We would like to thank the staff for a candid and well-balanced report. Our authorities broadly agree with the staff’s appraisal and recommendations.

The authorities would also like to thank management and staff for a productive policy dialogue throughout the program negotiations, which was crucial not only to reach agreement on main policy measures, but also to foster Honduras’ re-engagement with the Fund. We are also grateful to the Executive Directors for their support during this process.

To bolster their economic program, the authorities request the approval of a combined SBA/SCF arrangement totaling SDR 129.5 million (each equivalent to 50 percent of quota), covering 18 months. Their intention is to treat the arrangement as precautionary.

The new arrangement will provide crucial support to the authorities’ commitment to sound macroeconomic policies and will help anchor confidence of depositors, investors (domestic and foreign) and creditors. It will also provide an important liquidity buffer to support the economy in case negative shocks occur. Finally, it will also open the door for additional support from other multilateral institutions.

Recent Developments

During 2009, the Honduran economy was severely affected by the global crisis, as well as domestic political turmoil. Real GDP declined by 1.9 percent and unemployment rose significantly. In addition, the fiscal position deteriorated markedly and international reserves declined by about US$360 million, to the lowest level since 2006. Although external conditions have begun to improve in 2010, economic growth is still weak and the recovery faces risks.

To establish conditions for robust and sustainable growth in the medium term, the Government has started to implement key reforms, and has developed an economic program for 2010–11 aimed at reducing macroeconomic imbalances and strengthening the finances of the public sector. They expect that strong implementation of this program will help bolster investor confidence and build up further support of the international community.

Macroeconomic Policies for 2010–11

The economic program envisages a gradual recovery, with real GDP growth in the range of 2.5-3.5 percent during 2010–11. Inflation is expected to rise, largely reflecting higher prices of imported goods (mostly oil), but authorities will conduct monetary policy in order to maintain inflation below 6 percent throughout the program. The deficit in the external current account is projected to rise to 6–7 percent of GDP (from 3.2 percent in 2009) owing to higher prices of imported commodities (mostly oil) and strong demand for public and private investment. A strong pickup in FDI and in official external financing throughout the program period is expected to be sufficient to cover the current account deficit and, as a result, gross international reserves are expected to increase gradually.

Fiscal Policy

Our authorities’ fiscal policy aims at improving the quality of public expenditure, reducing the overall deficit of the public sector to 2 percent in the medium term, and keeping the debt-to-GDP ratio below 30 percent. In line with these objectives, the overall deficit of the consolidated public sector for end-2010 will be lowered to 3.7 percent of GDP (4.6 percent in 2009), provided a higher tax revenue and expenditure restraint. The 2011 budget, submitted to Congress in mid-September 2010, targets an overall fiscal deficit of the central government of 3.4 percent of GDP, in line with the overall deficit of the consolidated public sector of 3.1 percent of GDP. The budget will accommodate higher spending in priority areas, mostly poverty reduction and public investment. To achieve this objective, the authorities plan to fully implement tax measures approved last April, and exercise strict control of public sector current spending. In addition, they plan to adopt the following measures during 2010–11:

Improve tax administration: further strengthening of the institutional framework for tax collections, including submitting to Congress legal reforms to enhance tax administration and introducing institutional upgrading of the tax collection agency (DEI).

Budget financing. Our authorities’ strategy includes a lower reliance on domestic financing. In line with this objective, they have requested budget support from the World Bank and the IDB totaling US$220 million for 2010-11. In addition, the Central American Bank for Economic Integration (CABEI) recently approved a non-concessional loan of US$280 million, which remains within the limit on the contracting of non-concessional debt of US$350 million. The authorities maintain constant communication with those multilaterals in order to avoid delays in the disbursements programmed for 2010.

Control of the wage bill. Policies in this area are aimed at reining growth of the wage bill of the central government. In that sense, the authorities approved a plan in June designed to verify the number of public employees in the education and health sectors, suspend hiring of new workers, and eliminate all redundant or irregular positions. They also took actions to guarantee that the increase in the wage bill for 2010 would only reflect contractual obligations in the education sector; nominal wages of government employees in other sectors have remained broadly unchanged. Authorities are resisting pressures from unions to increase the salaries of the public sector employees for 2011.

Control of expenditure in goods and services. For 2011, authorities will maintain the ceiling established in the 2010 budget for central government expenditure in goods and services. In addition, they will start using reverse auctions and online purchases to reduce costs and increase availability of indispensable goods in the public sector.

Improved public investment management. Our authorities will develop, by March 2011, a plan to strengthen management of investment projects at the institutional and execution levels through simplification of the mechanisms and processes for the procurement, implementation, and monitoring of public investment.

Elimination of energy subsidies. In June, energy subsidies were eliminated, except for consumers with electricity consumption below 150 KWh.

Strengthening of the operating balance of key public enterprises. Tariffs in the electricity, telephone, and water companies have been raised with the view of making them gradually compatible with projected costs. Comprehensive plans for restoring financial and operational viability of key public sector enterprises will be prepared during 2011.

Strengthening the financial position of public pension funds. The pension funds together with the Banking and Securities Commission have developed an action plan to reform the law in order to reduce the actuarial deficit of the main public pension funds by redefining benefits and contributions. They will present a draft law based on this action plan to Congress by December 2010.

Audit of government arrears to private sector suppliers. By January 2011, with IDB’s assistance, a contract will be signed with a reputable international audit company to undertake an audit of accumulated domestic arrears to the private sector. Based on this audit, authorities will develop a plan to clear only arrears generated from contracts that adhered to existing regulations and procedures.

Monetary and Exchange Rate Policies

Keeping inflation under control, while maintaining an adequate level of international reserves, remains the main goal on monetary policy. Authorities will monitor monetary conditions throughout the program period and will stand ready to change monetary policy stance by adjusting policy interest rate as necessary to maintain inflation between 5.5–6 percent (+/- one percentage point) in 2010–11 and to protect the external position.

It is worth to mention that the authorities have been placing central bank instruments to sterilize excess liquidity and have stopped lending to the financial public sector since last January. They have been analyzing ways to improve the exchange regime administration. Moreover, based on past technical assistance missions from the Fund, the authorities plan to reform the operational framework for monetary policy and set up the infrastructure to enhance functioning of the exchange market.

To boost the Central Bank’s ability to pursue effective monetary policy, the authorities will develop a plan for its capitalization and institutional strengthening by December 2011. To this purpose, they will request technical assistance from the IMF.

Financial Sector Policies

The financial system has weathered the crisis well, and remains liquid and solvent. Building on the progress achieved in recent years, our authorities are fully committed to further improve the regulatory framework and supervisory practices in the financial system and to strengthen the financial safety net, as recommended in the update of the Financial Sector Assessment Program (FSAP). The efforts include improvements in risk-based supervision, enforcing capital and provisions requirements effectively, and enhancing liquidity monitoring. To achieve these objectives, the authorities are executing an ambitious reform program to comply with regulations on credit and liquidity risk management according to international standards, improve banking supervision, and consolidate the financial safety net.

Structural Reform Agenda

The priorities in this area are consistent with our authorities’ long-term growth strategy and will be implemented in the next four years. In that sense, envisaged reforms include adopting a multi-annual budgetary framework, strengthening debt management capacity, and increasing efficiency of public enterprises. In order to improve the investment climate, Congress is considering a draft law on investment protection and promotion. To enhance transactions safety, and to facilitate commercial and administrative operations, the authorities will make the use of electronic signatures legal.

Finally, we believe that the envisaged policies are adequate to meet the objectives of the authorities’ economic and social program and we are certain that authorities stand ready to take additional measures (in consultation with the Fund) that should be necessary for that purpose. In this vein, our authorities share the staff’s assessment related to the program’s risks and, as a prudential measure, have been working on a contingency plan to face a scenario in which some of the risks materialize. We also think that a new program will be instrumental to preserve Honduras’ macroeconomic stability and to help support economic recovery.