The IMF-supported program (2014-17) succeeded in reducing Honduras' macroeconomic imbalances.

Abstract

The IMF-supported program (2014-17) succeeded in reducing Honduras' macroeconomic imbalances.

Background

1. Honduras’ public debt increased slightly in 2017. After satisfactory completion of the IMF-supported program (December 2017), gross public debt stood at 40¾ percent of GDP in 2017, an increase of about ¼ percentage point of GDP relative to 2016.2 In 2017, the NFPS posted a deficit of ¾ percent of GDP, and the sovereign placed international bonds for US$700 million at a historically low rate of 6¼ percent.

2. External debt increased in 2017. The increase in 2 percentage points of GDP (from 35½ percent of GDP in 2016 to 37½ percent of GDP in 2017) reflected the above-mentioned bond placement. The procedures from the placement were used to pay liabilities from the public electricity company ENEE. Consequently, the actual change in the stock of total external debt is larger than the implicit variation derived from identified debt-creating flows in the LIC-DSA template, thus causing a large residual in 2017. Total external debt figures are consistent with the standard BOP coverage including public banks and the monetary authority.

3. Public debt is mostly with foreign creditors. The share of public debt that is external rose from 72 percent in 2016 to about 77 percent in 2017 due mainly to the above-mentioned external bond issuance. The main external lenders to Honduras are the Inter-American Development Bank (IADB), the Central American Bank for Economic Integration (BCIE), and the World Bank. Debt to these institutions carries long maturities but only the IADB continues to provide loans on concessional terms (i.e., with a grant element of at least 35 percent). Domestic public debt is mainly with commercial banks, has a shorter—though rising—maturity (about 3 years), and carries a higher real interest rate. In March-2018, the authorities placed their first 15-year Lempira-denominated bond in the local market at a fixed interest rate of 11 percent.

Underlying Assumptions

4. Economic growth. The baseline scenario assumes that growth will decelerate to 3¾ percent in 2018, owing to less favorable conditions abroad and uncertainty affecting private consumption and investment. Private consumption and public investment will be the main drivers of growth. Over the medium term, it is expected that growth will converge towards potential (3¾ percent), a similar outlook as envisaged in the previous DSA

5. Fiscal policy. As in the previous DSA and consistent with the fiscal responsibility law (FRL) we expect the fiscal outlook continued to be anchored by the FRL, which sets a NFPS deficit ceiling of 1 percent of GDP from 2019 onwards and a limit of about 3 percent in the real increase for current spending. Additionally, the DSA is aligned with the authorities’ priority to control the increase in public debt stated in their revised macroeconomic framework. In the baseline scenario, the primary balance becomes consistently positive backed by fiscal reforms undertaken in 2013–2017. As part of these reforms, the gatekeeper role of the minister of finance has been strengthened with the requirement of a formal assessment on the size of fiscal liabilities (including contingencies) by the newly created contingency unit for all PPP operations. Thus far this new unit has resulted in a better prioritization of PPP projects. The baseline projection assumes that starting in 2021, the net flows from PPPs would be negative.

6. Fiscal institutions. Consolidating the role of the FRL as the cornerstone of macroeconomic policies continues to be the main challenge for the next years. On this front, the experience in Latin America with the adoption of a FRL is mixed. In some countries, a FRL failed to institutionalize fiscal prudence while in others it served to catalyze fiscal reforms and became the backbone of sound policy making. The implementation of the FRL in Honduras requires developing institutions, strengthening commitment, and fostering transparency and accountability across all levels of government. This process is off to a good start but it needs to be entrenched as a binding medium- term target.

7. Public sector financing. It is assumed that public financing will be contracted mainly from external sources. Financing conditions are expected to change toward less concessional terms compared to recent years, including with multilateral institutions and in line with Honduras increasing ability to tap international markets. Authorities have been targeting increased Lempiras-denominated debt issuance, with a longer maturity profile. Domestically, authorities target a minimum of 80 percent of the public debt portfolio be issued at fixed rates.

8. External sector. On the back of large remittances inflows, favorable terms of trade, and a recovery in coffee production, the current account deficit declined to 1¾ percent of GDP in 2017, its lowest level since 2001. The current account deficit is projected to hover around 4 percent over the medium term, and stabilize at around 3½ percent of GDP over the longer term. Slower growth in remittances, coupled with less favorable terms of trade, explain the move toward higher deficits, which is in line with fundamentals and desired policy settings (see Annex I). As in the previous DSA, the current account deficit continues to be financed primarily by foreign direct investment and, to a lesser extent, public sector borrowing, with small private sector flows. This outcome allows for international reserves to remain around 5 months of non-maquila imports throughout the projection period.

External Debt Sustainability Analysis

9. Public and public guaranteed (PPG) of external debt is expected to start decreasing in the medium term (Annex II. Table 1). PPG external debt is projected to peak at about 33 percent of GDP in 2022, from about 31 percent of GDP in 2017. The share of PPG external debt in total public debt rises slowly to about 82 percent by 2022. The increase takes place as total debt decreases substantially due to fiscal consolidation. Private external debt is projected to be around 4 percent of GDP through the period.

Table 1.

Honduras: External Debt Sustainability Framework, Baseline Scenario, 2015–38 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r – g – ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growt h rate, and ρ = 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 PV 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 PV of new debt).

Selected Macroeconomic Indicators, Current vs. Previous DSA

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Source: IMF staff estimates.

Defined as the last 15 years of the projection period. For the current DSA, the long term covers the period 2024–38, whereas for the previous DSA it covered 2023–37.

10. External debt ratios remain within indicative thresholds in all scenarios.3 The ratios for the PV of PPG external debt and PPG debt service remain below their indicative thresholds in all scenarios throughout the projection period. PV of external PPG remains initially stable and starts to decline in 2023.

11. In the baseline scenario, debt indicators remain within indicative thresholds under the probability approach. All ratios remain within indicative thresholds under the baseline scenario (Figure 2). Under the most extreme shock (one-time 30 percent depreciation), the ratio for the PV of debt-to-GDP plus remittances ratio breaches the threshold in 2020 and only returns to levels below the threshold in the late 2026. The ratio of debt service to revenue is breached only in 2020 under the most extreme shock (a one-time 30 percent depreciation), reflecting the bullet payments of the 2013 bond issuance.

12. External debt indicators appear resilient to a customized scenario combining negative real, fiscal and financing shocks. The customized scenario aims at capturing possible downside risks and key vulnerabilities in Honduras. It includes negative shocks to GDP growth, which could arise from weaker external conditions; tighter external financing conditions that could be associated with negative developments in international financial markets; and a weaker fiscal position from possible slippages in the implementation of the fiscal responsibility law. In this scenario, the PV of PPG external debt-to-GDP plus remittances ratio rises initially up to 24 percent and starts to decline in 2023. The ratio of debt service-to-exports plus remittances and debt service to revenue also remain below their indicative thresholds throughout the projection.

Baseline vs. Customized Scenario 1/

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Source: IMF staff estimates.

In the customized scenario, (i) real GDP growth is 2.5 percent in 2018 and 2.8 in 2019, and rises on average 0.25 percentage points per year to reach 3.5 percent in 2022, staying at this level for the remainder of the DSA period; (ii) financing conditions from external capital markets deteriorate permanently, raising the average interest rate on new external debt by 100 basis points; and (iii) the overall deficit increases by 2 percent of GDP in 2018 compared to the baseline and then fades out partially at a constant rate of 15 percent during the DSA period.

Defined as the last 15 years of the projection period. For the current DSA, 2024–38.

Public Debt Sustainability Analysis

13. Public debt ratios are expected to peak in 2021 and then start to decline subsequently (Table 3). Public debt is projected to peak at about 41½ percent of GDP in 2021 (up from 40¾ percent of GDP in 2017) and start falling slowly as fiscal consolidation proceeds and interest payments decline reaching 30 percent of GDP by 2028. In present value terms, the debt-to-GDP ratio is expected to peak at around 36¼ percent of GDP in 2021 and fall to about 25 percent of GDP by the late 2020s. Public debt dynamics remain somewhat vulnerable to both policy-related and exogenous shocks, especially to those related to economic growth and fiscal policy (Annex II. Table 4). However, under no scenario the PV of debt-to-GDP ratio breaches its benchmark.

Table 2.

Honduras: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2018–38

(In percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt 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 (implicitly 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.

In the customized scenario, (i) real GDP growth is 2.6 percent in 2016 and 2.5 in 2017, and rises on average 0.25 percentage points per year to reach 3.5 percent in 2021, staying at this level for the remainder of the DSA period; (ii) financing conditions from external capital markets deteriorate permanently, raising the average interest rate on new external debt by 100 basis points; and (iii) the overall deficit of the CPS increases by 2 percent of GDP in 2015 compared to the baseline and then fades out partially at a constant rate of 15 percent during the DSA period.

Table 3.

Honduras: Public Sector Debt Sustainability Framework, Baseline Scenario, 2015–38

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Gross debt of t he Combined Public Sector

As defined in t he fiscal accounts

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.

Table 4.

Honduras: Sensitivity Analysis for Key Indicators of Public Debt 2018–38

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Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.