Haiti: Selected Issues

Abstract

Haiti: Selected Issues

External Buffers and Competitiveness to Absorb Shocks and Support Growth1

A. Introduction

1. Haiti’s real exchange rate is broadly aligned with fundamentals, but competitiveness is severely constrained by structural factors. This note presents the external stability assessment for the 2015 Article IV consultation. The application of various methods of analyzing the appropriateness of Haiti’s real exchange rate (RER) level suggests that it is broadly aligned with fundamentals. This is the case despite some ‘fear of floating’ given the large pass through from exchange rate depreciation to inflation. Haiti’s exchange rate arrangement is, nonetheless, flexible enough to respond to shifts in underlying economic conditions. Formal assessments of the RER are of limited use as a measure of competitiveness, which in Haiti is constrained by weak institutions, poor infrastructure, and a cumbersome regulatory environment. In this regard, synthetic indicators place Haiti near the bottom of cross-country indices of international competitiveness.

2. Maintaining international reserves equivalent to 4–5 months of imports would provide an adequate buffer for Haiti to withstand shocks and avoid stop-and-go growth dynamics. The estimates presented in this note balance the use of reserves a buffer against shocks against the costs of holding relatively low-yielding reserve assets. The analysis suggests that maintaining reserve coverage of 4–5 months of prospective imports is appropriate for Haiti given its high level of vulnerability to shocks and limited response capacity. This should allow attenuating stop-and-go growth dynamics that have characterized the country during the last 30 years, and capital accumulation.

3. The recent decline in international oil prices is the most significant terms of trade shock facing Haiti since 2008–09. The oil price decline has been a positive terms-of-trade shock for Haiti, which has significantly narrowed the current account deficit and has contributed to increasing domestic fiscal revenue in a context of fixed pump prices. However, these gains have been partially offset by lower Petrocaribe financing flows.

B. External Stability Assessment

4. The equilibrium real exchange rate approach suggests that Haiti’s currency is broadly aligned with fundamentals. The application of the equilibrium real exchange rate (ERER) approach developed by the Consultative Group on Exchange Rates (CGER) suggests that the RER has not significantly deviated from the level implied by its fundamentals during the last two decades. The ERER approach estimates Haiti’s equilibrium exchange rate as a function of its terms of trade, productivity relative to trading partners, changes in public spending, net foreign assets, and remittances. All variables except changes in public spending were found to be statistically significant, and the results suggest that the real exchange rate has closely tracked these fundamentals over a long period. In particular, the surge in transfers and debt forgiveness that occurred after the 2010 earthquake caused the ERER to rise (see Chart 1), but the RER adjusted more slowly, as the central bank (BRH) intervened to boost its international reserve position. More recently (in FY2013 and FY2014), the BRH has sold reserves to smooth the pace of depreciation, and end-FY2014 results suggest a modest overvaluation of under 5 percent.

Chart 1.
Chart 1.

Real Exchange Rate Assessment

(CGER Equilibrium Real Exchange Rate Approach)

Citation: IMF Staff Country Reports 2015, 158; 10.5089/9781513541587.002.A004

Sources: IMF staff estimates.

5. Haiti’s RER has remained broadly appropriate despite some ‘fear of floating’. While the de jure exchange rate regime is a float, the BRH seeks to limit the annual nominal depreciation against the U.S. dollar, given the significant pass-through to inflation, and as a way to anchor expectations. As inflation has been higher in Haiti than in its trading partners over the last few years, limiting exchange rate depreciation has resulted in some real appreciation of the gourde (Chart 2).

Chart 2.
Chart 2.

Real Effective Exchange Rate

(January 2007 = 100)

Citation: IMF Staff Country Reports 2015, 158; 10.5089/9781513541587.002.A004

Sources: IMF staff estimates.

6. The application of the Macroeconomic Balance (MB) and External Stability (ES) approaches to assess the RER do not point to significant deviations from equilibrium. MB approaches estimate benchmark current account balances based on a set of relative fundamentals. This note reports the application of two of those approaches to Haiti. The first, a modified External Balance Assessment approach (“EBA Lite”), produces a very large benchmark deficit for 2015 of 7.1 percent of GDP, implying a very large undervaluation of close to 40 percent, using an assumed elasticity of the current account derived from Isard and Faruquee (1998) (Table 1). In Haiti’s case, the results are driven by a very low level of relative productivity, which is associated with capital inflows, and by relatively high levels of aid and remittances, which are associated with a weaker current account. The second, the MB presented in IMF (2006) suggests a smaller current account deficit of 3.6 percent of GDP as a medium-term benchmark; this MB approach is based on a different set of fundamentals, with Haiti’s low productivity being partially offset by its relatively balanced net foreign asset position (post–debt relief). Finally, the ES approach calculates the current account deficit that is consistent with keeping external debt at some benchmark level (in this case, 40 percent of GDP). This approach results in a current account benchmark of -3.2 percent of GDP, close to current levels, again suggesting that the currency is broadly aligned with fundamentals.

Table 1.

Current Account Benchmarks

(Units as indicated)

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Source: IMF staff estimates. CGER approach calculates benchmark based on medium-term fundamentals, EBA uses current year. ES approach uses long term growth and inflation projections.

7. All of these approaches have significant shortcomings as a measure of Haiti’s competitiveness. As suggested in Di Bella et al. (2007), analyses of the RER as a measure of competitiveness are complicated by the use of the CPI as a proxy for the price of non-tradables. In the case of Haiti, food accounts for half the CPI basket, making it unlikely to be representative of the costs of firms. Moreover, standard RER measures ignore the effect of imported inputs, which become more expensive in local currency terms as a currency depreciates, offsetting some of the competitiveness gain of devaluation. The vast majority of Haiti’s exports involve the final processing of imported fabric into apparel, and thus Haitian exports have very high import content. Moreover, the results of econometric models should likewise be treated with caution, as they rely on a set of fundamentals that in Haiti have been volatile due to a wide range of shocks and are subject to data quality issues, and use coefficients that do not directly account for country-specific structural factors. For example, while Haiti’s still-low wages are assumed to be a powerful factor for attracting capital by implying a higher return, in practice (for reasons discussed below), financial flows into Haiti have long been low despite its location and favorable access to the U.S. market (See Selected Issues Paper, “Opportunities and Challenges for Growth”).

8. Haiti’s competitiveness is constrained by numerous structural factors. While econometric analysis suggests that the exchange rate is not a key obstacle to Haiti’s external performance, such models do not directly account for a set of other factors that in Haiti’s case are serious obstacles to its international competitiveness. The lack of basic public services means that firms must often arrange for their own electricity, sanitation, and security, and must deal with poor infrastructure. Haiti’s port costs are the highest in the region, driving up the costs of Haiti’s exports and also the imported inputs into those exports. For example, exporting through Haiti’s ports costs 15 percent more than in the neighboring Dominican Republic; importing costs 35 percent more, and in both cases the necessary procedures require 2–3 more weeks (World Bank 2014). Haiti’s business environment is also difficult from a legal and regulatory perspective, with cumbersome procedures (including on land transactions, see Selected Issues Paper “Opportunities and Challenges for Growth”), and an often unclear and sometimes outright contradictory legal framework. This legal framework, combined with a weak rule of law, creates further uncertainty, for example in whether the Labor Code permits nighttime work in the assembly industry, or under what terms productive workers must be paid more than the base minimum wage (Better Work Haiti, 2015). Haiti also appears to have lost ground in relative terms in recent years, as measured by its percentage rank in the World Bank’s “Doing Business” survey, where it remains in the bottom 5 percent of all countries surveyed (Chart 3 3; see World Bank 2014). Haiti has seen some progress with regard to perceptions of corruption, albeit from a low base, but comparator countries have made progress as well (Chart 4; see Transparency International 2014).

Chart 3.
Chart 3.

Evolution of Ease of Doing Business

(Percentage rank)

Citation: IMF Staff Country Reports 2015, 158; 10.5089/9781513541587.002.A004

Sources: World Bank; and IMF staff estimates.
Chart 4.
Chart 4.

Evolution of Corruption Perceptions

(Percentage rank)

Citation: IMF Staff Country Reports 2015, 158; 10.5089/9781513541587.002.A004

Sources: Transparency International; and IMF staff estimates.

9. A number of cross-country surveys illustrate some of the biggest obstacles to Haiti’s competitiveness. According to “Doing Business”, Haiti performs particularly poorly on starting a business, which involves 12 procedures and generally takes 97 days (see table). Notably, the costs involved have risen considerably since 2010. Haiti is the last place on the survey on resolving insolvency. The World Economic Forum’s “Global Competitiveness Report” has a broader focus and assigns gives the lowest rank for Haiti under its Institutions sub-index. Within the category of institutions, insecure property rights, transparency of government policymaking, and the efficiency of the legal system are highlighted as particular concerns.

Table 2.

Haiti’s Ranking on International Surveys, Latest Available Year

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Source: World Bank; Transparency International; and World Economic Forum.

C. Haiti’s Optimal Level of Reserves

10. Haiti’s needs a substantial reserve cushion due to its vulnerability to shocks. Estimating an optimal reserve level begins with an assessment of the trade-off between the likelihood and potential costs of shocks against the costs of holding reserves. Haiti’s undiversified economy faces a wide range of potential shocks spanning weather events, political tension, and volatile external financing. The human costs of a shock to domestic absorption are high, as a large share of the population lives close to subsistence. On the other hand, Haiti also has large infrastructure gaps and thus faces significant opportunity costs in holding low-yielding reserve assets.

11. An appropriate reserve cushion would help Haiti attenuate the stop-and-go growth dynamics that have lowered Haiti’s per capita income in recent decades. Haiti has seen several periods of negative per capita income growth over the past 30 years, often associated with political instability but which have also been due to a food price shock and an earthquake. The severity of these shocks has driven per capita income downward despite positive growth in non-crisis years (see Staff Report, Box 2). An adequate reserve buffer would reduce the severity of these shocks but also avoid the destruction of capital that later impedes growth in non-crisis years, promoting steadier per capita income growth.

12. At about 4.8 months of imports and 45 percent of broad money, Haiti’s international reserves remained appropriate according to generally used rules of thumb. While this represents a decline from the post-earthquake peak, reserves remain appropriate according to frequently used rules of thumb. The first such rule (i.e., that reserves cover three months of imports), measures the appropriateness of the reserve cushion to withstand a shock to the current account. The second (i.e., that reserves correspond to 20 percent of broad money) measures resilience in the face of capital flight. On both measures, Haiti’s reserve coverage remains appropriate and higher than in most low-income countries (see Charts 5 and 6). However, such generic benchmarks ignore the frequency of idiosyncratic shocks and country-specific circumstances.

Chart 5.
Chart 5.

Gross International Reserves

(Months of Prospective Imports)

Citation: IMF Staff Country Reports 2015, 158; 10.5089/9781513541587.002.A004

Sources: IFS; WEO; and IMF staff estimates.
Chart 6.
Chart 6.

Reserves as Share of Broad Money

(Percent)

Citation: IMF Staff Country Reports 2015, 158; 10.5089/9781513541587.002.A004

Sources: WEO; and IMF staff estimates.

13. A model accounting for a Haiti’s specific circumstances may produce a better estimate of optimal reserve coverage than generic benchmarks. The framework proposed by Dabla-Norris et al (2011) attempts to measure the benefit of reserves in avoiding crises and in reducing their severity as well as the costs of reserve holdings. This model takes country-specific characteristics into account that have a known relationship in influencing whether a given shock results in an economic crisis (defined as a drop in domestic absorption). The shock variables (terms of trade, external demand, FDI to GDP, and aid to GDP) were set at the bottom 10 percent of Haiti’s specific distribution over the past ten years, and are intended to estimate Haiti’s vulnerability to crisis events. Haiti’s fundamentals (CPIA, fiscal balance, and imports to GDP), set at current levels, are intended to gauge the potential severity of a crisis event (see Table 3).

Table 3.

Variables for Optimal Reserves Estimate

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Sources: IMF staff estimates.

14. The frequency of shocks is another important factor in the model. Over the past ten years Haiti has seen at numerous distinct shocks, counting only weather events that impacted more than 200,000 people (Table 4). A longer-term analysis, carried out by the International Disaster Database reports that Haiti has been struck by shocks every 1–2 years since 1900. Accordingly, for the purposes of the model, the unconditional probability of a shock is assumed at 0.5, i.e., that Haiti is assumed to have a 50 percent chance of undergoing some shock each year, albeit not necessarily one that generates a crisis.

Table 4.

Significant Shocks to Haiti Since 2004

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Source: EMDAT; and IMF staff estimates.

15. The results suggest an optimal level of reserves of 4 months of imports. This estimate of an optimal level of reserves is based on the unconditional probability of a shock, the country-specific factors that influence a shock’s impact on the economy, and an assumed opportunity cost of holding reserves of 4.5 percent. Haiti’s calculated optimal reserve level is pushed upwards by the volatility in external demand, terms of trade, and FDI and aid in recent years, as well as by its weak CPIA score. The country’s flexible exchange rate is an important mitigating factor. Also important is the recent decline in the import bill and the significant fiscal consolidation programmed for FY2015.

16. This estimate should be treated with some caution and may best be seen as a lower bound. The decline in international oil prices is an important driver of these results by reducing Haiti’s import dependence (see Section C); if reversed Haiti’s optimal reserve level would rise. In addition, Haiti is classified as having a flexible exchange rate for the purpose of this analysis, but the exchange rate’s role as a nominal anchor suggests that the costs of a sharp devaluation would be sizeable and thus the exchange rate may not be able to fully accommodate a significant shock. The analysis is also designed to be risk-neutral, but some degree of risk aversion may be warranted, as external shocks can quickly lead to food insecurity and human suffering. Taken together, maintaining reserves near the mid-point of 4–5 months of imports may be prudent, in order to balance the use of reserves as a buffer against the costs of holding relatively low-yielding reserve assets.

D. The Impact on Haiti of Lower Oil Prices

17. The sharp decline in international oil prices improves Haiti’s terms of trade. Oil prices have recently witnessed the largest decline since the global financial crisis. As of March 2015, spot crude oil prices were down 50 percent from one year earlier (see Regional Economic Outlook, Western Hemisphere, Box 2.3). This sharp drop represents a large positive terms-of-trade shock for oil importers, including Haiti. Under the latest WEO projections, Haiti’s oil balance would improve by about 4.5 percent of GDP in FY2015.

18. However, the oil price fall also reduces Petrocaribe financing, partially offsetting the improvement in the balance of payments. Since, 2007, Haiti has borrowed from Venezuela under the Petrocaribe agreement, which allows participating countries to obtain long-term debt at below-market rates as they purchase oil from Venezuela. The level of financing is tied to the international oil price, and during the recent period of high oil prices, Petrocaribe flows to Haiti were about 4 percent of GDP per year. The current period of lower oil prices should reduce Petrocaribe flows to about 2 percent of GDP, partially offsetting the improvement in Haiti’s balance of payments.

19. The fall in Petrocaribe financing has also prompted Haiti to carry out a fiscal adjustment. Petrocaribe financing has financed a large part of the fiscal deficit in recent years, with the financing being used for domestic infrastructure projects but also for transfers to EDH. The authorities are pursuing the necessary fiscal adjustment in large part by reducing energy subsidies. By keeping domestic pump prices essentially unchanged in the face of the fall in international oil prices, the authorities are again able to collect customs duties and excise taxes that were previously forgone (that in FY2014 represented about 2 percent of GDP).2

20. The decrease in oil prices also increases the risk of a sudden stop. The fall in oil prices exacerbates the economic situation in Venezuela, raising the risks of a possible discontinuation of the Petrocaribe program. As Haiti still receives relatively large flows and has little alternative financing sources, a significant further adjustment would be necessary, although the impact on the economy would be less than in an environment of high oil prices.

References

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1

Prepared by Lawrence Norton (WHD)

2

The authorities increased fuel prices in October 2014 (7.5 percent for gasoline, 9.3 percent for diesel and 6.2 percent for kerosene), but decreased prices in February 2015.

Haiti: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.