified)

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The end-June performance criterion for net international reserves will be adjusted downwards by up to US$80 million if the foreign exchange proceeds from the sale of the mobile phone license are unrealized by that date. Conversely, the end-June performance criteria for net domestic assets of the central bank will be adjusted upwards by up to the same amount.

Prior action for end-March.

Table 2.

Honduras - Prior Actions and Structural PCs

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Sincerely yours,

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Attachment II. Memorandum of Economic and Financial Policies of the Government of Honduras

I. Program Objectives

1. Over the last four years, economic performance in Honduras has been strong. Output has grown rapidly at over 6 percent per year, inflation remained in single digits, and poverty declined. Since 2007, however, world oil and agricultural prices have surged, and remittances decelerated, especially in 2006–07. Credit to the private sector expanded rapidly, boosting domestic demand (both private investment and consumption) and imports, and the budget helped smooth the oil shock and social demands. Thus, pressures emerged on inflation, public finances, the energy sector, and the balance of payments.

2. The Government of Honduras has developed a stabilization program to address these pressing challenges. The program aims to preserve the conditions for sustained growth and poverty reduction through the consolidation of macroeconomic stability. Within a context of a slowdown in the global economy, the program seeks to achieve real GDP growth of about 5 percent in 2008, maintain single-digit inflation, and strengthen the external position. The program also includes a comprehensive reform to put the energy sector on a sound footing.

3. To achieve these goals, the government is implementing a package of economic and financial policies. The 2008 budget will target a combined public sector deficit of 1½ percent of GDP, while increasing infrastructure and anti-poverty spending. The monetary program supports an expansion of bank credit in line with growth objectives and maintains international reserves at 4 months of nonmaquila imports. Exchange rate policy will be managed to help maintain external competitiveness. The package will support a decline in the external current account deficit to 6 percent of GDP over the medium term.

4. The government will continue to refine its medium-term policies for poverty alleviation and growth and, in coming months, plans to finalize a program that could be supported under the Poverty Reduction and Growth Facility. To this end, in consultation with the Honduran society, the government will develop an agenda to: strengthen the medium-term fiscal framework; implement a comprehensive wage policy consistent with a steady increase in key social and infrastructure spending; improve the energy sector; enhance the transparency of the budgetary process; improve public sector institutions and fight corruption; further modernize the financial system, and continue to enhance the investment climate and overall competitiveness.

II. Economic and Financial Policies

A. Fiscal Policy

5. The 2008 budget (prior action) aims at containing the overall fiscal deficit at 1½ percent of GDP, down from 2¼ percent of GDP in 2007. This is consistent with a recovery in priority spending, with public investment rising 1¾ percent of GDP in 2008. Fiscal consolidation will continue in 2009, with the overall deficit target contained at about 1½ percent of GDP, helping public debt (both external and domestic) to remain stable at 22½ percent of GDP and locking in the benefits of substantial debt relief obtained in recent years. To attain these targets, the 2008 budget includes the following key actions:

  • Stabilizing the wage bill. The central government wage bill will be held constant at 9.2 percent of GDP in 2008 and 9.1 percent of GDP in 2009 (indicative target). To this end, the Government will strictly adhere to the 2006 wage agreement with teachers; grant wage increases for other civil servants, in line with projected inflation; and offset increases in employment in 2008 in priority sectors of the central government with retirements and other steps consistent with the findings of ongoing censuses and audits to keep employment at the level of December 2007. Actions will be taken to tighten payroll control, through: (i) setting up a centralized unit for payroll monitoring at the Ministry of Finance by end-April 2008; (ii) fully integrating payroll management modules of the health ministry and the civil service with the integrated system of financial management, SIAFI by end-August 2008, with the design of the module for the education sector completed by January 2009; (iii) finalizing a census and auditing of teachers by end-August 2008 and start acting on any irregularities by end-September; and (iv) extending the census and audit to the rest of the central government, starting with the health sector, by end-September 2008.

  • Further strengthening tax policy and administration. The Government will make permanent an income tax surcharge (Aporte Solidario Temporal) of 5 percent in the 2008 budget and submit to congress a draft anti-tax evasion law in May to improve tax administration. It will also enforce strict compliance of regulations for the sales and income tax exemptions by June 2008. The annual yield from this strategy is estimated at 0.6 percent of GDP.

  • Strengthening the operating balance of the main public enterprises. Key actions include: (i) implementing a tariff policy that covers operational costs over time and gradually modernizing ENEE (see below); (ii) introducing new temporary charges for international calls (US$0.03 per minute), and the adoption, by the state company (HONDUTEL), of increased charges for fixed lines—increasing revenue by about 0.3 percent of GDP; and (iii) completing financial audits for the two largest public enterprises (ENEE and HONDUTEL) by June 2008 and designing modernization plans for 2009 by October 2008.

  • Increasing priority spending. Current primary spending of the central government will be contained at 15.8 percent of GDP (indicative ceiling), consistent with a redirection of spending to priority sectors. Anti-poverty spending will increase to 7.0 percent of GDP (indicative floor) and public sector investment will increase to 6.5 percent of GDP, with the investment plan placing priority on basic infrastructure such as roads, energy, and ports.

  • Targeting subsidies to the poor. The direct electricity subsidy and the Bonochenta will be limited to users consuming less than 150 kwh per month (from 300 kwh) in April. The direct fuel subsidy will be capped at L1000 million (0.4 percent of GDP) for 2008 and targeted to the poor. The Government will appoint a technical group to strengthen the targeting of the overall subsidy policy, and prepare by July 2008, a report with recommendations to improve delivery of subsidies and identify enhanced schemes to better target direct fuel subsidies.

  • Adopting a policy of new lending consistent with loan recovery by the public pension funds. This policy is in line with the budget proposals of the public pension institutes and will result in fiscal savings of 0.8 percent of GDP in 2008. This measure will help contain the lending program of public pension institutes to their members, thus limiting the risk in their portfolios and protecting their financial integrity.

  • Reliance on external financing. The Government intends to substantially reduce domestic financing, helping crowd in private investment. The policy of contracting external financing only on concessional terms will be maintained (performance criterion, ceiling). Concessional financing from Petrocaribe for US$350 million in 2008–09 has been obtained; about US$140 million of these resources have been earmarked in the 2008 budget for projects on transmission and distribution of energy during the period 2008–09, and the rest will be earmarked for energy projects on hydroelectric generation and other infrastructure projects in poor areas. To maintain transparency, the government has established a trust fund at the central bank to manage the resources from Petrocaribe; and the central bank will report periodically on the operations of the trust to a blue ribbon committee comprising civil society members. In addition, the Government intends to use one-time proceeds of 0.6 percent of GDP from the sale of a mobile phone band to finance already budgeted investments in productive infrastructure projects, mostly roads.

B. Monetary, Exchange Rate, and Prudential Policies

6. Monetary policy will contain inflation at 8–10 percent in 2008, consistent with the adjustment of energy prices, a sustainable expansion of bank credit to the private sector, and strengthened net international reserves (NIR). The central bank has raised its policy interest rate (by 25 bps to 7¾ percent in February) and is taking measures by an amount equivalent to 2 percentage points in reserve requirements (either by increasing obligatory investments with a monetary effect or through additional sales of central bank bills to nonbank local investors), to bring NIR at end-March to the level of end-2007 (prior action). The central bank began raising obligatory investments by 5 percentage points in March (starting with 2 percentage points and subsequent monthly increases until June), which can be met with government paper to facilitate the repayment of arrears to private generators. To protect growth in a context of deteriorating external conditions, the central bank is reducing reserve requirements (by 5 and 10 percentage points for local and U.S. dollar deposits, respectively, in monthly steps over the period March–November) to those banks directing credit to productive sectors. Starting end-February, the central bank intends to maintain the stock of open market bills at or above a monthly indicative target to meet the program targets. The effectiveness of the recent reforms on reserve requirements will be assessed during the first review of the program and amended, if needed.

7. The central bank will aim to preserve the stability of the current exchange rate system, which allows the value of the currency to be determined within a band (± 7 percent from a mid-point). Consistent with this framework, the central bank will use more actively its monetary and exchange rate policy instruments, in a manner consistent with safeguarding external competitiveness and helping protect the economy against external shocks and achieving the reserve target in the program. This policy will be underpinned by prudent monetary and wage policies and will be adjusted as necessary in the event of adverse external developments. The Fund will undertake a study by end-May to assess the exchange rate system and adequate responses to external shocks.

8. The central bank monetary program is consistent with a prudent expansion of bank credit to support the program objective for growth. To encourage banks to internalize risks from a rapid credit expansion and reorient credit toward productive enterprises, the Comisión Nacional de Bancay Seguros (CNBS) will issue stricter norms for loan classification and raise loan provisioning (mainly for consumption credit) in March 2008 that will be implemented during 2008. These measures are equivalent to about 0.2 percentage points of risk-weighted capital asset ratio. The CNBS will also issue a regulation on risk-based supervision to improve its supervisory capacity and facilitate observance of the new classification and provisioning norms (structural performance criterion, April 2008). Looking ahead, the CNBS will develop a medium-term reform agenda, based on the findings and recommendations of the recent FSAP update.

C. Energy Policy

9. A center piece of the government program in 2008 is to implement a broad based strategy to strengthen the energy sector, expected to be supported by the World Bank and the IADB. This strategy is designed to: (i) put ENEE on a sustainable financial footing; (ii) improve the corporate governance of ENEE; (iii) reduce distribution losses and fraud, through congressional approval of anti-theft legislation in April 2008; and (iv) address a chronic under-investment in the sector. Of key importance from a macroeconomic perspective, is:

  • Implementing a tariff structure that covers operational costs. The Government will raise electricity tariffs by an average of 11 percent to cover ENEE’s operational cost at current bunker prices (US$72 per barrel), when a revised tariff structure, that better focuses subsidies on the poor, comes into effect in April (structural performance criterion). This revised tariff, set in accordance with the electricity law, will be adjusted periodically to fully pass-through any changes in international bunker prices. Government transfers will continue to cover ENEE’s financial cost and investments in 2008, but will be phased out in the medium term as the company further improves its revenue stream.

  • Resolving payment arrears. The 2008 budget authorizes the issuance of government bonds (L4 billion or 1½ percent of GDP) to clear payment arrears of ENEE with private generators. Upon transfer of these funds from the central government to ENEE, all public sector arrears with ENNE (½ percent of GDP) will be cleared. All arrears as of end-March 2008, of ENEE with private generators will be cleared by end-June 2008 (structural performance criterion). The new tariff policy will ensure that ENEE no longer falls into arrears with the private sector (quantitative performance criterion). The public sector will remain current on payments for electricity consumption.

D. Institutional Strengthening

10. The Government will implement a strategy to fight corruption and strengthen public institutions, which was presented to the international community in September 2007. Key actions include: providing legal protection to public employees involved in anti-corruption cases; reducing partisan influence in employment policy; disclosing financial statements of political parties and its financing, as well as on cabinet and high-level officials. With World Bank assistance, corporate governance and the AML/CFT framework will be strengthened.

III. Program Monitoring

11. The program will cover the economic program from January–December 2008 and will be monitored through quarterly reviews, with indicative targets for end-March and test dates for end-June, end-September, and end-December 2008 (Table 1). Prior actions and structural performance criteria are set out in Table 2. The definitions and reporting procedures are described in the attached Technical Memorandum of Understanding.

Attachment III. Technical Memorandum of Understanding

1. This memorandum sets out technical understandings between the Honduran authorities and the Fund for monitoring the economic program during 2008 supported by a Stand-By Arrangement. It defines the concepts used to assess observance of quantitative performance criteria and benchmarks specified in Tables 1 and 2 of the Memorandum of Economic Policies (MEFP). It also specifies the frequency of the data to be provided to the Fund for monitoring the program.

Table 1.

Honduras: External Debt Sustainability Framework, Baseline Scenario, 2005-2028 1/

(In percent of GDP, unless otherwise indicated)

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Source: Fund staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - r(1+g)]/(1+g+r+gr) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and r = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the NPV of new debt).

Table 2a.

Honduras: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2008-28

(In percent)

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Table 2b.

Honduras: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2008-28

(In percent)

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Sources: Fund staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), noninterest current account in percent of GDP, and nondebt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline, while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicity assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

I. Fiscal Targets

2. The deficit of the combined public sector (CPS) will be measured from the financing side, and corresponds to the net borrowing requirements of the CPS, from both external and domestic sources. The combined public sector comprises the nonfinancial public sector (NFPS) and the operating result (quasi-fiscal balance) of the central bank. The NFPS covers the central government (including its agencies), local governments and decentralized agencies, the social security institute (IHSS), the pension institutes for executive branch staff (INJUPEMP) and teachers (INPREMA), and the public enterprises.

3. The deficit of the central government will also be measured from the financing side. The central government includes the executive, judicial, and legislative branches of government. It consolidates the operations of trust funds created to support agricultural loans and so-called deconcentrated agencies.

4. The current primary expenditure of the central government is defined as total current expenditure less interest payments.

5. The central government wage bill is defined as all central government wages and salaries including severance payments, plus employer social security and pension contributions, and other remunerations (such as special bonuses and performance related remuneration to teachers under the PASCE).

6. Anti-poverty spending comprises all spending on programs and projects of the Poverty Reduction Strategy (whether financed by domestic savings, HIPC debt relief, grants, and external loans), as defined in the relevant annex of the 2003 PRSP and the latest update to the PRS. Programs and projects in the PRSP will be labeled in the 2008 budget and tagged through the SIAFI. Anti-poverty spending will be presented by economic classification, type of program, and source of financing.

7. The operating surplus of the public enterprises is the difference between the operating revenue (excluding interest earnings and transfers) and the operating expenditure (excluding interest payments and transfers) of the enterprises. For the purposes of the program, the public enterprises comprise the State Electricity Company (ENEE), the State Telecommunications Company (HONDUTEL), the State Water and Sewerage Company (SANAA), and the State Ports Company (ENP).

8. Net domestic financing of the CPS comprises the operating result of the central bank and the change relative to end-2007 in the stocks of: (1) outstanding indebtedness of the NFPS (direct bank credit plus bank holdings of public sector bonds less deposits) to the domestic financial system (central bank, commercial banks, and other financial institutions); (2) outstanding public sector bonds held outside the financial system; (3) outstanding deposits held abroad; (4) outstanding suppliers’ credit and floating debt (uncashed and undelivered checks, and unpaid invoices and orders) of the central government, and unpaid orders of the rest of the NFPS (all domestic debt is in domestic currency); and (5) proceeds from the sale of the mobile phone license.

9. Discrepancies. The authorities will undertake periodic reconciliations to minimize discrepancies between above-the-line and financing data. If needed, these reconciliations should be carried out prior to completion of the first and second reviews under the program.

II. Monetary Targets

10. Net International Reserves (NIR) of the central bank. For program purposes, NIR will be measured as gross international reserves that are readily available (including the balance of the Trust Fund instituted to manage financing from Petrocaribe) minus short-term reserve liabilities (including purchases and credits from the Fund), as described in the international reserves table prepared by the central bank according to the new monetary statistics presentation (MEMF). Readily available reserves also exclude those assets that are pledged or otherwise encumbered, including but not limited to reserve assets used as collateral or guarantee for a third-party external liability. NIR excludes (1) any conversion of short-term reserve liabilities; (2) foreign assets stemming from foreign currency deposits of financial institutions at the central bank; and (3) transfer to the central bank of foreign currency deposits of HONDUTEL, INJUPEMP, and IHSS held abroad, which amounted to US$121 million at end-2007. NIR will be valued at current exchange rates.

11. Net domestic assets (NDA) of the central bank will be measured as the difference between currency issue and NIR, both measured on the basis of end-of-period data.

12. Prior action. Monetary measures equivalent to 2 percentage points in reserve requirements (MEFP ¶6) will be defined over a base of end-December local currency deposits. The stock of central bank bills in the hands of nonbank local investors will be defined as the total stock of central bank bills less the stock in the hands of commercial banks (otras sociedades de deposito).

13. Adjustor: The end-June performance criterion for the floor on net international reserves of the central bank will be adjusted downwards by the amount of the proceeds from the sale of the mobile phone license that are unrealized by that date, or the amount of the proceeds that are realized in lempiras, by up to US$80 million. Conversely, the end-June performance criterion for the ceiling on net domestic assets of the central bank will be adjusted upwards by up to the same amount.

III. External Targets

14. External debt. As indicated in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted by the IMF Executive Board on August 24, 2000, debt will be defined as a current (not contingent) liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms: (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair, or maintenance of the property. (b) Under the definition of debt set out above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.”

15. Stock of external debt arrears. For the purpose of the program ceiling, external debt-service arrears are defined as overdue debt service arising in respect of obligations incurred directly or guaranteed by the public sector, except on debt subject to rescheduling or restructuring, as indicated by the respective creditors.

16. Borrowing on nonconcessional terms. For the purposes of the program, this ceiling applies to the contracting or guaranteeing of nonconcessional external debt by the CPS or any other agencies on their behalf. The ceiling applies not only to debt as defined above, but also to commitments contracted or guaranteed for which value has not been received.

17. Concessionality will be based on a currency-specific discount rate based on the 10 year (6-month) average of the OECD’s commercial interest reference rates (CIRR) for loans or leases with maturities greater (less) than 15 years, and following the methodology set out in Fund documents of April 8, 1996 and June 30, 2000. Maturity will be determined on the basis of the original loan contract. Under this definition of concessionality, only debt with a grant element equivalent to at least 35 percent (referring to the difference between the nominal value and the net present value of debt) will be excluded from the debt ceiling. In determining whether multiple financing instruments would be considered as an integrated incurrence of debt for the purposes of assessing the concessionality of that debt, the elements that Fund staff would take into account include: (i) identical intended use or purposes for the financing; (ii) inter-related schedules for disbursement; (iii) cross-conditions for entry into legal effect, availability of funds and default; and (iv) identical parties to the financing.

18. Excluded from the external debt ceiling are: (1) the use of Fund resources; (2) debts classified as international reserve liabilities of the central bank; (3) short-term import financing (with a maturity of less than one year); (4) debts to restructure, refinance, or prepay existing debts; and (5) central bank instruments placed in the domestic market held by nonresidents.

IV. Structural Reforms

E. Energy Policy

19. Arrears of ENEE are defined as overdue payments (principal and interest) as stipulated in the corresponding contracts. With proceeds from the issue of government bonds authorized in the 2008 budget, ENEE will clear all arrears to generators by end-June 2008. No new arrears to the private sector shall accumulate during 2008.

F. Monitoring and Reporting Requirements

20. The information required to monitor the compliance with quantitative and structural performance criteria and benchmarks specified in the MEFP will be supplied to the Fund at least monthly (electronically, to the extent possible) within 45 days of the end of the previous month (unless otherwise noted) according to the following sources:

21. The ceilings on the deficit of the central government and of the CPS will be monitored below-the-line on the basis of the monthly reports Financiamiento de la Administración Central and Financiamiento del Sector Público Combinado, respectively, prepared by the central bank, which contain:

  • Net external financing of the central government and the NFPS, respectively, with detailed information on disbursements, amortizations, exceptional financing, zero-coupon bond, and accumulation of arrears. This information is prepared by the central bank and reconciled with the Ministry of Finance.

  • Net domestic financing of the central government and the NFPS, respectively, with detailed information on: (1) net domestic financing from the central bank and the rest of the financial system to the central government and the NFPS, as contained in the Panorama Financiero monthly report; (2) net placement of bonds (including stabilization bonds) by the central government and the NFPS outside the financial system, as reported by the central bank with data from the Public Credit Directorate of the Ministry of Finance; (3) change in foreign currency deposits held abroad by the central government and the NFPS; and (4) change in the outstanding stock of suppliers’ credit and floating debt of the central government, as reported by the Treasury, and the rest of the NFPS as reported by the central bank. To monitor the net domestic financing to the CPS, the central bank will provide the Fund with detailed data on a cash basis on the operating revenue and expenditure of the central bank.

22. The ceilings on the wage bill of the central government will be monitored monthly on the basis of the ministry of finance report: Información institucional por objeto de gasto -servicios personales y aportes patronales.

23. To complement the monitoring of fiscal performance, a breakdown of tax revenue by type of tax will also be provided monthly to the Fund.

24. Anti-poverty spending will be monitored quarterly on the basis of the information provided by the ministry of finance. Anti-poverty spending will be obtained from the detailed central government report: Cuenta Financiera. The Ministry of Finance will also provide the breakdown between anti-poverty and other spending by expenditure category (i.e., wages and salaries, goods and services, current transfers, fixed capital formation, and capital transfers).

25. The floor on NIR and the ceiling on NDA of the central bank will be monitored on the basis of information produced by the central bank, in accordance with the new presentation of the monetary statistics (MEMF). This information will be provided within two weeks of the end of the previous month.

26. The ceilings on the contracting of nonconcessional external debt and on the nonaccumulation of external payments arrears will be monitored with information provided by the Ministry of Finance. The accounting of nonreschedulable external debt-service arrears by creditor (if any), with detailed explanations, will be transmitted by the Ministry of Finance on a monthly basis within four weeks of the end of each month. Moreover, a loan-by-loan accounting of all new loans contracted or guaranteed by the public sector, including detailed information on the amounts, currencies, and terms and conditions, as well as relevant supporting materials, will be transmitted by the central bank on a quarterly basis within four weeks of the end of each quarter.

Appendix II. Assessing External and Public Sector Debt Sustainability1

Honduras’ debt ratios will remain below their indicative thresholds and resilient to shocks over the medium and long term. This reflects low initial debt ratios and the projected consolidation of macro stability. After receiving debt relief under the HIPC Initiative and MDRI, the NPV of Honduras external debt declined to 12 percent of GDP at end-2007. Honduras reached the Completion Point under the HIPC initiative in April 2005 and received over US$800 million in stock of debt reduction. The debt was reduced further by US$2.3 billion when additional stock of debt relief was provided by the IMF and the World Bank in 2006 under MDRI and by the IDB in 2007. As a result, the external debt-to-GDP ratio declined from 60 percent of GDP at end-2003 to 16 percent at end-2007. Debt to multilateral institutions represented about 77 percent of the total stock of debt at end-2007.

The baseline scenario assumes low fiscal and current account deficits, low inflation, and sustained growth over the medium and long run. In the short run, a stabilization program will contain demand pressures, initiate a sustainable energy policy, increase public investment, and make permanent recent revenue gains. In the medium term, structural reforms will sustain growth in traditional sectors, and a better investment climate will spur growth in maquila, tourism, construction, and the financial sector, contributing to the consolidation of macroeconomic stability. Uncertainties in the external environment (in the medium term) and stabilization of migratory flows (in the long run) will contribute to a slow-down in the growth of remittances. Sound fiscal policy will keep the overall fiscal balance below 2 percent of GDP, and investments in the energy sector will help reduce dependency on imported fuel. As a result, long-run growth will stabilize at 4.2 percent, and export and import growth will stabilize at about 8 and 7 percent, respectively, allowing the current account deficit to remain below 6 percent of GDP (on average). Financing will remain mostly external and concessional for the medium term, although at a declining rate of concessionality.2 In the long-run, after Honduras’ likely graduation from concessional multilateral donor financing, the grant element of new debt will decline below 35 percent.

Honduras’ external debt ratios will remain stable under the baseline scenario, with the debt outlook remaining robust under alternative scenarios. The NPV of debt-to-GDP will remain below 14 percent over the horizon of the analysis; only under extreme negative shocks does this ratio peak at 32 percent in 2013. Similarly, all relevant debt ratios remain stable under the baseline scenario and substantially below the indicative debt burden thresholds under the extreme stress test.3

Honduras’ public debt will continue on a sustainable path. The NPV of public debt-to-GDP will remain below 20 percent under the baseline scenario, and below 40 percent under the most extreme stress test (a permanent decline in GDP). Consolidation of improvements in revenue administration will be key to keep the debt service ratio at current levels.

Table 3.

Honduras: Sensitivity Analysis for Key Indicators of Public Debt 2008-2028

article image
Sources: Honduran authorities; and Fund staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of 20 (i.e., the length of the projection period).

Revenues are defined inclusive of grants.

Table 4.

Honduras: Public Sector Debt Sustainability Framework, Baseline Scenario, 2005-2028

(In percent of GDP, unless otherwise indicated)

article image
Sources: Honduran authorities; and Fund staff estimates and projections.

Debt of the general government, includes treasury bonds issued to repay arrears of ENEE.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Figure 1.
Figure 1.

Honduras: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Source: Fund staff projections and simulations.
Figure 2.
Figure 2.

Honduras: Indicators of Public Debt Under Alternative Scenarios, 2008-2028 1/

Citation: IMF Staff Country Reports 2008, 241; 10.5089/9781451817201.002.A001

Source: Fund staff projections and simulations.1/ Most extreme stress test is test that yields highest ratio in 2018.2/Revenue including grants.

Appendix III. Honduras—Summary of Annexes

Fund Relations

Honduras’ outstanding purchases amount to SDR 20.34 million, 15.71 percent of the quota. Honduras’ de jure exchange arrangement is a crawling band, but the de facto exchange rate regime is a conventional pegged arrangement. The last Article IV consultation with Honduras was concluded on February 21, 2007. An FSAP mission was conducted in 2003 and an update was carried out in September–October 2007. The Banco Central de Honduras (BCH) was subject to an assessment completed on February 11, 2004. It identified certain weaknesses and made recommendations to which the BCH has responded by adopting several measures in the field of internal controls, financial reporting framework, and external auditing. An update assessment of the BCH safeguards framework has been recently initiated in relation to the requested new arrangement. Honduras’ most recent Stand-By Arrangement expired in 1992.

Relations with the World Bank Group4

As of January 22, 2008, the IDA active portfolio in Honduras consists of 16 projects for a total commitment of US$347.6 million; of which US$198 million remain to be disbursed (Honduras was declared IDA-only in September 1991). The active projects are focused on infrastructure, growth to address poverty, and financial sector institutional development. Overall, the IDA expects to disburse $93.5 million in calendar year 2008, $144.1 million in 2009 and $46 million in 2010, of which $27.3 million and $30 million in 2008 and 2009 would be in the form of fast-disbursing budget support. The current CAS covers the period 2007–2010.

Relations with the Inter-American Development Bank5

As of January 22, 2008, there were 31 projects in the Bank’s loan portfolio for US$671.3 million, with an undisbursed balance of US$460.3 million. After the Bank Debt Relief the annual allocation for 2008 is US$97.1 million for each year. Total MDRI debt relief from IDB to Honduras was approved on February 2007 and the debt relief amount was US$1367 million (principal plus interest). A new country strategy is expected to be approved for the board in March 2008.

Statistical Issues

Data on the public finances, balance of payments, and external debt broadly satisfy minimum criteria required for surveillance and program monitoring purposes. However, a consistent and reliable method is needed for deriving estimates of private capital flows. Honduras has participated in the General Data Dissemination System (GDDS) since September 29, 2005.
1

A precautionary SBA is more appropriate than a Policy Support Instrument (PSI) given Honduras’ uneven performance under previous PRGF’s and because the authorities have yet to finalize a three-year policy framework and policy matrix.

2

Arrears with private creditors of US$5 million were recorded when some creditors did not participate in the October 2000 IDA debt repurchase offer for lack of sufficient supporting documentation; no request for payments has been received since then. The existence of these arrears does not undermine program implementation.

1

This is a Fund staff update of the joint World Bank/IMF DSA conducted in Country Report 06/442. The annual joint World Bank/IMF DSA will be prepared at the occasion of the next Article IV Consultation.

2

According to Honduras’ public sector credit norms, it can borrow externally only on concessional terms.

3

The thresholds are determined by the World Bank’s Country Policy and Institutional Assessment (CPIA) rating. In 2005, Honduras was upgraded from a medium to a strong performer, and Honduras remained a strong performer since then, with a CPIA rating of 3.9 on a scale of 1 to 6.

4

Adapted from text prepared by World Bank staff on January 23, 2008.

5

Adapted from text prepared by IADB staff on January 8, 2007.

Other IMF Content

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Cover IMF Staff Country Reports
Honduras: Request for Stand-By Arrangement-Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Honduras
Author:
International Monetary Fund
Volume/Issue:
Volume 2008: Issue 241
Publisher:
International Monetary Fund
ISBN:
9781451817201
ISSN:
1934-7685
Pages:
78
DOI:
https://doi.org/10.5089/9781451817201.002

Honduras is among the poorest countries in the region.
Figure 1.

Honduras: Macroeconomic Performance—Imbalances are Growing

Inflation is among the highest in the region.

The deficit is increasing and the quality of spending is deteriorating.

The wage bill is the highest in the region.

The monetary stance is expansionary, and the stock of open market bills has fallen.

The REER has appreciated in the context of a stable nominal exchange rate…

…but there is no evidence of significant misalignment.

The finances of state enterprises have weakened.

Reliance on domestic financing will be substantially reduced.

The growth of remittances has decelerated sharply in 2007.
Figure 1.

Honduras: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027
Figure 2.

Honduras: Indicators of Public Debt Under Alternative Scenarios, 2008-2028 1/