Statement by Hurtado, Executive Director for Honduras and Ms. Garcia Corzo, Advisor to the Executive Director October 26, 2016

The Honduran authorities thank staff for the candid and productive discussions during 2016 Article IV Consultation and Third and Fourth Reviews Under the Stand-By Arrangement (SBA) and Standby Credit Facility (SCF). They also thank Management and Executive Directors for their continued support.

In 2013, Honduras medium-term economic and development prospects were undermined by fiscal imbalances, weak external position and structural weaknesses. A strong comprehensive fiscal consolidation strategy and an ambitious structural reform plan were needed to preserve fiscal sustainability and pave the way for higher sustainable and inclusive economic growth.

In October 2016, after almost two years of successful program implementation and strong ownership by the government, Honduras has taken significant steps on the right path for achieving its economic and development goals over the medium-term. Fiscal sustainability has been restored, fiscal prudence has been institutionalized with the approval of the Fiscal Responsibility Law, social expenditure has been protected, public investment has increased, the external position has been strengthened, significant advances have been made on structural reforms (including tax administration, state-owned enterprises and the public wage bill) and investment confidence has been bolstered. Furthermore, successful program implementation has been a catalyst for other multilateral and bilateral donors’ support as well as for sovereign credit ratings upgrades.

Recent economic developments

Economic activity remains strong. The quarterly GDP increased 4.5 percent (yoy) during the second quarter of 2016, with all economic sectors reporting a positive performance. The main economic activities contributing to growth were financial intermediation, manufactures, agriculture, communications, energy and commerce. On the expenditure side, growth was supported mainly by exports and private consumption encouraged by lower gasoline prices and strong remittances inflows. The economic outlook for the remainder of the year is positive. Real GDP growth is projected at 3.6 percent in 2016, supported by increased public sector infrastructure investment and a supportive monetary policy stance.

Lower international commodity prices continue impacting the external accounts. As of June 2016, total exports have decreased by 5.5 percent (yoy) mainly due to lower exports of coffee (-22.6 percent) as a result of a reduction of about 19 percent in prices and to a lesser extent of exported volumes (-4.5 percent). Total imports reported a contraction of 9.4 percent during the same period, mainly due to lower imports of machinery for energy plants already in operation and to lower fuel prices as imports of fuels decreased about 22 percent. As a result, the trade deficit improved by 21.8 percent. Remittances inflows increased by about 6 percent during the same period and are expected to remain strong, reaching almost 19 percent of GDP by end-2016. A current account deficit of 5.3 percent of GDP is expected for end-2016 (9.5 percent of GDP at end-2013).

Inflation and inflation expectations remain contained. Headline and core inflation continued their downward trend reaching 2.90 percent and 3.29 percent (yoy), respectively, in September, supported by continued low oil prices and a still negative output gap, while inflation expectations set the rate at 2.96 percent by the end of the year, below the lower band of the inflation target range of 4.5 +/- 1 percent set by the Central Bank. Considering that inflationary pressures are contained, the Central Bank has implemented a more supportive monetary policy stance by reducing its monetary policy interest rate in 150 bps from 7.00 percent in December 2014 to 5.50 percent in June 2016. This reduction has already translated to lower interest rates in the banking system as interest rates for loans in local currency have decreased 79 bps from Dec-2015 to July-2016 and 143 bps since Dec-2014. Regarding interest rates for loans in foreign currency, the downward trend shown during the last years has changed in recent months, showing an increase of 11 bps from Dec-15 to July-2016. Meanwhile, total credit to the private sector increased by 10.9 percent as of July (yoy) mainly supported by credit in local currency (13.7 percent increase) which accounts for more than 70 percent of total credit. Credit in foreign currency increased by 4.0 percent as of July, significantly lower than the two-digit growth rates observed in previous years (18.2 percent in Dec-2013), in part due to the tightening of regulations on credit to unhedged borrowers.

The banking system remains sound and profitable while actions are being taken to further strengthen its supervision and legal frameworks. The capital adequacy ratio was 13.7 percent as of July, above the 10 percent minimum legally required; the ratio of non-performing loans to total loans was 3.6 percent with more than a 100 percent coverage; the return on equity reached 13.6 percent and liquid assets represented 3.3 percent of deposits. Furthermore, actions are being taken to reduce risks in the financial sector including by strengthening the legal framework for bank resolution; upgrading an early warning committee to perform as a Financial Stability Council; adopting higher capital requirements for foreign-currency borrowing by unhedged agents; issuing new guidelines to strengthen pension funds’ investment policies and governance according to international best practices; and strengthening anti-money laundering regulations including the recent resolution issued by the Central Bank to reduce the amount of cash deposits in local and foreign currency on a monthly basis. Also, the Fund is providing TA to strengthen the macro-prudential framework and the results from the recent Financial Sector Stability Review mission will provide key additional elements to further improve the financial system’s supervision and legal framework.

Fiscal discipline has been restored. The balance of the non-financial public sector was 0.9 percent of GDP by June, supported by strong tax collections (17 percent annual increase) and expenditure control. However, a deficit of 1.5 percent of GDP is expected at the end of 2016 (well below the 7.2 and 3.9 percent of GDP of 2013 and 2014, respectively), to accommodate higher infrastructure and social spending, As of June, total public debt was 46.3 percent of GDP of which 34 percent was denominated in local currency and 74 percent was at fixed interest rates. Also, less than 5 percent of total debt is due within the next year.

Fiscal policy is expected to become more prudent, predictable and transparent. In April, Congress approved the Fiscal Responsibility Law which will lock-in fiscal discipline and increase fiscal policy predictability and transparency by: i) establishing limits to the non-financial public sector deficit, the annual growth rate of nominal current expenditure and new arrears; ii) instituting the adoption and publication of a medium-term fiscal framework whose implementation has to be reported to Congress on an annual basis by the Secretary of Finance; and iii) establishing that all trust funds (former and new) financed with public resources should be managed within the public budget. Regarding control of the payroll, important advances have been made as currently all payrolls in the central administration are executed through the integrated financial management information system which is linked to the public employment management system.

The government launched a five-year strategic program to foster employment and economic growth. The program was launched earlier this year and approved by Congress in April. It benefits from a broad support of the private sector and focuses on six key sectors: i) tourism; ii) textile industry; iii) intermediate manufactures; iv) services to support businesses (e.g. call centers); v) housing; and vi) agroindustry. A specific entity was created to coordinate program implementation; its Executive Director will report to a board comprised by members of government and private sector.

Strengthening institutions and fostering investment climate

The tax authority has undergone complete overhaul with a new and strengthened tax authority already in place which is in the process of hiring and training new personnel. The new agency will be fully operational early next year. Customs reforms are also ongoing, a detailed mapping of the business process has been established and operating manuals have been issued and implemented in one of the seaports as a pilot to enhance collection of import duties in gasoline and bulk freight.

Measures to strengthen the financial position of the energy company (ENEE) are ongoing. Besides the reduction of the wage bill, the creation of an independent regulatory agency for the electricity sector (CREE) and the appointment of its three commissions, all measures taken last year, in 2016 the CREE has put in place a comprehensive tariff scheme that will secure cost recovery. Furthermore, the government is implementing an aggressive plan to reduce non-technical electricity losses, maintain and upgrade the distribution network and streamline costs. Specific targets for the reduction of non-technical losses have been set for the current and the next six years.

The operational framework for conducting monetary policy keeps improving. The Central Bank (BCH) has introduced daily liquidity auctions and is working on further improving its liquidity forecasting and management. Furthermore, the information exchange with the Secretary of Finance, which will improve monetary and fiscal policy coordination, was recently formalized through an agreement between the two institutions. Also, with TA from the Fund, BCH plans to develop the interbank market and increase the signaling content of the monetary policy rate. With support from the Fund, BCH has decided to gradually implement an inflation-forecast targeting framework which will be accompanied by continued progress towards a more flexible exchange rate. In order to reduce excess liquidity and within a medium-term strategy to phase out mandatory investments for financial institutions, in September the Central Bank increased reserve requirements from 7 percent to 12 percent and reduced mandatory investments (mainly in government bonds) from 10 percent to 5 percent.

Decisive actions are being taken on fighting corruption, strengthening the rule of law and reducing the levels of crime and violence. Earlier this year, the government and the Organization of American States (OAS) signed an agreement to establish the Mission to Support the Fight Against Corruption and Impunity in Honduras (MACCIH). Its areas of action are based on four components: i) prevention of and combating corruption; ii) reform of the criminal justice system; iii) political and electoral reform; and iv) public security. It is expected that MACCIH will be fully operational shortly and its members will provide active cooperation, technical advice, supervision and oversight of the state institutions responsible for preventing, investigating, and prosecuting corruption. Furthermore, the government has made the reduction of crime and violence one of its top priorities. Progress on this front include an ongoing strong police force reform as well as a comprehensive plan to fight gangs and drug trafficking which is being implemented in close coordination with the governments of neighboring countries (El Salvador and Guatemala). Also, the budget allocated for security purposes is expected to continue increasing in the following year.

Improving social programs management. The government is working with the World Bank to strengthen management of the conditional cash transfers program (Bono Vida Mejor) to ensure that it is more effective, cost efficient and transparent. Also, additional resources have been secured for the rest of the year as the government seeks to expand coverage of the extreme poor to reach 300,000 families by 2017. The Secretaries of Labor and Social Security, Education, and Social Inclusion are developing a study to identify ways of formalizing the linkages between existing Active Labor Market Programs and CCT beneficiaries to support the transition from schools to jobs and with microenterprise programs to support entrepreneurial opportunities.

Investment confidence has improved. Besides the actions being taken to fight crime, violence and corruption as well as to strengthening the rule of law and preserving macroeconomic and financial stability, the government has been working on promoting doing business easing. The progress made so far on these areas has been recognized by credit rating agencies Moody’s and Standard & Poor’s by improving Honduras’ ratings (Moody’s) and setting a positive outlook (both) in May and July, respectively, reflecting the view of continued progress on fiscal policy and reform agenda for the near term. Furthermore, Honduras improved five positions on the ease of doing business 2016 World Bank ranking (110 out of 189); it was also highlighted in the report as the country that improved the most (43 positions) in the area of protecting minority investors in the last years and was noted among the countries with more improvement on strengthening frameworks for secured transactions.

Regarding program implementation, most performance criteria (PC) and all of the indicative targets for end-December 2015 and end-June 2016 have been met. The PC on net domestic assets of the Central Bank for end-December 2015 was missed by a minor deviation and corrected by end-June 2016. Also, the authorities have taken the corrective measures to address the deviation from the net-lending by public pension funds program target for end-June 2016 as well as to clear the temporary increase in domestic arrears from the National Electricity Company. Thus, on behalf of our authorities we request a waiver for these nonobservances. We also request the completion of the Third and Fourth Reviews under SBA and SCF arrangements.

The authorities remain confident that the planned policy mix is adequate for a successful implementation of the program. Nonetheless, the government stands ready to take additional measures that may be required to achieve program objectives. The program will continue to be treated as precautionary.