Dominican Republic: Request For Purchase Under The Rapid Financing Instrument—Press Release; Staff Report; And Statement By The Executive Director For The Dominican Republic
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
07 May 2020
eISBN:
9781513543109
Language:
English
Keywords:
ISCR; CR; financing; request; resource; financing gap; Executive Board discussion; monetary policy rate; inflation targeting framework; request for emergency; headline inflation; COVID-19; Public sector; Fiscal stance; Emergency assistance; Global; operating income; urgent balance of payments; net error; percent of GDP; urgent BOP need; Foreign direct investment; NPLS net
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Request for Purchase under the Rapid Financing Instrument-Press Release; Staff Report; and Statement by the Executive Director for the Dominican Republic

Abstract

Request for Purchase under the Rapid Financing Instrument-Press Release; Staff Report; and Statement by the Executive Director for the Dominican Republic

Background

1. The Dominican Republic has enjoyed a prolonged period of impressive economic performance. It has been the fastest growing economy in Latin America (6½ percent) over the last several years, while inflation was muted and the external position strong.

2. The political calendar reduces the room for policy maneuver. Presidential elections (initially scheduled for May 17, 2020) have been posponed to July 5, 2020 due to the COVID-19 pandemic, but the change of government will continue to take place on August 16, 2020. Municipal election (initially scheduled for February 16, 2020) were suspended due to the failure of the e-voting system, which prompted social protests. The rescheduled elections were held on March 15 (despite the COVID-19 outbreak), and the opposition Modern Revolutionary Party won the majority of the mayor offices.

Recent Developments

3. The COVID-19 pandemic came at a time of macroeconomic strength and stability:

  • Economic activity moderated in 2019. Real GDP growth eased to 5.1 percent in 2019 (from 7.0 percent in 2018). High-frequency indicators point to a robust expansion in January and February.

  • Inflation remained within the Central Bank target range of 4±1 percent. Inflation increased to 3.7 percent in 2019 (from 1.3 percent in 2018) and stayed at that level through February.

  • The fiscal stance remained relatively neutral. The consolidated public sector deficit fell to 3.3 percent of GDP (from 3.5 percent in 2018) with no change in the central government deficit.

  • Monetary policy remained accommodative. The BCRD lowered its policy rate during Q3–2019 by 100 basis points (in 3 stages) to 4.5 percent and eased reserve requirements.

  • The financial system ended 2019 sound but vulnerable. Banks remained well capitalized, profitable and liquid. Credit continued growing at a healthy rate. NPL fell to 1.6 percent in 2019.

  • The external position remained stable. In 2019, the current account deficit remained steady at 1.4 percent of GDP (similar to 2018), fully financed by foreign direct investment (FDI).

Impact of COVID-19

(Percent of GDP unless otherwise indicated)

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Source: IMF staff calculations.

Impact of COVID-19

4. The COVID-19 pandemic has severely affected the Dominican economy. As of April 13, there were 3,167 confirmed cases with 177 fatalities. President Medina declared a national state of emergency on March 19 establishing a country-wide curfew accompanied by school and border closures and the suspension of public activities and mass gatherings. Non-essential businesses have been ordered to close for 15 days (with the exception of supermarkets, grocery stores, gas stations, pharmacies, and medical supply stores). As a result, commercial activity has been heavily disrupted, and the tourism industry has been paralyzed.

5. The unanticipated global shock from the pandemic has deteriorated the outlook. Preliminary estimates suggest that real GDP will fall to -1 percent in 2020 (from an expansion of 5.1 percent in 2019), while the current account deficit could widen to 5.2 percent of GDP in 2020 (from 1.4 percent of GDP in 2019). Containment costs and pressures on revenues could likely increase the fiscal deficit to 6.0 percent of GDP in 2020 (from 3.3 percent of GDP in 2019).

6. The shock will also have a large balance of payments impact. The urgent balance of payments (BOP) needs in 2020 emanate from a deterioration in tourism and trade activities in the free trade zone, and a decline in capital inflows, although the historic decline in oil prices offsets some of these pressures. The impact of the COVID-19 shock on the BOP can be analyzed by comparing current BOP projections for this year with a baseline projection in the absence of COVID-19. Under this metric, the BOP impact of the shock for 2020 could amount to US$4.8 billion (5.7 percent of GDP) despite some relief coming from lower oil prices. The BOP gap is driven by a projected deterioration in the current account (US$3 billion) and portfolio investment (US$1.3 billion).1 Part of the the BOP gap will be closed with use of international reserves.

Balance of Payments: COVID-19 Impact

(In billions of U.S. dollars)

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Source: IMF staff estimates.

7. External debt obligations are large. External debt amortizations are estimated at US$1.9 billion (2.3 percent of GDP) in 2020 and could increase financing needs in the event of a sudden stop in capital flows.

8. The authorities are approaching other multilateral institutions to cover external and fiscal financing needs. While the 2020 budget was fully financed, staff expects the fiscal position to deteriorate by about 2¼ percent of GDP. To this end, the authorities have approached the World Bank, the Interamerican Development Bank (IDB), and the Development Bank for Latin America (CAF) to mobilize loans and commercial credit lines to shield the economy. Disbursements are expected soon.

Risks to the Outlook

9. The main risk to the outlook arises from a greater-than-expected severity of the epidemic. The economic outlook is subject to an unusual degree of uncertainty related to the impact of COVID-19 on the global economy and the Dominican Republic, and the outlook can easily turn out much worse than envisaged. Staff projections assume that the spread of the disease will be contained at moderate levels and activity will resume relatively rapidly as the health crisis begins to wane. However, the situation could evolve along a more negative trajectory. Should this occur, additional measures to strengthen domestic health services and provide support to vulnerable populations would be needed.

Policy Discussions

10. The authorities have already announced a package of measures to counter the COVID-19 shock on the economy. On March 25, President Medina announced a package of fiscal measures amounting to RD$32 billion (about ¾percent of GDP, including reallocation of expenditures) focused on providing temporary relief to poor households. The government created a social assistance program titled Quédate en casa (Stay at Home) to support informal-sector workers, low-income families, formal-sector workers on furlough, as well as students and the elderly during the quarantine. It aims to disburse funds and food rations to 5.2 million Dominicans to sustain their consumption needs through May 31. The government also undertook temporary tax administration measures such as extending deadlines for filing tax declarations. Moreover, the health authorities announced a number of measures to face the pandemic (see text table.).

Healthcare Policy: COVID-19 Measures

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Source: Dominican authorities.

11. The government will face additional fiscal pressures due to the nature of the crisis. As the economy decelerates and conditions deteriorate, it will be difficult for taxpayers to meet their obligations. Tax collections and other public revenues will suffer. Staff estimates conservatively that a shortfall of the central government revenues could amount to about ¾ percent of GDP. The announced expenditure package is a vital and welcome economic measure. The authorities would need to allocate more resources to health and social benefits, including by redirecting budgetary appropriations from other areas. Staff estimates conservatively that central government expenditures could be 1¼ percent of GDP higher than before the shock. The government needs to ensure that these public spending measures are both targeted and temporary, focusing on protecting those most vulnerable to the shock and on supporting demand. With that goal in mind, the authorities should allow automatic stabilizers, including the support for the unemployed and means-tested transfers. All in all, the consolidated deficit of the public sector has been conservatively estimated to be 6 percent of GDP in 2020 (some 2⅓ percent of GDP higher than before the COVID-19 shock). The additional financing needs amount to some US$1½ billion, of which the RFI could cover almost one-half.

Fiscal Accounts: COVID-19 Impact

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Source: IMF staff estimates.

12. The BCRD eased its monetary policy stance to provide additional liquidity to support the economy. The monetary policy council of the BCRD decided (in an extraordinary meeting of March 16) to reduce the monetary policy rate by 100 basis points to 3.5 percent, and approved a number of other measures (see text table). The BCRD is monitoring the situation closely and has sufficient monetary space to further ease its policy stance if needed. Staff encouraged the authorities to continue implementing a more flexible exchange rate policy at a measured pace (given unknown foreign exchnage exposure in the non-financial private sector), taking into account inflationary expectations and balance sheet exposures, as this can be used as an effective shock absorber, especially if external conditions deteriorate further. Interventions in the foreign exchange market should be limited to preventing disorderly market conditions, and large interventions should be avoided given that international reserves are still below IMF’s recommended reserve adequacy metric (ARA) of 100–150 percent.2

Monetary Policy: COVID-19 Measures

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Source: BCRD.

13. The BCRD also adopted several macroprudential and supervisory measures to provide additional liquidity to support the economy. These measures aim to provide liquidity to the banking system and ease financial tensions. An important measure was the reduction in reserve requirements which would provide significant liquidity to the system (¾ percent of GDP), as well as a number of other measures (see text table). The authorities should ensure that these extraordinary measures are temporary and targeted specifically to the borrowers adversely affected by the COVID-19 outbreak.3

Macroprudential Policy: COVID-19 Measures

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Source: BCRD.

Rapid Financing instrument Issues

14. The RFI is the most appropriate instrument at this juncture. The Dominican Republic meets the eligibility requirements for support under the RFI. It faces an urgent BOP need, which, if not addressed, would result in immediate and severe economic disruption. There is also a high d degree of uncertainty on the duration and scale of the COVID-19 impact and practical difficulties of holding comprehensive discussions with the authorities in the current no-travel/work-from-home environment.

15. Staff proposes to provide support for 100 percent of quota under the RFI. This access is within applicable limits under the GRA. The annual access of 100 percent of quota (SDR 477.4 million or about US$650 million) would provide financing relief to the budget. RFI resources will be disbursed to the Ministry of Finance allocated to provide financing for virus-related spending.4 Remaining needs are expected to be filled by other donors. In the absence of adequate financing, additional adjustments will be needed.

16. A safeguards assessment of the BCRD will be needed. The authorities commit to undergoing a safeguards assessment that would need to be completed before the Executive Board approval of any subsequent arrangement, to provide Fund staff with the most recently completed external audit reports, and to authorize the external auditors to hold discussions with staff. In their Letter of Intent, the authorities confirm that they will establish a framework (e.g., through a memorandum of understanding) between the BCRD and the Ministry of Finance, that clarifies the responsibilities for timely servicing of the financial obligations to the IMF.

17. The Dominican Republic is assessed as having sustainable debt and adequate capacity to repay the Fund. The RFI resources would be the first time in a decade that the Dominican Republic uses Fund resouces, and they only represent about 0.8 percent of GDP. The Fund’s risks from this RFI exposure will be low given the authorities’ excellent track record of servicing their debt obligations. Furthermore, the DSA (Annex I) shows debt to be sustainable with a sufficient buffer to remain sustainable even after the impact of the pandemic. The Dominican Republic also has the capacity to repay the Fund (Table 8), with scheduled repayments of the RFI at no point in excess of 2 percent of exports or 4 percent of reserves.

Authorities’ Views

18. The authorities foresee a significant weakening in economic activity in 2020. Policymakers recognize that the COVID-19 shock will have a large short-term impact on economic performance as consumption, investment and exports deteriorate amid the global pandemic. They are particularly concerned with the sharp decline in tourism receipts and the impact it will have on foreign-currency liquidity. The government has been negotiating financial assistance with several IFIs, including the IDB, World Bank and Development Bank of Latin America (CAF) to cover their budgetary and BOP needs.

19. There is an urgent need to support health and social sectors at a time tax revenue are softening, leading to a widening of the fiscal deficit. The authorities recognize the mounting fiscal pressure from unbudgeted current expenditure—namely on healthcare needs and the announced fiscal stimulus measures—while at the same time facing declining receipts, especially from consumption taxes. They plan to reallocate resources from other budget items and reduce 2020 capital expenditure to ongoing high-priority projects. The authorities do not foresee granting tax exemptions but are providing relief by allowing postponements and incremental payments of income taxes. They underscore their commitment to continued consolidation efforts in the medium term, but in view of the large-scale shock to the economy in 2020, these efforts must be postponed until the pandemic recedes.

20. The authorities acknowledged the need to ease their policy stance while confirming their commitment to the inflation targeting framework. The nature of the shock calls for a more accommodative policy stance, and the BCRD is prepared to provide additional monetary and financial stimulus if needed. They believe that recent trends in soft commodities prices, weak economic activity, and contained inflationary expectations surveys all point to the absence of any meaningful inflationary pressures in 2020.

21. The authorities are taking macroprudential policies to ensure the proper functioning of the financial system. While the banking system had sufficient capital and liquidity buffers before this shock, the authorities think it is important to provide additional liquidity to the system to avoid financial stress as bank’s clients will be going thorough financial difficulties related to the COVID-19 shock. They agree on the need to carefully monitor the financial system.

Staff Appraisal

22. The outlook has weakened significantly in the near term. Growth prospects for 2020 have been severely curtailed by a near standstill in economic activities following the lockdown and health concerns related to the pandemic while tourism and re-exports from the free zone have dwindled significantly following border closures, heightened risk aversion and deterioration in global trade.

23. The fiscal position will weaken but debt remains sustainable. Staff supports fiscal measures, including higher public healthcare spending and the use of automatic stabilizers (support to the unemployed and transfer programs). Despite the sizable fiscal pressures and a rising debt burden, the country’s debt repayment capacity is assessed as robust (see the DSA for more details).

24. Staff concurs with the monetary and macroprudential policy easing at this juncture. In staff’s view, the authorities’ decision to have more accommodative policy stance was adequate. Staff encourage the authorities to continue monitoring the situation closely and be prepared to take additional measures if necessary.

25. Staff urges the authorities to allow greater exchange rate flexibility as a shock absorber and preserving an adequate international reserve cover. Foreign exchange market interventions should be limited to preventing disorderly market conditions. The exchange rate is a powerful tool that can serve as a very useful to cushion the economy in times of crisis.

26. Against this background, staff supports the authorities’ request for the RFI in the amount of SDR477.4 million (100 percent of quota). Staff’s assessment is based on the severity of the COVID-19 outbreak, urgent BOP needs, and the authorities’ existing policies to mitigate this external shock, which include actively pursuing financing options with other IFIs.

Figure 1.
Figure 1.

Dominican Republic: Real Sector Developments

Citation: IMF Staff Country Reports 2020, 154; 10.5089/9781513543109.002.A001

Sources: National authorities and IMF staff calculations.
Figure 2.
Figure 2.

Dominican Republic: Fiscal Developments

Citation: IMF Staff Country Reports 2020, 154; 10.5089/9781513543109.002.A001

Sources: National authorities and IMF staff calculations.
Figure 3.
Figure 3.

Dominican Republic: Monetary Policy and Inflation

Citation: IMF Staff Country Reports 2020, 154; 10.5089/9781513543109.002.A001

Sources: National authorities, Haver, and IMF staff calculations.
Figure 4.
Figure 4.

Dominican Republic: Exchange Rates and Sovereign Spreads

Citation: IMF Staff Country Reports 2020, 154; 10.5089/9781513543109.002.A001

Sources: National authorities, Bloomberg, and IMF staff calculations.
Figure 5.
Figure 5.

Dominican Republic: External Sector Developments

Citation: IMF Staff Country Reports 2020, 154; 10.5089/9781513543109.002.A001

Sources: IMF WEO; National authorities and IMF staff calculations.
Table 1.

Dominican Republic: Selected Economic and Social Indicators, 2015–25

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Sources: National authorities; World Bank; and IMF staff calculations.

Latest available.

Improvement in 2015 reflects the grant element of a debt buy back operation with Venezuela’s state owned-oil company (PDVSA) of 3.1 percent of GDP.

The consolidated public sector includes the central government, some decentralized entities, the electricity holding company, and the central bank.

Table 2.

Dominican Republic: Public Sector Accounts, 2015–25

(In Percent of GDP)

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Sources: National authorities and IMF staff calculations.

Based on Government Financial Statistics Manual (GFSM) 2014.

Outcome in 2015 reflects the grant element of a debt buy back operation with Venezuela’s state owned-oil company (PDVSA) of 3.1 percent of GDP.

Net of one-off revenues, including gains from PDVSA debt buy back.

Adjusts revenues and expenditures for the economic cycle, and excludes one-off gains from PDVSA debt buy back

Before government transers; it covers the Dominican Corporation of State Electricity Companies (CDEEE).

Table 3.

Dominican Republic: Public Sector Accounts, 2015–25

(In Billions of Dominican Pesos)

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Sources: National authorities and IMF staff calculations.

Based on Government Financial Statistics Manual (GFSM) 2014.

Outcome in 2015 reflects the grant element of a debt buy back operation with Venezuela’s state owned-oil company (PDVSA) of 3.1 percent of GDP.

Before government transers; it covers the Dominican Corporation of State Electricity Companies (CDEEE).

Table 4.

Dominican Republic: Income Statement of the Central Bank, 2015–25

(in billions of Dominican pesos, unless otherwise specified)

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Sources: National authorities and IMF staff calculations.

Includes both interest on recapitalization bonds and direct transfers.

Includes the cost of issuing money bills.

Stock at end of period. Equivalent to the par value, minus the net discount/premium at which paper was sold, plus accrued but unpaid interest.