Dominican Republic: 2022 Article IV Consultation-Press Release; and Staff Report
Author:
International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
08 Jul 2022
eISBN:
9798400214196
ISBN:
9798400214196
Language:
English
Keywords:
national authorities; pro-competition authority; government transfer; IMF staff calculation; commitment to enhancing PFM; Inflation; Global
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1. The economy rebounded strongly, aided by positive global spillovers and a well-phased reopening. Through prompt procurement and an expedient vaccination campaign, the authorities implemented a well-attuned reopening—including to international travel—that made the most of the global rebound. The early upturn in manufacturing and construction was followed by a stronger-than-expected recovery in tourism. Sound market access and Fund support through the RFI aided the recovery. By end-2021, GDP was 5 percent above pre-pandemic levels.

Abstract

1. The economy rebounded strongly, aided by positive global spillovers and a well-phased reopening. Through prompt procurement and an expedient vaccination campaign, the authorities implemented a well-attuned reopening—including to international travel—that made the most of the global rebound. The early upturn in manufacturing and construction was followed by a stronger-than-expected recovery in tourism. Sound market access and Fund support through the RFI aided the recovery. By end-2021, GDP was 5 percent above pre-pandemic levels.

Strong Recovery, Policy Adjustments and Ongoing Reforms

1. The economy rebounded strongly, aided by positive global spillovers and a well-phased reopening. Through prompt procurement and an expedient vaccination campaign, the authorities implemented a well-attuned reopening—including to international travel—that made the most of the global rebound. The early upturn in manufacturing and construction was followed by a stronger-than-expected recovery in tourism. Sound market access and Fund support through the RFI aided the recovery. By end-2021, GDP was 5 percent above pre-pandemic levels.

2. A frontloaded fiscal consolidation bodes well for fiscal sustainability and is instrumental to address challenges, including inflation. The policy mix comprised a front-loaded fiscal consolidation that tailored support to the evolving impact of COVID while significantly reducing public debt. Monetary policy appropriately supported activity while the fiscal consolidation was taking place, and gradually shifted to normalization to address inflation pressures towards end-2021. Overall, this should help facing challenges from the impact of the war in Ukraine and tightening global financial conditions on inflation and activity amid still-constrained policy space.

3. The authorities are committed to a reform agenda to improve policy frameworks, strengthen inclusive growth and secure stability. The agenda conveys the authorities’ vision of effective public institutions and should aid sustainable policies and the tackling of challenges from productivity bottlenecks and gaps in social outcomes. It comprises stronger policy frameworks—including a fiscal responsibility law—better governance and transparency, a sustainable electricity sector, an enhanced business environment, and stronger social programs. A timely implementation and good sequencing of reforms can build consensus for revenue mobilization to finance development needs and build buffers.

Recent Developments, Outlook, and Risks

4. A strong and broad-based recovery took place in 2021, with a notable recovery in tourism and real GDP increasing by 12.3 percent. Tourism arrivals recovered faster than expected—exceeding 2019 levels by 15 percent in the last quarter—supporting the rebound in services, which accounted for half of 2021 GDP growth. Construction and manufacturing, which led the recovery initially, accounted for another third. At end-2021, output in all sectors was above pre-pandemic levels (Figure 1), aiding the withdrawal of fiscal support and giving way to the start of the monetary policy tightening cycle.

5. Inflation remains above the target range pushed mainly by persistent global factors (Annex I), while wage pressures remain relatively contained. At 8½ percent, inflation continued to exceed the target range due primarily to external factors: while the nominal exchange rate appreciated, high US inflation, higher global fuel and food prices, COVID-related supply disruptions (e.g., container shipping costs), and the recovery of US demand pushed inflation above its target range. Real wages in 2021 recovered slightly—1½ percent—from the fall in 2020, which reached 13 percent.

6. The external position remained in line with fundamentals and desirable policies (Annex II). The current account (CA) deficit increased, as strong remittances and the recovery in exports and tourism—which benefitted from global spillovers—only partially offset the increase in imports due to strong domestic demand and higher prices, especially fuels (Figure 5). Nonetheless, FDI continued to cover the CA deficit while portfolio flows remained positive. Along with the SDR allocation, this helped strengthen the reserve position, which ended at a historic high, exceeding traditional metrics and reaching 83 percent of the ARA metric.

7. The financial sector passed a tough resilience test. Despite the withdrawal of COVID-related regulatory flexibility and the legacy of the crisis on credit quality, capital and liquidity buffers remain sufficient (Table 5). Credit growth rebounded with the recovery, though distressed loans (notably, restructurings in the service sector) are still elevated. Deposits growth remained strong. A recent liquidation of a very small bank, due to issues pre-dating COVID, was handled appropriately and had no visible effect on the market.

8. Following the strong recovery last year, growth is expected to decelerate to its potential rate in 2022. While there is a strong carryover for 2022, global demand will slow down. And while direct trade linkages and spillovers in the financial sector are relatively limited, the war in Ukraine is adding to inflation pressures through international energy and food prices and slowing global growth—dampening income growth and increasing risks and the current account deficit in the short-term (Annex III). In the medium-term, maintaining potential growth at 5 percent would require continued investment and labor-force participation growth, and higher productivity to offset demographic trends (Annex IV).

Medium-Term Macroeconomic Framework

(Selected Indicators, In Percent of GDP, Unless Otherwise Specified)

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Sources: National authorities and IMF staff calculations

9. While uncertainty remains high, the medium-term outlook is positive; continued reforms could reduce vulnerabilities and support inclusive growth. The recovery facilitated a reduction in the public sector deficit (by 5 percent of GDP, to almost pre-pandemic levels) and debt (by 9 percent of GDP).1 Aided by pro-active debt management—the Dominican Republic tapped international markets last February—the 2022 budget is mostly financed, and refinancing risks have been curbed amid slightly lower financing costs (Annex V). Credit growth is expected to slow down as GDP growth converges to potential and monetary policy tightens. A gradual reserve accumulation is expected to continue going forward. Returning inflation to the target and persevering on reforms to better anchor medium-term policies and enhance productivity and effective social programs will help build buffers, improve social outcomes, and limit scarring—as in other emerging economies, GDP has not recovered yet to the levels of its pre-pandemic trend.

10. Short-term risks to the outlook are tilted to the downside, but more balanced in the medium-term (Annexes VI and VII).

  • Global Risks—war in Ukraine. The increase in geopolitical risks have tilted the balance of risks—for both growth and inflation convergence—to the downside. Stronger-than-envisaged inflation from higher commodity prices may create further pressures in the fiscal accounts—due to a need for increased social support—and require stronger-than-expected monetary policy tightening, affecting growth.

  • Global Risks—global financial conditions. Stronger-than-envisaged tightening of global financial conditions can curb capital flows, posing further challenges to monetary policy and increasing pressure on financing costs and the currency. This could increase debt burdens, especially for unhedged borrowing in foreign currency.

  • COVID-19. New variants may reduce global output, spilling over to the domestic economy through trade linkages. Viral transmission to the Dominican Republic could hurt the service-oriented economy—although it has been resilient so far.

  • Domestic risks. These are slightly tilted upwards over the medium-term. Expanded investment opportunities and ongoing reforms may reduce risk premia and boost potential growth. On the other hand, unexpectedly high inflation or other shocks could hinder the reform momentum.

Authorities’ Views

11. The authorities agreed with staff on outlook and risks. They noted that the staff’s 2022 growth forecast is on the conservative side of their 5-5½ percent range and agreed with the outlook for inflation. They emphasized that major downside risks are associated with external factors and remain confident that their policies will continue to support growth in the medium-term. They agreed with staff that there is upside risk associated with successful implementation of structural reforms and recognized the importance of social support and political stability.

Policy Discussions

Discussions focused on the policy mix and medium-term structural reforms, especially on: (i) fiscal consolidation and support for the vulnerable; (ii) the need to secure inflation convergence amid a complex external environment; and (iii) ongoing reforms to ensuring a good quality and equitable consolidation, building consensus for further reforms, maintaining financial stability and fostering inclusive growth.

A. Supporting Inclusive Growth and Policy Sustainability

12. The front-loaded fiscal consolidation paves the way for reforms to secure policy sustainability and support inclusive growth. While consolidation has placed public debt on a solid downward path, increasing inflationary pressures point to the need to fine tune normalization of monetary policy and create space for targeted policies to protect the most vulnerable. Sound sequencing to enhance medium-term fiscal and financial regulatory frameworks would further support stability and sustainable growth.

13. Fiscal policies in 2021 took advantage of the economic recovery to frontload a consolidation, securing policy sustainability. The budget redirected spending at aiding the reopening—especially through vaccination—and at mitigating the impact of rising commodity prices.2 The recovery allowed the gradual phase-out of income and employment pandemic-related support while the key social program was expanded (see ¶38). One-offs and the strong recovery in tax collection more than offset lower other revenues from delays in contracting electricity sector concessions.3 Along with strict expenditure controls, these helped reduce the deficit by about 5 percent of GDP.

Emergency Measures: Key Impacts on Fiscal Accounts

(in percent of GDP)

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Sources: National authorities and IMF staff calculations

Not included in original budget.

Includes salary incentives for other sectors and other spending.

Superate/Alimentate since May 2021, previously Quedate en Casa / Comer es Primero.

Temporary emergency programs (FASE and Pa'Ti).

Smoothing of fuel prices

14. The 2022 budget continues to prioritize expenditure rationalization while mitigating the impact of higher commodity prices. The fiscal position aims at protecting the consolidation achieved last year despite global shocks—the fiscal stance will be broadly neutral this year. The authorities intend to continue curbing current spending and proceed with reforms in the electricity sector—including gradually adjusting tariffs towards cost recovery and replacing consumption-based subsidies with targeted transfers to offset the impact on the poor (Annex VIII).4 However, with the shock to commodity prices, 2022 subsidies will remain elevated given additional temporary support to mitigate the impact of higher energy and food prices on the vulnerable (see also ¶38).5 The authorities may extend some measures—i.e., those affecting fuel, gas and transport prices that impact heavily on informal employment. About 0.7 percent of GDP in non-priority spending was identified to accommodate this, with scope also to reduce capital spending given the large end-2021 transfers.6 Staff assess that the budget is conservative in terms of tax revenue, but revenues from sales of minority stakes in energy generation assets are uncertain. Overall, the 2022 deficit would remain in line with last year’s outcome.

2022 Budget, Main Accounts

(In percent of GDP) 1/

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Sources: National authorities and IMF staff calculations.

The budget assumes GDP is RD$5,837 bln. Staff assumes GDP of RD$6,160 bln.

The budget includes revenue from assset sales, while staff consider only usual capital revenue.

Since the budget, the government announced additional subsidies and social benefits to mitigate the impact of higher fuel and food prices. Staff assume these are partially offset by less goods and services spending. Budgeted interest expenses include interest for Jan. 2023.

Fiscal Measures to Mitigate Commodity Price Shock, 2022

article image
Sources: National authorities and staff calculations.

Includes expansion of community canteens and markets for subsidized sale of basic food basket (INESPRE); and distribution of food rations (President's Social Plan).

Includes subsidies for rice price freeze and fertilizer.

15. The central bank started the normalization of monetary policy. Monetary policy supported the recovery during the fiscal consolidation. As inflation convergence slowed and the economy recovered quickly the BCRD tightened, mopping up exceptional liquidity starting in August 2021 and increasing the reference rate by 350 bp since November 2021 (from 3 to 6½ percent), which staff views as appropriate. The monetary stance remains supportive, as the real policy rate is still negative. While fiscal measures will curb the impact of energy prices, inflation pressures persist and may call for further adjustments in the context of the ongoing tightening cycle. The pace of the tightening should continue to be data dependent—the central bank monitors a broad set of indicators, including monetary policy in advanced economies—and should allow for inflation convergence to the target range (4±1 percent) over the policy horizon. Graduality in the process has been currently justified by well anchored two-year inflation expectations and subdued wage pressures (see ¶5). The authorities and the staff agreed that maintaining expectations anchored is of essence.

16. The policy mix and shock mitigation measures are broadly appropriate, though more persistent inflation may require further policy adjustments. Further gradual fiscal consolidation—which calls for continued reforms in the electricity sector and expenditure control—will allow a steady decline in the debt burden. While the targeting of some measures to mitigate high commodity prices can be improved going forward, they are assessed as broadly appropriate because they are temporary, managed within the budget envelope, and important to help maintain the reform momentum. As for contingency planning, even if shocks required some budget revisions, these would be contained and financing would not pose a major challenge. To maintain the course over the medium-term, the fiscal strategy would benefit from fiscal responsibility legislation (¶22) and policies to protect the vulnerable in the context of the envisaged electricity sector pact reforms (Annex VIII). On the monetary front, depending on the impact of external developments on domestic inflation and given the importance of maintaining the hard-earned credibility of the inflation targeting regime, the central bank may need to pursue higher-than-expected monetary tightening.

Authorities’ Views

17. The authorities are confident that policies will continue to support growth and maintain internal and external balance. The central bank will conduct monetary policy to keep inflation expectations well-anchored and bring inflation back to the target range within the policy horizon. The fiscal stance will lead to a further—though more gradual—consolidation while providing support for the vulnerable—fiscal discipline is being strengthened by on-going and planned reforms. Confidence in economic policies is reflected in the continued strength of FDI and tourism—key drivers of the robust growth and the external position, including historically-high reserve buffers.

B. Consolidating Policies to Secure Fiscal Sustainability

Securing a High-Quality and Equitable Consolidation

18. Ongoing reforms in the electricity sector can gradually eliminate treasury transfers, increasing the quality of fiscal spending (Annex VIII). The electricity sector has been a drain on fiscal resources—with annual transfers of around 1 percent of GDP over the last decade. The Electricity Pact has given the authorities a mandate to enhance governance in the sector, create conditions to facilitate private investment, and implement tariff and subsidy reforms—the first tariff increase in 10 years took place last November and quarterly adjustments continued in 2022. Reforms intend to gradually reach cost-recovery levels by 2026 while increasing targeted transfers through a social program (Bonoluz) to mitigate the impact on the poor. Tariff adjustments will be conceived to eliminate consumption-based (poorly targeted) subsidies. Staff believes that the electricity sector pact follows a balanced approach by implementing gradual tariff adjustments while strengthening the social safety net.

19. Pro-active debt management is serving consolidation efforts and helps building buffers against short-term downside risks. The country is taking advantage of its market access and its recently upgraded credit outlook to actively implement debt management operations. Those transactions are lowering interest costs, extending the maturity of debt, and smoothing the amortization schedule.

uA001fig01

Bond Amortizations

(In RD$ bln.)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

20. Continued enhancement of Public Financial Management (PFM) and transparency are critical to strengthen the fiscal framework. These reforms will also support the adoption of a fiscal rule (¶22). The government’s commitment to enhancing PFM is manifested in the approved plan to make public administration more efficient and continued efforts to enhance budget control and monitoring—e.g., reduction of administrative debt (accounts payable); and integration between the Expenditure Module of the Financial Management Information System (SIGEF) and the Electronic Public Procurement System (SECP). Further, the authorities requested TA to help identify key weaknesses in PFM and provide a road map to strengthen the institutional capacity for a Medium-Term Fiscal Framework (MTFF). Areas to strengthen include the assessment of the fiscal outlook and the management and reporting of fiscal risks. Setting up a PFM reform coordination mechanism, ensuring consistency between MTFF and strategic planning, strengthening the MTFF content, and implementing multiannual spending commitments will be instrumental going forward. The authorities requested further FAD TA, including on fiscal risks and a Public Investment Management Assessment (PIMA).

21. The authorities continue to work on strengthening public procurement and COVID-spending audits. Proposed amendments to the procurement law—currently in Congress—would strengthen powers to eliminate loopholes and shift to a more modern system (Annex X). Regarding COVID spending, due diligence of suppliers was strengthened; and a special fraud unit at the Comptroller General and a transparency portal were rolled out. While the external audit is not finished yet, the Chamber of Accounts has been collecting information and coordinating with other institutions. In order to finish the COVID-spending audits in line with RFI commitments, the authorities have sought guidance from the IMF staff, and they are working to complete the report. Staff stand ready to provide further guidance if requested.

22. Plans to strengthen the Medium-Term Fiscal Framework—including through a Fiscal Responsibility Law (FRL)—are welcome. As strong PFM systems are established, enhancing institutional effectiveness and the decision-making process through an FRL would be more achievable. Staff considers that such a framework could focus on two main pillars:7 (i) a medium-term fiscal anchor based on a debt-to-GDP ratio of 50 percent; and (ii) an operational target (expenditure growth rule) calibrated to balance sustainability, stabilization, and simplicity of fiscal rules (Annex IX). This would require strengthening of medium-term fiscal management, curbing budget rigidities and rebuilding fiscal buffers during the transition to the anchor.

Creating Policy Space Through Medium-Term Revenue Mobilization

23. Ongoing tax administration reforms can help strengthen collections in the near-term, while revenue mobilization reforms are needed to create policy space over the medium term. Higher revenues are required to increase needed social spending, strengthen public institutions, fill infrastructure gaps, reduce debt to safer levels, and balance the composition of the adjustment.

24. Improved tax administration can increase yields from the current tax base. The 2021 customs law and the planned overhaul of tax procedures (Title I of the Tax Code), which is already in congress, should strengthen powers of the collection agency and reduce discretion. Expected implementation of electronic-invoicing and taxation of digital services should also generate some yield. Recent Fund TA argues for further focus on fostering tax collection through a recovery of filing and payment obligations, compliance control, and reforms to improve the risk-based strategy to manage tax debt, and to strengthen audit and governance functions. These efforts and reforms should lead to higher collection efficiency.

25. A more comprehensive tax-reform can broaden the tax base. Tax collection is low compared to peers in the region, reflecting a narrow base due to tax incentives and exemptions—over 4 percent of GDP—coupled with relatively low collection efficiency. A reform aimed at eliminating economically ineffective exemptions combined with measures to rationalize the high-income threshold in the personal income tax can bolster revenue mobilization. The authorities have been assessing revenue mobilization alternatives, which require consensus building.

Tax Expenditures - 2021

(In percent of GDP)

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Source: National authorities
uA001fig02

Consolidated Public Sector Debt1

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: National authorities and IMF staff calculations1/ Includes the Central Bank’s quasi-fiscal debt.

26. Revenue mobilization measures and targeted social benefits and investment could support an equitable adjustment. A reduction in exemptions to VAT and income taxes along with increases in targeted social benefits and investment could allow for a stronger, yet equitable and growth-friendly fiscal adjustment. An alternative scenario assumes that exemptions are reduced by 1 percent of GDP in 2024–25, the consolidated public sector (CPS) debt ratio could decline faster and provide additional fiscal space to protect investment and social spending.

Authorities’ Views

27. The authorities emphasized that policies aim at increasing primary balances and strengthening public administration and financial management to secure equitable debt sustainability. They stressed strict control of non-priority spending and tax revenue performance are providing space for mitigating measures of inflation shocks. Time-bound measures allow to reassess these to contain fiscal pressures, with scope for a slightly higher deficit if shocks persist. Continued implementation of electricity sector reforms—with appropriate support for poor households—is critical to improving public finances. Ongoing work to strengthen tax administration and public financial management—especially the transparency and control of spending, and the FRL design—would enhance confidence, critical to building consensus for a fiscal pact to mobilize the revenues needed to achieve investment grade and achieve sustainable economic and social goals.

C. Maintaining Financial Stability and Strengthening Policy Frameworks

28. Deposit Taking Institutions (DTIs) remained resilient despite expiration of flexibilization measures and a gradual absorption of restructured loans. While past due loans are at historic lows, the increase in restructured loans—driven by hotel, restaurant and transportation sectors—upon expiration of the regulatory flexibility per March 2021 weighs on credit quality (see Figure 6). To allow for a gradual absorption of the impact of the expiration of the regulatory flexibility, the authorities provided DTIs until December 2023 to phase-in any resulting regulatory provisioning shortfall. However, on a system level the shortfall as of end-2021 is immaterial as most DTIs constituted the necessary provisions and the shortfalls of individual DTIs that need the phase-in period appear manageable. Also, when compared to a stressed measure of asset quality, the provisioning coverage ratio is on its way to recover its pre-pandemic average (see Figure 6). The expiration of regulatory flexibility and continued credit growth reduced capital adequacy from 22.4 percent in June2021 to 19.0 percent by year-end—this is still higher than its pre-pandemic level (see Table 5), as DTIs’ capital positions have been supported by profitability and limitations in dividend distribution during the pandemic and the phase-out period.

Macrofinancial Policy: COVID-19 Measures and Phase-out Arrangements

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Source: National authorities.

29. Tighter financial conditions will require close monitoring. Monetary policy normalization and the moderation of growth may have an impact, as increasing interest rates will likely affect the valuation of DTIs’ securities portfolio and the repayment capacity of borrowers. The global liquidity tightening will bring additional challenges in terms of risk aversion and higher financing costs. While recent top-down and bottom-up stress testing suggests a manageable impact of these factors, supervisory authorities should remain vigilant. The authorities are in the initial stages of improving the data collection and macroprudential analysis of household and corporate balance sheets to allow for a better assessment of their debt service capacity.

30. The dissolution of a small bank by the Monetary Council—0.13 percent of DTI assets—is proceeding well. The bank’s problems predated the pandemic, and the existing resolution framework permitted a swift handling of the case with no visible impact on the market. The financial system would benefit from enhancing the bank resolution framework to align it with best practice; the staff remains ready to collaborate with the authorities on these issues.

31. The central bank recapitalization can further enhance policy frameworks. While the 2022 budget includes a provision for recapitalization transfers to the BCRD—0.6 percent of the GDP—the BCRD balance sheet still requires further strengthening. There are several possible modalities; the process should have a predictable path and be financially sustainable. The resolution of this legacy issue from the 2003 crisis would have no impact on total public debt (see Annex V) but it would strengthen BCRD’s institutional independence.

32. Foreign exchange (FX) market intervention declined in 2021 while increasing use of non-deliverable forwards (NDFs) and the FX platform added efficiency and transparency. Amid lower volatility in FX markets, intervention volumes were about 55 percent lower than in 2020 and remained two-sided. The full adoption of the FX platform, introduced in 2019 to buy and sell FX, increased market transparency and the quality of information to market participants. At the same time, BCRD interventions with NDFs are more prevalent than spot transactions, making FX liquidity more predictable and smoothing out the reserve path. While intervening to limit excess volatility has proved effective, the introduction of well-communicated intervention rules would further enhance the FX market performance. With reserves at 83 percent of the ARA metric, there is still room for continued gradual reserve accumulation.

33. Part of the recommendations of the 2021 safeguards assessment to strengthen the central bank’s institutional framework have been implemented, but some measures would require more time. The BCRD implemented the recommendations related to strengthening the governance of the internal audit committee, but other actions remain outstanding, including: (i) recapitalization of the BCRD; (ii) increasing institutional and personal autonomy; and (iii) implementation of IFRS. The authorities indicated that some recommendations require a legal reform—which is not planned in the short term.

34. The authorities should continue their efforts to realign the financial sector regulatory framework with best practices over the medium term. The Superintendency of Banks has implemented a program to further strengthen supervisory capacity and a risk-based supervisory approach. Financial sector authorities are also working towards enhancing the macroprudential tool kit, stress testing frameworks, and a roadmap for the implementation of Basel II/III and IFRS (with support from CAPTAC). Ongoing efforts to enhance data collection on the private sector balance sheet should continue. Credit and savings cooperatives (about 3.5 percent of DTI assets) still require an effective regulatory and supervision framework. The coordination of micro-prudential regulations and requirements that are similar or relevant across financial sectors could be enhanced. The authorities are cautiously exploring the benefits of a Central Bank Digital Currency (CBDC); staff stands ready to offer capacity development support.

Authorities’ Views

35. The authorities agreed that continuous monitoring of financial sector risks is important and emphasized their plans to further strengthen policy frameworks to ensure stability. They agreed on strengthening monitoring—including through enhanced stress tests, especially during the unwinding of regulatory flexibility and given monetary policy tightening. They emphasized that priorities for the next year are related to enhancing supervisory capacity and the risk-based supervisory approach. They also noted enhancements to their foreign exchange intervention framework adding transparency and efficiency in the market. Authorities agree that the recapitalization of the BCRD is essential and discussion on the modalities and appropriate timing will continue.

D. Strengthening Institutions and Supporting Inclusive Growth

36. Recent and ongoing initiatives to enhance the rule of law and the regulatory framework can enhance the business climate. Past expert reports have pointed mainly to the need to strengthen the independence of the judiciary and prosecutor, and to simplify the regulatory framework (Annex X). Staff believes that timely implementation of ongoing initiatives will be critical going forward, as they have the potential to mitigate risks in these areas. There has been progress along both dimensions in recent years, notably associated with prosecutorial and high court member appointments free from political ties and more effective procedures in key institutions, though there is still room for improvement. Key regulatory framework initiatives aim at enhancing transparency (including through a new public procurement law); reducing red tape through the “Zero-Bureaucracy” plan; and modernizing, simplifying, and expediting international trade procedures through a new customs law (see below)—which can reduce the regulatory burden and discretion, and hence the scope for corruption. Further, the pro-competition authority has been granted new tools and institutional structure conducive to its mission. The appointment of an independent attorney general and the autonomy of the office are steps in the right direction for strengthening the rule of law, and the authorities should follow through with plans to entrench prosecutorial and judicial independence in the legal framework (see Annex X).

37. Continued progress in addressing key structural bottlenecks can increase productivity and boost growth potential. The authorities’ agenda includes actions in the following areas:

  • Product-market and logistics reforms. The 2021 custom law allows for the use of new technologies to facilitate operations, instrumental to the objective of becoming a regional logistics hub through expedite dispatches. Reducing transport costs and improving sea and air transport facilities could further increase competitiveness.

  • Labor and social security reforms. The multisectoral dialogue for an integrated reform of labor and social security laws, launched in May 2021, is expected to develop consensus in the following months.

  • Electricity supply. Distribution companies now fulfill close to 100 percent of demand, reducing service disruptions to planned maintenance. The National Commission of Energy (CNE) is finalizing medium-term energy demand projections to guide the expansion of generation to further increase reliability.

  • Financial inclusion and payments system efficiency. The 2020 law on movable property guarantees helps increase micro-, small- and medium-enterprises (MIPYMES) access to credit. The authorities are nearing completion of the National Plan for Financial Inclusion, which includes the development of a fintech hub, regulation facilitating development of electronic payments systems (e-money), and enhanced consumer protection.

  • Skills gap. The authorities continued to launch job fairs to facilitate skill matching in labor markets and to repurpose general high school curricula to technical education. Further efforts to enhance schooling and vocational training will be important going forward.

38. Improved social outcomes should remain a key objective. While the pandemic increased poverty, social assistance helped cushion the shock. To reduce poverty and vulnerability further, the government is improving targeting and increasing the number of households assisted under the main social program (Supérate), which provides support to enhance economic resilience and inclusion.8 To mitigate the impact of higher fuel and food prices, the government is increasing targeted cash transfers, while those for electricity—Bonoluz—are also being gradually increased to compensate for the structural adjustment to electricity tariffs (Annex VIII). These steps are important to make the needed fiscal consolidation and the electricity sector transformation equitable.

Fiscal Policy: Key Targeted Social Protection Measures in 2022

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Sources: National Authorities.
uA001fig03

Poverty Rates

(percent)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: National authoritiesNote: Extreme poverty rate is relative to the cost of the basic food basket and the general poverty rate is relative to the basic food and non-food basket (i.e., including clothing, housing, health and education).

39. Energy sector reforms support climate change adaptation and mitigation strategies. The electricity reforms support the gradual elimination of untargeted electricity subsidies, improve the efficiency of energy generation/distribution, and diversify the energy mix away from hydrocarbons (Annex VIII). In addition, the Nationally Determined Contribution action plan (based on NDC-2020) continues to guide the overall climate strategy for mitigation and adaptation. Among other actions, with support from the World Bank, the authorities are evaluating disaster insurance coverage and a plan to reach carbon neutrality by 2050. They are also exploring reforms to the legal framework for public investment and risk management, aiming at incorporating climate change considerations. Finally, the authorities are working with multilaterals, foreign governments, and the private sector to develop a financing plan for climate-related investments.9

40. The authorities are in the process of strengthening the implementation of the AML/CFT framework and preparing for the planned Mutual Evaluation.10 The next evaluation is scheduled to start in the second half of 2023. The authorities have been coordinating on a national level the follow up on the recommendations of the 2018 Mutual Evaluation. In this context and with assistance from the World Bank, the authorities started in 2021 a process to update the National Risk Assessment (NRA). The Superintendency of Banks strengthened its internal sanctions process, enhanced its risk-based supervisory approach, and increased its supervisory resources to further improve the effectiveness of the AML/CFT framework. In addition, they prohibited licensed financial institutions to interact with informal exchange entities and their owners, and are in the process of further tightening the ability of such entities to operate in the market. The authorities noted that enhancements to the supervision of designated nonfinancial businesses and professions (DNFBPs) are in progress, while the effective supervision and implementation of AML standards by credit and savings cooperatives requires further attention.

Authorities’ Views

41. The authorities agreed on the need for multifaceted reforms to foster inclusive growth through better institutions. They aim at increasing political independence of key institutions and strengthening procurement controls, competition and trade facilitation—even if some reforms require new laws. They highlighted the National Competitiveness Strategy, including the streamlining of the regulatory framework (zero bureaucracy and new customs laws) to improve the business climate as well as infrastructure investment and better education outcomes. They stressed that improving social programs is essential to maintain positive social outcomes. Regarding climate change, the authorities remain committed to goals in their 2020 NDC submission and are working towards their next submission in 2025. Financial inclusion remains critical, and a comprehensive strategy is being finalized. The authorities continue to follow through on recommendations of the 2018 AML/CFT Mutual Evaluation, especially to strengthen the supervision of DNFBPs and other relevant sectors.

Fund Relations

42. The Dominican Republic has adequate capacity to repay the Fund. The country has a sound debt service track record and risks from RFI exposure are low. The DSA shows debt to be sustainable, and scheduled RFI repayments do not exceed 1.2 percent of exports or 2.1 percent of reserves (Table 6). The authorities have maintained the SDR allocation as international reserves.

Staff Appraisal

43. As in the past, the Dominican Republic’s economy showed remarkable resilience. Sound policies that supported stability and maintained good market access, an effective health campaign and well-attuned re-opening—including to tourism—allowed the Dominican Republic to make the most of the global rebound and to limit scarring and the increase in poverty. The strong, broad-based recovery—with GDP at end-2021 about 5 percent above pre-pandemic levels—allowed a front-loaded fiscal consolidation and the normalization of monetary policy to address inflationary pressures.

44. Strong growth momentum and a well-sequenced policy response continue to help the Dominican Republic face a challenging global environment. Amid abating global tailwinds, growth should converge to its longer-term trend. Supply shocks have driven inflation higher than previously projected, but fiscal measures are easing the impact while the normalization of monetary policy should allow inflation convergence to the target over the policy horizon. Risks are mainly associated with the war in Ukraine and the tightening of global financial conditions. The main impact from the war is expected to take place through higher commodity prices—direct trade and financial linkages are limited—while global financial conditions may have a stronger-than-expected impact on capital flows. The front-loaded fiscal consolidation, timely debt issuance and pro-active debt management help reduce vulnerabilities through lower near-term financing needs. Overall, this provides some space to face downside risks.

45. The external position is broadly in line with fundamentals and desirable policies. Exports and remittances grew robustly, while higher domestic demand and commodity prices increased the current account deficit—which nonetheless remained fully financed by resilient FDI—the external position is assessed as sustainable, with international reserves up strongly, improving reserve adequacy. The real exchange rate appreciated slightly in 2021 and remains broadly in line with fundamentals.

46. Economic policies—fiscal prudence, temporary commodity price mitigation measures, and monetary policy tightening—remain appropriate. Expenditure rationalization and tax administration efforts will help maintain a gradual fiscal consolidation, putting public debt on a stronger downward trajectory than previously projected while protecting investment and social spending. The use of temporary fiscal measures to contain the impact of commodity price shocks on domestic fuel and food prices are appropriate, as well as continuing with electricity sector reforms and improved targeting of subsidies and social assistance. Ongoing monetary and prudential policy normalization are warranted to maintain inflation expectations anchored and moderate financial risk-taking, respectively.

47. The exit from the financial regulatory response to the pandemic has been appropriate and the financial system proved its resilience. The exit was well designed and remains based on intensive monitoring and transparency in the assessment of asset quality. Going forward, the system would benefit from implementing higher international standards of supervision and regulation, enhancing the macroprudential and crisis management toolkit, and strengthening the regulatory framework for credit and savings cooperatives financial oversight.

48. Well-sequenced reform implementation can help strengthen medium-term policies. The authorities continue taking steps to strengthen policy frameworks, in particular by enhancing public financial management and transparency. This will pave the way for the introduction of fiscal responsibility legislation to better anchor medium-term policies and further secure debt sustainability. Together with ongoing reforms in the electricity sector, enhanced policy frameworks can build consensus for future revenue mobilization initiatives that create space for needed investment in infrastructure and human capital. An agreed roadmap for central bank recapitalization can also help by enhancing financial and institutional independence.

49. Reforms to foster inclusive growth and improved social outcomes remain critical. Ongoing efforts to improving governance, securing stable, competitive, and sustainable energy supply, building climate change resilience, and tackling other productivity bottlenecks—e.g., modernizing the labor code, increasing years and quality of education, and narrowing skills gaps in labor markets—along with enhanced effectiveness of social programs continue to be critical for sustainable and more equitable growth. Further efforts to address social issues—such as reducing regional and gender inequality—would also help making growth more inclusive.

50. It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

Figure 1.
Figure 1.

Dominican Republic: Real Sector Developments

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: National authorities and IMF staff calculations.

Figure 2.
Figure 2.

Dominican Republic: Fiscal Developments

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: National authorities and IMF staff calculations.

Figure 3.
Figure 3.

Dominican Republic: Monetary Policy and Inflation

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.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 2022, 217; 10.5089/9798400214196.002.A001

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

Figure 5.
Figure 5.

Dominican Republic: External Sector Developments

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

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

Figure 6.
Figure 6.

Dominican Republic: Financial Sector Developments

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: National authorities and IMF staff calculations.1/ NPLs only include loans past due, while the stressed delinquent loan index also includes restructured loans and loans foreclosed or written-off during the past 12 months, providing an alternative/complementary view on asset quality developments.

Table 1.

Dominican Republic: Selected Economic and Social Indicators, 2017–27

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

Latest available. For the Policy interest rate, the latest available is as of end-May (effective June 1).

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

Excluding reserves.

Table 2a.

Dominican Republic: Selected Economic and Social Indicators, 2017–27

(In Percent of GDP)

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Sources: National authorities and IMF staff calculations.

Based on Government Finance Statistics Manual (GFSM) 2014.

Consolidated public sector debt includes the Central Bank's quasi-fiscal debt.

Net of one-off revenues.

Adjusts revenues and expenditures for the economic cycle.

Equal to change in cycically adjusted consolidated overall balance, i.e., (-) = surplus decline or deficit increase; (+) = surplus increase or deficit decrease.

Table 2b.

Dominican Republic: Public Sector Accounts, 2017–27

(In Billions of Dominican Pesos, Unless Otherwise Stated)

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Sources: National authorities and IMF staff calculations.

Based on Government Finance Statistics Manual (GFSM) 2014.

Consolidated public sector debt includes the Central Bank's quasi-fiscal debt.

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

Table 3.

Dominican Republic: Summary Accounts of the Banking System, 2017–27

(In Billions of Dominican Pesos, Unless Otherwise Stated)

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Sources: National authorities and IMF staff calculations.

On a residency basis.

Excludes transfers related to central bank recapitalization.

Table 4.

Dominican Republic: Balance of Payments, 2017–27

(In Millions of US Dollars, unless otherwise specified)

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Sources: National authorities and IMF staff calculations.

Table 5.

Dominican Republic: Financial Soundness Indicators, 2012–21

(In Percent, End of Year)

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Sources: National authorities.

These figures do not include credit and savings cooperatives, which account approximately for 3.5 percent of total DTI assets (staff estimate). The 17 commercial banks account for 88 percent and the top 5 banks for 79 percent of total DTI assets.

See Figure 6 for a stressed measure of asset quality (the so called stressed delinquency index) and its corresponding provisioning coverage.

Table 6.

Dominican Republic: Indicators of Fund Credit, 2022–27

(In Millions of SDRs, Unless Otherwise Stated)

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Source: IMF staff estimates.

Table 7.

Dominican Republic: Recommendations of the 2021 Article IV Consultation

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Annex I. Inflation Drivers1

This note assesses the drivers of inflation in the Dominican Republic during the Covid-19 pandemic using a small semi-structural model. It analyzes separately the drivers of the three CPI components—core, non-core food, and energy—considering, in each case, equation and shock decompositions. External factors, specifically the exchange rate, foreign prices, and foreign demand, were the primary factors driving all components of inflation. Oil prices and the wedge between the policy rate and the one implied by the assumed Taylor rule also had an impact on inflation dynamics, particularly in 2021. Looking forward, model-implied inflation expectations have increased by end-2021, due to a pickup in US inflation and output gap, as well as a moderate depreciation.

A. Analytical Approach

1. This note examines inflation dynamics using a small structural macroeconomic model developed at the International Monetary Fund.2 This is a semi-structural model building on the new-Keynesian framework and which consists of four main equations: (1) an aggregate demand equation (IS curve) that relates the domestic output gap to real interest rate, exchange rate, and foreign output gaps; (2) aggregate supply equations (Phillips curves) that relate components of inflation (core, non-core food, and energy) to the output gap, the real interest rate gap, the exchange rate, international commodity prices and foreign inflation; (3) an uncovered interest parity condition for the exchange rate; and (4) a monetary policy reaction function which has elements of a standard Taylor rule and also seeks to maintain some stability in the exchange rate.3

2. The analysis is based on both equation and shock decompositions of the inflation dynamics. Equation decompositions of a variable show the contribution of contemporaneous endogenous variables, while shock decompositions show contributions from all past structural shocks on the deviation of a variable from its steady-state.4 The latter therefore differ from the former in two ways. First, they decompose variable into contributions from exogenous, mutually independent shocks. Second, they are cumulative, showing the contribution from all prior shocks (including the present quarter) to the value of the variable in that quarter. It can be thought of as a cumulation of all impulse responses to all of the shocks in all preceding quarters. All variables are defined in annualized quarter-on-quarter terms.

B. Headline Inflation

3. Headline inflation was initially driven by non-core food and energy, with core picking up since the fall of 2020. Early in the pandemic, headline CPI inflation was significantly below its 4 percent target due to significant disinflation in energy-related goods and services. During the second half of 2020, however, inflation in non-core food and energy increased, with a significant impact on headline inflation, which in turn exceeded the target consistently. After a decline in at the end of 2020, non-core non-energy inflation (primarily food, henceforth non-core food for simplicity) again increased throughout 2021, before abating in the last quarter of the sample. Energy inflation, by contrast, showed a gradual decline throughout 2021, reemerging during the last quarter. Core inflation began to increase during the second quarter of 2020 and remained elevated throughout 2021, even during periods in which food and energy inflation has been receding.

uAapp01fig01

Contributions to Headline Inflation

(Equation Decomposition, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

C. Core Inflation

4. Core inflation was primarily driven by the exchange rate and foreign inflation, though inertia and short-term inflation expectations have played a role since the fall of 2020.5 Core inflation was initially pushed up by the exchange rate depreciation throughout 2020. It increased in the second quarter of 2020 due to a depreciation of the exchange rate—which drives the ‘depreciation’ component directly (through imported goods included in core CPI) and the ‘real exchange rate gap’ component indirectly (through pass-through to higher imported input prices leading to higher prices of domestically produced core items). Exchange rate dynamics continued to drive core inflation in subsequent quarters.

uAapp01fig02

Contributions to Core Inflation

(Equation Decomposition, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

5. In 2021, appreciations curbed the impact of the exchange rate on core inflation, although this pattern reversed in the last quarter of 2021, as the exchange rate depreciated. Inertia and short-term inflation expectations picked up significantly since the fall of 2020 and remained elevated through the pandemic, while the output gap has contributed negatively to core inflation consistently, as expected. Finally, note that the large positive shocks directly to core inflation in the first and third quarters of 2021 may reflect the contribution of higher container shipping costs. These have increased by a factor of seven since the beginning of 2020, with the increases particularly concentrated in those two quarters.

6. The shock decomposition confirms the primacy of external factors, and an impact of the interest rate and oil prices since late 2020.6 The most important driver of core deviations from the target has been shocks to the nominal exchange rate, which contributed positively in 2020 and negatively in 2021. However, core inflation remained elevated in 2021—despite exchange rate appreciations in the first three quarters—due to increasing positive contributions from shocks to US inflation, the US output gap, and international oil prices—though the latter is to some degree counteracting shocks to energy inflation due to regulatory price-smoothing, which we discuss in the section below on energy inflation.7 Finally, the wedge between the monetary policy rate and the rate implied by the model’s Taylor rule had a positive contribution on core inflation since late 2020, similar to the one from oil prices.

uAapp01fig03

Shock Decomposition of Core Inflation

(Deviation from target, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

7. The drivers of core inflation expectations are similar to those of core inflation, though with somewhat different dynamics—including a large pick-up at the end of the sample. Early in the pandemic, core inflation expectations increased significantly due to the exchange rate depreciation, largely offset by the negative output gap. By 2021, the exchange rate appreciation began to reduce expectations. However, the latter remain elevated due to increasing positive contributions from shocks to US inflation, US output gap, international oil prices, and the wedge between the policy rate and the implied Taylor rule. This was particularly so in the last quarter of 2021, in which expectations were driven up by increases in the contribution from foreign inflation and output gap, as well as a reduced negative contribution from the exchange rate, reflecting its depreciation.

uAapp01fig04

Shock Decomposition of Core Inflation Expectations

(Deviation from target, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

D. Non-Core Food Inflation

uAapp01fig05

Contributions to Non-Core Food Inflation

(Equation Decomposition, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

8. Non-core food inflation has been largely driven by external factors, expectations, and one-off supply shocks. In the spring of 2020, the depreciation in the exchange rate contributed positively to non-core food inflation—although in part offset by negative shocks to domestic food prices. In late 2020 and early 2021, there were significant positive contributions to non-core food inflation from rising world food prices, as well as additional moderate shocks that are not explained by the model and some relatively small negative contributions from the exchange rate appreciation. Food prices experienced two significant one-off supply shocks during the pandemic. First, in the third quarter of 2020, the substantial pick-up in food inflation was likely driven by a large storm which caused flooding, restricting food supply.8 Public transportation, a non-food item included in non-core food, also experienced a significant increase in prices in that quarter, contributing about 7 percent to non-core food inflation. By the following quarter this shock dissipates—the negative shock in the fourth quarter offsets the lag term due to the shock in the preceding period, as there appears to have been less backward-looking price indexation following this shock than the model assumes.9 Second, the large positive shock in the third quarter of 2021 is likely due to a swine flu epidemic which required the slaughter of pigs and shifted demand to consumption of chicken.10 By end-2021, non-core food inflation declined significantly, and expectations are well-anchored.

9. The shock decomposition confirms the conclusions of the previous analysis—food inflation driven by the exchange rate, world prices, and one-off supply shocks—as well as an impact from the interest rate wedge. There was a significant positive contribution from shocks to the exchange rate early in the pandemic, which turned negative by 2021, though lessened in the last quarter due to the partial reversal of the previous appreciation. Rising world prices also had a sizable positive impact in late 2020 and early 2021. However, the contributions from the positive shocks to the US output gap and from rising food prices were substantially weaker than the analogous contributions in the case of core inflation (i.e., of US output gap and rising US CPI inflation), explaining the difference in the two near the end of the sample. The decomposition also points to a positive contribution from the wedge between the policy rate and the implied Taylor’s rule interest rate, as with core inflation.

uAapp01fig06

Shock Decomposition of Non-Core Food Inflation

(Deviation from target, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

E. Energy Inflation

uAapp01fig07

Contributions to Energy Inflation

(Equation Decomposition, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

10. Energy inflation was driven primarily by the price of oil, though the pass-through into energy inflation has been smoothed by domestic pricing of energy. The equation decomposition of energy inflation shows large contributions of fluctuations in the world oil price, typically offset by shocks to oil inflation, reflecting regulated prices which smooth the pass-through of international price changes. The initial fall in world oil prices at the onset of the pandemic was not reflected in domestic energy prices, as well as the subsequent reversal that drove world prices up since the fall of 2020—with two exceptions during early 2020 and late 2021, when the world oil price and the shock to domestic energy inflation had contributions of the same sign.

11. The shock decomposition shows a similar picture to the equation decomposition. It highlights the importance of shocks to oil prices and stabilizing contributions from the smoothing of energy prices, except for the first quarter of 2020 and the last quarter of 2021.

uAapp01fig08

Shock Decomposition of Energy Inflation

(Deviation from target, in percent, QoQ)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

Annex II. External Sector Assessment

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Figure AII.1.
Figure AII.1.

Dominican Republic: External Debt Sustainability: Bound Tests 1, 2

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: International Monetary Fund, Country desk data, and IMF staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2022.

Table AII.1.

Dominican Republic: External Debt Sustainability Framework, 2018–27

(In percent of GDP, unless otherwise indicated)

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Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Annex III. Implications of the War in Ukraine for the Dominican Republic1

The war in Ukraine will affect mainly inflation, given the impact of higher international commodity prices on domestic fuel and food prices—fiscal measures to contain the impact on the population will affect fiscal accounts but this is manageable. Direct trade linkages are relatively limited, but the current account deficit will widen due to higher import prices. The impact on financing requirements is limited given a frontloaded budget financing for 2022, proactive debt management policies, and limited financial linkages.

A. Trade Channels

1. Direct trade linkages are limited, but the current account deficit will widen due to a higher import bill. Direct exposure is mostly through services trade, as tourist arrivals from Russia and Ukraine accounted for almost 6 percent of the total arrivals in 2021. However, as of March 2022 the decline in arrivals from Russia and Ukraine is being offset by increased arrivals from Canada and Western European countries. Aggregate merchandise trade linkages are very limited at about 0.7 percent of total trade but there is some concentration in certain imports, in particular steel and iron—accounting for about 10 percent of total steel and iron primary imports in 2020—and fertilizer from Russia—about 7 of total imports of fertilizer. These will need to be sourced from other suppliers—with regard to steel and iron, Dominican companies are already looking to Brazil and Mexico, who were their main suppliers before 2020. Overall, the current account deficit is expected to widen given the Dominican Republic’s imports of commodities whose prices have been most affected by the War—notably, fossil fuels.

uAapp03fig01

Direct Trade Linkages: Tourism and Commodities

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: National authorities (BCRD, DGA).

B. Inflation and Growth

2. The war in Ukraine will add to inflation pressures while the impact on growth is expected to be limited. Inflation will be affected through the direct impact of higher international fuel and food prices and an indirect impact on the cost of imported goods. With regards to the former, the government has announced measures to limit the impact on domestic basic fuel—gasoline and LPG—and food prices—in particular, the basic food basket (see ¶14). Considering, both direct and in-direct effects, staff estimate that the geopolitical shock could add 2 percentage points to headline inflation in 2022. While this is expected to also reduce real incomes and dampen consumer demand in 2022, the carry-over from 2021 growth is strong and high-frequency data point to continued strong external demand—with good export growth through February and tourist arrivals through March.

uAapp03fig02

Inflation

(percent)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

C. Financial Impact

3. Proactive debt-management operations have extended maturities, reducing near-term financing requirements. In mid-February, the government placed US$3.6 billion in international markets—about US$2.2 billion was to finance the 2022 budget, and the reminder to retire debt coming due in 2023–24, thus reducing near-term gross financing needs. Previous debt management operations undertaken in 2020–21 also reduced financing needs for the 2022–27 period (see DSA, ¶4) While sovereign spreads initially rose following the invasion on February 24, currently spreads are about 60 bp lower compared to pre-war levels. For the private sector, higher external and domestic interest rates—due both to the geopolitical shock and the normalization of monetary policy rates—will likely reduce borrowing but is not expected to have a major impact on financial sector soundness.

uAapp03fig03

Bond Amortizations

(In RD$ bln.)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

Annex IV. Potential Growth1

This note presents estimates of the Dominican Republic’s potential growth—and relatedly, the output gap—as well as the estimated contributions of capital, labor, and labor efficiency to potential output growth. Pre-pandemic potential growth is estimated to have averaged around 5—and ranged between 4 to 6—percent since 2010, while the pandemic had an important temporary impact on potential growth and created a historically large output gap in 2020. Since then, the output gap has closed substantially while potential growth appears to be recovering back to its the long-term average due to strong investment growth and some recovery in labor productivity. However, the contribution from employment remains below pre-pandemic levels. Maintaining a 5 percent potential growth rate will likely require on-going investment and labor force participation growth and higher productivity to offset demographic trends.

A. Potential Output and Output Gap Estimates

1. Methodology: Staff estimated potential output and output gaps using the following approaches:

  • Hodrick-Prescott filter (HPF) applied to the level of real GDP;2

  • Multivariate filter (MVF) of real GDP, headline inflation and a broad unemployment rate,3 whereby the unobserved variables (potential, output gap and NAIRU) are linked to the observable data based on a simple model in which (i) output evolves according to an assumed steady-state growth rate and shocks to potential and the output gap; (ii) a Phillips Curve relationship links inflation to the output gap as well as projected inflation and inflation shocks; and (iii) the unemployment rate evolves according to an assumed steady-state of the equilibrium unemployment rate (NAIRU) and shocks to NAIRU, while Okun’s Law relates the unemployment gap to the output gap and shocks to the unemployment gap. The parameters and variances of shocks are estimated using Bayesian (MLE) techniques and the Kalman filter is used to obtain estimates of the unobservable variables (potential GDP, output gap and NAIRU).4 MVF estimates can vary depending on priors regarding the relative contribution of shocks as well as the steady-state values of potential growth and the unemployment rate.

  • Production function approach (PFA) that employs a Cobb-Douglas production function whereby potential output is calculated as the weighted sum of the potential (or trend) estimates of capital, employment and labor efficiency.5

2. Since all filters suffer from end-point problems, and the COVID shock resulted in a large decline in GDP, we employed a “Tuned” MVF, whereby we impose judgement on the 2019 gap when we filter over the entire history (i.e., data until 2021).6 This results in less “revision” to the history of potential and gaps than the HPF (or un-Tuned MVF) and highlights how the MVF can be more flexible and produce more reasonable results when based on well-informed judgement.7 The PFA also makes extensive use of HP filters that would then lead to a revision of the gap and potential just before the pandemic. To avoid this, staff employed two measures of PFA potential that are spliced together: first, potential GDP is estimated over the period 1991–2019—which by truncating the sample ahead of the COVID turning point mitigates much of the end-point bias problem from the shock. Next, growth rates from a second estimate of potential fit over the entire sample (including staff’s medium-term forecasts) are used to extend the level from 2019 to 2021.

Results

3. Pre-pandemic, the average estimate of potential growth based on the three approaches was around 5 percent and ranged approximately between 4 and 6 percent since 2010.8 In the pre-pandemic period, a low of around 3 percent was reached during the banking crisis of 2003. The Global Financial Crisis (GFC) of 2009 also appears to have depressed potential, but less so than the 2003 crisis. Since the GFC, potential growth continued to gradually increase, peaking around 5.8 percent in 2016 before slowing to slightly above 5 percent by 2019.

uAapp04fig01

Potential Growth and Output Gaps

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations and National authorities

4. The COVID shock led to sizeable slowing of potential in 2020, although its growth rate appears to be converging quickly to its pre-pandemic pace. Averaging the different methodologies, potential growth is estimated to have slowed to 3 percent in 2020. A robust recovery in investment and a rapid exit from very strict restrictions on mobility and physical distancing limited the scope for long term, structural scarring. Furthermore, a successful vaccination campaign in 2021 allowed for further lifting of COVID restrictions9, and should support potential growth approaching its previous long-run average (see next section for drivers).

5. The COVID shock also produced the largest output gap in the last 20 years; the impressive recovery in 2021 positions the gap to close by 2023. Unlike the 2003 banking crisis—which, while having a large negative impact on domestic investment, was nonetheless a DR specific event10—the pandemic also triggered a very large external demand shock (possibly much larger even than that caused by the global financial crisis). The large gap in 2020—which the Tuned-MVF and the spliced PFA method estimate at between -8 and-10 percent—may also reflect the high uncertainty associated with COVID and related behavioral changes (i.e., reduced domestic demand for contact-intensive services).11 However, the gap began to close much faster than in previous crises as buoyant remittances, rebounding US growth and competitive positioning of the tourism sector supported growth above 12 percent. That said, according to the Tuned-MVF, this gap remains substantial (around -4 percent of potential GDP), which presents a challenge for closing the unemployment gap (typically lags the closing of the output gap).

uAapp04fig02

Output and Employment Gaps

(In percent)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations

B. Potential Growth Accounting

6. Before the pandemic, potential growth had already slowed slightly from the recent peak in 2016 due to a lower contribution from trend employment. The lower employment contribution appears driven mostly by demographic factors, in particular the slowing growth rate of the working age population (WAP), which in turn largely reflects an on-going decline in fertility rates and may also reflect increased emigration.12 Smaller gains in the trend unemployment rate (measured by the NAIRU) also added to the compression of trend employment. Modest increases in the capital contribution between 2017–19 kept overall potential from falling below its estimate long run average of 5 percent.

uAapp04fig03

Production Function – Growth Decompositions

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations and National authorities

7. When COVID hit in 2020, potential growth was reduced by decelerations in trend labor efficiency, trend employment contribution, and capital accumulation. The strict lockdown impacts on employment13 and investment were of relatively short duration and so largely present as cyclical responses. However, staff expectations that working age population growth will continue to slow and that trend unemployment14 (NAIRU) will level off, imply a modest degree of structural change reflected in lower trend employment growth and in turn total potential.

8. The output gap is expected to close in the near term as potential growth runs below its historical average while actual GDP growth remains solid. In addition to reduced employment contributions, total potential may suffer from a more measured pace of capital stock accumulation reflecting construction activity that had been pulled forward by the opportunity to expand and renovate resorts during the global pause in tourist travel. On the other hand, actual growth is expected to benefit from a tourism sector whose successful re-opening efforts may have captured regional market share. To return to a potential growth rate of close to 5 percent, the Dominican economy would thus need continued investment and labor efficiency growth, given also that demographic trends (lower WAP growth) will weight on potential growth.

uAapp04fig04

Estimates of Potential Unemployment (NAIRU) and Labor Force Participation

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations and National authorities

Production Function Approach (PFA) for Potential Output

The PFA assumes a Cobb-Douglas production function (i.e., with elasticity of substitution between capital labor equal to one), in log-linear form:

Yp = (Ep * Lp) α * K(1-α) → yp = α*ep + α*lp + (1-α)*k

Here, Lp is potential labor input (employment) and K is the observed capital stock,1 which is assumed to always be fully utilized. Yp is the unobserved potential output and Ep is the potential estimate of labor efficiency (i.e., growth that is not explained by changes in labor and capital). The labor share, α, is assumed to 65 percent.2

The potential labor input (employment) is disaggregated into its components: (i) the working age population (WAP); (ii) the labor force participation rate (LFPR); and (iii) the employment rate, which is equal to one minus the broad unemployment rate (UNR).3 Potential WAP is estimated simply as the HPF trend of historical data plus five years of forecasted growth provided the Dominican Republic’s Office of National Statistics (ONE). The potential unemployment rate (NAIRU) is estimated by the multivariate filter (MVF), based on the Phillips Curve and Okun’s Law, discussed earlier. Labor efficiency and the LFPR, are cyclically adjusted prior to being filtered as follows:

  • Labor efficiency: is cyclically adjusted by regressing the efficiency gap (i.e., the difference between labor efficiency (e) and a simple HP trend of e) on a single lag of that efficiency gap and contemporary and lagged cyclical indicators. Whereas the OECD uses capital utilization gap, the current account gap and the national accounts gross fixed capital formation gap as cyclical indicators, for the DR the real export gap had more explanatory power and produced meaningful dampening of cyclical fluctuations. The coefficients from the labor efficiency gap regression are then converted to impulse responses and subtracted from the raw labor efficiency data yielding a cyclically adjusted labor efficiency series that is then smoothed with an HP filter.

  • LFPR: the gap between the observed LFPR and a simple HP filter of the LFPR (including 5 years of forecast) is regressed on a lag of itself and cyclical indicators: for the DR, employment gap and the real average wage gap (both constructed as observed minus their HP filter trend) are used. As with labor efficiency, the coefficients from the regressions are converted to impulse responses and subtracted from actual LFPR yielding a cyclically adjusted LFPR that is then smoothed with an HP filter.

Thus, the estimated potential output is the sum of the potential (or trend) components, some of which were cycically-adjusted (~):

yp = α * e~p + α (wapp + lfpr~p + (1 – nairu)) + (1- α)*k

The Figure below presents the impact of the cyclical adjustment and broadly confirms the procedure compresses the magnitude of temporary movements, notably during the global financial crisis and the COVID-19 pandemic.

uAapp04fig05

Cyclical Adjustments to Labor Force Participation Rate and Labor Efficiency

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations and National authorities.1/ Capital stock data is source from the Penn World tables 10.0 (PWT) using their index of capital services applied to the 2007 base year estimate of capital stock at historical prices. An important caveat is that data limitations prohibit the deduction of residential investment from PWT capital services estimates as is done by the OECD. Values for 2020-27 are derived from IMF staff forecasts of real gross fixed capital formation with depreciation estimated by quadratic estimation.2/ This is in line with past studies, e.g., see Garcia-Saltos et al (2016).3/ We used an extended measure of unemployment that includes people that are available to work but are not searching (perhaps including discouraged workers)—this corresponds to the reported SU3 unemployment rate. Labor force participation rate has also been adjusted to include these “potential” workers.

References

  • Alichi, Ali, and Olivier Bizimana, Douglas Laxton, Kadir Tanyeri, Hou Wang, Jiaxiong Yao, and Fan Zhang. “Multivariate Filter Estimation of Potential Output for the United States”, IMF WP/17/106.

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  • Chalaux, Thomas and Yvan Guillemette. “The OECD potential output estimation methodology”, OECD Economics Department Working Papers No. 1563, July 30, 2019. https://dx.doi.org/10.1787/4357c723-en

    • Search Google Scholar
    • Export Citation

  • Garcia-Saltos, Roberto and Iulia Ruxandra Teodoru and Fan Zhang. “Potential Output Growth Estimates for Central America and the Dominican Republic.” IMF WP/16/205, December 2016.

    • Search Google Scholar
    • Export Citation

  • Hernandez, Camila. “Modelos estructurales para estimar la brecha del producción: El caso de la Republica Dominicana”. Ministerio de Hacienda, Serie de Documentos de Investigación, No.202-03 https://www.hacienda.gob.do/wp-content/uploads/2020/08/2020-03-GAP_compressed.pdf

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  • Michel, José Manuel, Fidias J. Díaz y Paola Pérez Medrano, “Crecimiento Económico y Productividad en la República Dominicana (Parte I), BCRD 2016. https://www.bancentral.gov.do/a/d/2584-documentos-de-trabajo#

    • Search Google Scholar
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  • Ramirez de Leon, F. “Estimación del PIB potencial y la tasa de interés natural para la República Dominicana”, BCRD, Documento de trabajo 2019-03.

    • Search Google Scholar
    • Export Citation

  • Ramírez de Leon, F. “Modelos de Estimación de la Brecha de Producto: Aplicación al PIB de la Republica Dominicana”, Serie de Estudios Económicos No. 6, 2012, Banco Central de la República Dominicana.

    • Search Google Scholar
    • Export Citation

  • Ravn, M. and H. Uhlig, “On adjusting the Hodrick-Prescott filter for the frequency of observations,” Review of Economics and Statistics, 84 (2), p. 371, 2002.

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    • Export Citation

Annex V. Public Debt Sustainability Assessment

Public debt is sustainable, and risks have decreased compared to the previous DSA due to a lower debt burden and gross financing needs. This reflects a front-loaded fiscal consolidation, pro-active debt management, and strong economic growth. However, the downward debt path is vulnerable to growth or exchange rate shocks. The debt profile shows a high share of debt held by non-residents and in foreign currency—but this is long-term debt, and a significant amount is held by official creditors. Aided by active debt management that lengthened maturities, gross financing needs are smoother and remain well-below the risk benchmark under both the baseline and stress scenarios.

A. Debt and Financing Profiles

1. Debt definition. Public debt is defined as the consolidated sum of the non-financial public sector (NFPS)1 and central bank (BCRD) debt, net of recapitalization bonds issued by the central government and held by the central bank. Including central bank debt intends to capture debt issued as a consequence of the BCRD’s financial support to failed banks during the 2003 financial crisis, leading to a significantly negative capital position of the BCRD. The existing framework for recapitalization calls for the government to make transfers to the BCRD to gradually reduce the quasi-fiscal debt; agreement on a new framework to gradually transfer quasi-fiscal debt from the BCRD balance sheet to the Treasury is pending.2 Either way, the total level of public debt does not change—only its composition.3

2. Debt baseline scenario. The baseline was impacted by the strong growth and front-loaded consolidation in 2021:

  • The decline in debt in 2021 reflects an increase in the primary balance, which is close to pre-pandemic levels and above the historical average. It also reflects automatic debt dynamics—i.e., the strong rebound in economic growth, exchange rate appreciation, and the decline in the real interest rate—and the draw-down of deposits following the 2020 pre-financing of the 2021 deficit (Figure 1).

  • Going forward, the consolidated public debt-to-GDP ratio is projected to decline to about 54 percent of GDP by 2027, almost back to pre-pandemic levels. This reflects economic growth as well as reforms that allow for an important reduction in current spending (i.e., subsidies decline about 0.5 percent of GDP between 2019–25).

3. Sovereign yields. The Dominican Republic’s foreign currency sovereign bonds yields have generally followed peers. The credit spread of 396 basis points relative to U.S. Treasury Bonds (as of May 3, 2022) compares favorably to the average of other emerging market and Latin American economies, and the effective nominal interest rate is projected to move in line with Libor rates. Rating agencies improved their outlook on the Dominican Republic’s foreign and local currency credit ratings: in December 2021, Standard and Poor’s and Fitch upgraded the outlook to stable. Moody’s has maintained a stable outlook. The government was able to place $3.6 billion in mid-February 2022—almost fully financing the 2022 deficit and refinancing existing debt; the placement met with strong demand.

4. Gross financing needs remain well below the early warning benchmarks (15 percent) in the baseline. This benefits from the active debt management that has aimed at smoothing the path of amortizations. In June 2021, the government completed the first large scale domestic debt management operation that reduced amortizations by US$1.6 billion over 2021–25 and also reduced interest rates, extended maturities and increased the liquidity of domestic benchmark bonds. In February 2022, the government completed another debt management operation of both external and domestic bonds, retiring the equivalent of $1.2 billion. The February 2022 operation is reflected in the projections. The authorities will look for opportunities for additional operations to smooth financing needs and reduce the interest expense of debt.

Debt Operations 2020-22

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Source: National authorities and IMF staff calculations

No domestic bonds where issued at the time of the operation.

5. Public debt risk profile. Until the COVID crisis, the authorities were prioritizing issuances of longer-term, local currency debt with a view to minimizing public debt vulnerabilities to financing and market risks. However, the authorities prioritized external financing during the pandemic, amid good market access, leaving more space for domestic financing of the private sector as well as taking advantage of favorable external financing conditions. By end-2021, NFPS debt showed: (i) an average maturity of 11.5 years—up from 7.4 years in 2013; (ii) the share of short-term debt at 5.2 percent; (iii) the share of foreign-currency denominated debt at 76.1 percent; and (iv) the share of floating rate debt at 12 percent—down from 20 percent in 20184. As for domestic debt—31 percent of NFPS debt—it showed (i) an average maturity of 7.4 years: (ii) a low share at floating rates (one percent): (iii) about 21 percent in foreign currency; and (iv) 90 percent held by residents. The share of public debt held by non-residents—57 percent of total consolidated debt—is above the upper benchmark (45 percent). However, rollover risk should be mitigated by its longer maturity—14.3 years.

B. Realism of Baseline Scenario5

6. Growth. Staff’s growth forecasts tended to be lower than the actual growth outcomes during 2012–20, with a median forecast error of 0.28 percentage points. The forecast bias generally decreased in the years prior to the pandemic, then increased somewhat in 2021 along with the uncertainty generated by a crisis with limited precedent.

7. Inflation. While inflation was converging after the inception of the inflation targeting regime—until 2016—inflation forecasts tended to be downward biased. However, the bias declined significantly between 2016–19, in line with the decline in inflation volatility. It increased in 2020 given pandemic-related uncertainties.

8. Fiscal adjustment. The large, front-loaded, fiscal adjustment in 2021–22 reflects the normalization of revenues (and some one-offs),6 reduced extra-ordinary expenditures for additional health spending and social benefits as the COVID shock recedes, and the authorities’ commitment to cut other spending; going forward, reform of the electricity sector—in particular the gradual increase in tariffs to cost-recovery levels—will also increase the primary balance even though spending on social protection is expected to increase. The DSA template provides the distribution of projected primary balances across other debt market-access countries, placing the Dominican Republic at the 57th percentile rank in terms of the 3-year average level of cyclically adjusted primary balance (CAPB) during the forecast horizon and at 13th percentile rank in terms of the 3-year fiscal adjustment. With regard to the latter, as noted above, the adjustment was front-loaded; the authorities are strongly committed to fiscal discipline and working towards establishing a fiscal responsibility law. From 2023 onward, the fiscal impulse is around zero, implying a broadly neutral fiscal stance.

C. Stochastic Simulations

9. Fan charts. The fan charts illustrate the possible evolution of the debt ratio over the medium term, subject to shocks drawn from a symmetric distribution (upside and downside risks are treated equally) and an asymmetric distribution (which assumes there are no positive shocks to the primary balance). Under the symmetric scenario, there is a 100 percent probability that debt will remain below 70 percent of GDP benchmark for emerging economies over the medium term, while in the asymmetric (adverse) scenario, debt would remain below the 70 percent of GDP benchmark with a 75 percent probability.

D. Baseline Scenario Assessment

10. Debt remains sustainable and risks have decreased due to strong growth, on-going fiscal consolidation, and pro-active debt management. Public debt is projected to decline as the fiscal position gradually returns to pre-pandemic levels and reforms to the electricity sector continue. The main risk to the debt outlook is associated with slower growth, though mitigated by moderate gross financing needs over the projection horizon. The debt profile shows a high share of debt held by non-residents; a risk mitigated by the fact that this is long-term debt with a significant amount held by official creditors.

E. Stress Tests and Alternative Scenarios

11. Individual shocks. The debt-to-GDP ratio is not expected to breach the 70 percent benchmark under stress tests. For alternative scenarios, debt remains below the 70 percent benchmark. For all stress tests and alternative scenarios, gross-financing needs peaks at around 10.2 percent in 2026—well-below the risk benchmark of 17 percent.

12. Combined shock. A combined shock incorporates the largest effect of individual shocks (real GDP growth, inflation, primary balance, exchange rate, and interest rate). In this scenario debt would increase to a maximum of 72.3 percent of GDP while gross financing needs would increase to a maximum of 12.2 percent of GDP.

13. Contingent liability shock. The financial sector contingent liability shock is not triggered because the three-year cumulative increase of private credit relative to three-year average GDP (7.2 percent) and loan-to-deposit ratio (75.8 percent) are lower than the thresholds. Alternatively, staff has assumed a natural disaster shock given the country’s exposure to disaster risk. The scenario assumes a disaster with 100-year return period and a 20 percent of GDP economy-wide loss, of which 15 percent (3 percent of GDP) is assumed to be the responsibility of the government. It is also assumed that this disaster has an adverse effect on growth in the first year (-0.9 percentage points), with a slight rebound (+0.3 percentage points) in the year following the disaster due to reconstruction activity. Further, in the year of the shock, inflation is higher by 1 percentage point (given constraints on output), there is a primary deficit of 2.3 percent of GDP and a 50 bps increase in the effective interest rate. In this scenario, debt peaks at 62.5 percent of GDP and gross financing needs at 9.5 percent.

Figure AV.1.
Figure AV.1.

Dominican Republic: Public Sector Debt Sustainability Analysis – Baseline Scenario

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: National authorites and IMF staff.1/ Public sector is defined as consolidated public sector.2/ Based on available data.3/ Long-term bond spread over U.S. bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure AV.2.
Figure AV.2.

Dominican Republic: Public Debt Sustainability Analysis Risk Assessment

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: National authorites and IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white.Lower and upper risk-assessment benchmarks are:200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ Long-term bond spread over U.S. bonds, an average over the last 3 months, 02-Feb-22 through 03-May-22.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Figure AV.3.
Figure AV.3.

Dominican Republic: Public Debt Sustainability Analysis—Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: National authorites and IMF staff.1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Not applicable for Dominican Republic, as it meets neither the positive output gap criterion nor the private credit growth criterion.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Figure AV.4.
Figure AV.4.

Dominican Republic: Public Debt Sustainability Analysis—Stress Tests

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff.

Figure AV.5.
Figure AV.5.

Dominican Republic: Public Debt Sustainability Analysis—Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Sources: National authorites and IMF staff.

Annex VI. Risk Assessment Matrix 1

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Annex VII. Growth-at-Risk1

The application of the Growth-at-Risk (GaR) model to the Dominican Republic finds that short term growth prospects remain predominantly positive, but volatility is considerable and there is a non-negligible chance of low-growth in the short run. At the same time, the estimated probability distribution of GDP growth suggests that pre-covid potential growth is likely to return in the medium term.

1. The GaR model. This exercise follows the model initially developed by Adrian et.al. (2016).2 The model forecasts the conditional distribution of future GDP growth on the basis of quantile regressions using a set of macroeconomic variables. The GaR methodology does not establish causal links between the chosen variables and growth outcomes. Instead, the GaR framework was designed to map and quantify risks to economic growth associated with macroeconomic factors (partitions) through a segmentation of the sample into quantiles that reflect the business cycle. The model also allows to design shock scenarios and medium-term projections.

2. Implementation of the GaR model for Dominican Republic. The estimated model includes macrofinancial and fiscal variables to capture the rebalancing of the policy mix in the cycle. Following Bespalova and Rousset (2019),3 the variables used identify five macrofinancial partitions: domestic financial conditions, domestic leverage, external cost of borrowing, external liquidity, and external demand, all of which remain statistically relevant in the estimation. Additionally, in order to incorporate fiscal elements two variables are identified as significant: the primary balance and capital spending (both in percent of GDP). Table 1 lists the variables included. The sample covers the 1999–2021 period (with quarterly periodicity), which includes three critical periods: the banking crisis of 2003, the international financial crisis of 2008, and the covid pandemic.

Table AVII.1.

Partition Groups

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Source: IMF staff calculations and National authorities

3. Main results. The four-quarters-ahead estimated growth distribution suggests that low growth/recession outcomes are relatively unlikely but remain a possibility in the short run. The distribution is skewed to the right—i.e., expected outcomes are predominantly positive and relatively high, with a media of 4.5 percent and mean of 5.3 percent. While the probability of negative growth (0.5 percent) is relatively low, the growth at risk (at 5 percent) is still positive at 2.6 percent, i.e., there is a 5 percent probability that GDP growth is 2.6 percent or less.

uAapp07fig01

Quarterly T-skew Quantile Fit for 12/31/2021 Growth Rate Forward 4

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

4. Policy effectiveness during the cycle. These estimations also reveal that the association of some partitions with growth is stronger under certain circumstances (e.g., different growth quantiles). For instance, judging by the magnitude of coefficients, factors of domestic credit conditions have a stronger correlation with growth for both the top and the bottom quantiles, i.e., higher growth years and recession years. In contrast, the association of fiscal policy variables and GDP growth appears to be more significant for the lower quantile of growth outcomes. This reinforces the importance of fine tuning the mix of liquidity conditions and fiscal policy during recessions. Regarding exogenous factors, the linkage of external cost of borrowing and growth is stronger during the cycle trough, which is when external financing costs tend to be higher. At the same time external demand is associated with the top decile of growth outcomes during the sample suggesting that economic booms often correlate with positive global cycles.

uAapp07fig02

Quarterly T-skew Quantile Fit for 12/31/2021 Growth Rate Forward 4

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

uAapp07fig03

Quantile Regressions Coefficients

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

uAapp07fig04

Quarterly T-scew Forecast for Growth Rate

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

5. Projections and shock scenario. Extending the projections to 3-and 5-years horizons show that GDP growth dispersion remains similar, but the skewness of the distributions vary over time showing a fatter left tail in the medium run—i.e., the probability of low growth outcomes increases relative to the shorter horizon. This can be related to the starting point of the estimation which is a year of strong recovery right after a crisis, and the average length of the business cycles during the sample period, which is approximately 3.5 years. As a result, starting at end-2021, the estimated GaR (at 5 percent probability) falls from 2.6 percent (1 year ahead) to 0.98 percent (5 years ahead). Nonetheless, the expected medium term GDP growth would be around potential, as the estimated mean and median growth are around 5 percent in five years. Finally, a simulated shock to the fiscal and external conditions factors (one standard deviation each, combined) would be associated with a shift of the density distribution (four-quarters ahead) to the left, as expected, and with higher kurtosis. This would move the range of expected growth outcomes about 3 percentage points lower than baseline, but the GaR would fall marginally—i.e., such shock scenario would be accompanied by a significant GDP growth slow down but not be devastating for the economy.

uAapp07fig05

Scenario Test for 12/31/2021 Growth Rate Forward 4

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Annex VIII. Electricity Sector Reforms1

The electricity sector has been a drag on growth and fiscal accounts due to unreliable electricity supply, large losses, and poorly targeted subsidies. The Electricity pact sets a roadmap for reforms to improve electricity provision and gradually eliminate treasury transfers to the sector. To this end, the authorities are: (i) enhancing governance of the sector by defining policy/planning mandates and strengthening the independent electricity regulator; (ii) creating conditions to facilitate private investment in the distribution companies and (iii) implementing tariff reforms by gradually removing consumption-based subsidies to reach cost-reflective levels and reallocating transfers through a targeted social program.

A. Background

1. The Dominican state-owned electricity companies represent a long-standing drag on the country’s fiscal resources, primarily due to below-cost tariffs, large distribution losses, weak oversight, and poor targeting of subsidies. Financial losses incurred by the state-owned distributors are due to consumption tariffs that have not kept pace with costs (fixed since 2011 until last November) as well as a high share of unbilled energy and large transmission (technical) losses, exacerbated by high generation and operating costs. This has also severely constrained investment to enhance transmission capacity and improve service quality.

2. Deficits generated by the public electricity sector have been between 1 and 2 percent of GDP over the past decade. Each year, the government transfers to the sector to finance investment projects and to cover the financial deficits of public enterprises. The deficits have narrowed in recent years, reflecting lower costs from changes in the generation matrix. The deficit net of government transfers reached a balance in 2020, with the management of arrears improving. The decision by the government to fulfill 98 percent of energy demand (versus 85 percent in previous years) explains why fiscal losses have not come down as much. This shift towards closing the demand gap is a positive development for the real sector in terms of more reliable energy provision.

uAapp08fig01

Electricity Sector Deficit

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

B. Reforms

3. The Electricity Pact2, signed in February 2021, lays out a broad social agreement on the road map to reform the sector including the following:

  • Reforming institutional governance to ensure a clearer separation of policymaking, regulation, and operational functions across institutions. So far, the authorities are in the process of liquidating the state holding company (CDEEE3)—which owns the Punta Catalina plant—and transferring its assets to a public trust. They also mandated policy making to the Ministry of Energy and Mines and strengthened the regulatory body (SIE) which is now actively involved in the tariff changes.

  • Opening the distribution sector to private participation. The Pact envisages the use of performance-based concession contracts with the private sector in distribution to reduce technical and commercial losses.

  • Restoring financial viability of the sector. On the distribution side, this requires each distributor to develop—and be accountable for—a plan to increase operating efficiency, reduce losses and improve service quality with measurable targets monitored by the regulator. On the generation side, an escrow payment system for fuel subsidies to generators has been established to increase transparency and predictability for such payments.

  • Pricing system reforms to establish rates that reflect actual costs of service, while simplifying tariff structures. The first tariff adjustment in a decade was implemented in November 2021. The adjustment plan envisages that by the end-2026, consumption-based subsidies are removed, and tariffs reflect the cost of efficient service provision plus appropriate value added (Box 1).

  • Rationalizing consumption subsidies to target vulnerable households. According to the Presidential Decree (651-21), subsidies should be received exclusively by households in situations of poverty or vulnerability through the BONOLUZ Program (Box 2).

uAapp08fig02

Electricity Generation Matrix

(In percent of total generation)

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: National authorities and IMF staff calculations

4. Electricity reform can also support sustainable growth that is more consistent with climate change commitments. Given the Dominican economy reliance on imported fossil fuels for power generation, there is an objective to minimize cost of energy provision and to further diversify the generation mix by investing in renewables and greater energy efficiency. A priority of the Electricity Pact is to ensure that the sector is adapted for climate change resilience and mitigation. Key actions include: (i) prioritizing generation from clean and renewable sources including solar photovoltaic, wind, and bioenergy to reduce emissions from the energy sector; (ii) increasing the share of generation from lower-carbon fuels such as natural gas; (iii) conducting strict oversight of operation of the Punta Catalina coal-fired generation plant to meet environmental requirements, including removing the coal ash it generates.4

Tariff Adjustment Formula

Electricity tariffs will be adjusted according to the following scheme1:

  • Tariffs for all levels of consumption will be adjusted linearly from the corresponding base tariff (lower for lower levels of consumption) to the base reference tariff (same for all levels of consumption) over a period of 20 quarters. Because base tariffs are lower for lower levels of consumption, but the reference tariffs are the same, tariffs for lower levels of consumption will increase by a larger amount each quarter (in absolute and in percentage terms).

  • In addition, any changes to the reference tariff will be passed one-for-one into each tariff when they occur. These will reflect the input cost (which varies with the exchange rate and the international price of fuel), the cost of power generation (which depends on capital and technology investment in energy efficiency as well as changes in the energy mix, such as renewable energy), and the cost of electricity distribution.

  • Reference tariffs are set as a function of input costs of distribution, such as energy and commodity prices. They are set to a value that is consistent with appropriate profits for distributors (in particular, no need for subsidies) once the Electricity Pact goals for distribution technical and non-technical losses are met.

Tariffti=Tariff0j+A1tj+A2tA1tj=Reference Tariff0−Tariff0j20tA2t=Reference Tarifft−Reference Tariff0

The table below shows the level of tariffs and reference tariffs for low-voltage residential customers as of 2022Q1. It shows that most of the adjustment in tariffs will occur in the lower ranges of consumption (below 300 kWh per month). To avoid placing the burden of higher tariffs on the poorest consumers, the Bonoluz transfer scheme (Box 2) will provide additional electricity vouchers to those who demonstrate their low-income status. On net, the joint tariff adjustment and Bonoluz expansion is expected to reduce transfers to the sector while increasing overall progressivity, replacing poorly targeted transfers with more targeted ones through Bonoluz.

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Source: National Authorities’ data. EDESUR, EDENORTE and ESTESTE are the three state-owned distributers (EDE).

The tariff adjustment scheme is described in, e.g., Resolución SIE-021-2022-TF. Applied tariffs need not exactly coincide with transition tariffs defined by the formulae above in times of high volatility of reference tariffs, based on the discretion of the Consejo de la Superintendencia de Electricidad. This occurred in the second quarter of 2022, where the scheme described here would have implied an increase in tariffs of 27 percent for those consuming no more than 300 kWh per month; their tariffs were increased by 9 percentinstead. Other tariffs continue to follow the scheme.

The BONOLUZ Program

Bonoluz was created in 2009, as the Dominican Republic attempted to transition from generalized subsidies.1 It was aimed at poor and lower middle-class households. In 2021, Bonoluz was included under the newly created social protection program, Supérate program (Presidential Decree 377-21). The key features of the program include:

  • Eligible beneficiaries are poor and vulnerable households as identified by the single beneficiary system (SIUBEN).2/ To join BONOLUZ, households are required to have a contract with an electricity company. Beneficiaries are removed from the program if they do not use their benefits, change address, or are discovered to be un-metered/stealing electricity.

  • Bonoluz customers receive a cash transfer to pay their electricity bill for consumption up to 100kWh/month. Until 2021, beneficiaries also received an additional subsidy as they were charged lower tariff rates.

  • The Bonoluz cash transfer of up to RD$444 ($9) per month represented 2 percent of monthly income for poor households on average in 2018 (World Bank). As of late 2021, the cash transfer could be up to RD$574 ($10).3/

  • By end-2021, 330 thousand households were considered active and using their Bonoluz cards. However, the government has estimated that there were about 1 million poor households (i.e., with ICV1-ICV2) that could be eligible for Bonoluz support.

As part of the Electricity Pact, the government intends to gradually expand Bonoluz so that it adequately targets poor households—reaching 900 thousand by 2024 and 1 million households by 2026. A challenge is to ensure that the beneficiaries list is updated in a timely manner—Decree 426-04 stipulates that the list should be updated every four years, although there are plans to update the list more frequently—in particular, now that Bonoluz is part of Supérete, which benefits from a beneficiaries database that is now updated quarterly.

1/

Bonoluz was gradually phased in: the first phase targeted households in the former Blackout Reduction Program (Programa de Reducción de Apagones, PRA), that subsidized energy consumption in specific areas; and the second phase extended the program nationwide.

2/

Decree 421-09 specified the subsidy was for households registered in SIUBEN. SIUBEN classifies households into five quality-of-life index (ICV) categories—ICV1: extreme poor, ICV2: poor, ICV3: vulnerable, and ICV4: non-poor—based on four dimensions of poverty—household infrastructure conditions, household demographics, access to education services, and access to public services

Annex IX. Strengthening the Medium-Term Fiscal Framework1

The analyses presented in this note calibrate macroeconomic and fiscal parameters to illustrate types of fiscal rules available to the Dominican authorities, accounting for their sustainability, stabilization, and simplicity features. The calibration results suggest that: (i) The medium-term fiscal framework should be anchored on a medium-term debt-to-GDP ratio of 50 percent; (ii) Given the increasingly uncertain environment; it would be prudent to rebuild fiscal buffers towards the debt anchor; (iii) A well calibrated multi-year expenditure ceiling rule (linked to the debt anchor) that can achieve both sustainability and stabilization goals could be a more practical and desirable operational rule for the Dominican Republic.

1. The pandemic has brought to the forefront medium-term fiscal challenges in the Dominican Republic that require careful sequencing of reforms. The authorities aim to build on previous success achieved through fiscal and structural reforms and address the remaining challenges by strengthening the fiscal framework and improving fiscal governance. A fiscal responsibility law (FRL) would help anchor medium-term fiscal policies, potentially reduce financing costs, and further improve macroeconomic stability.

2. Experience has shown that to be effective, fiscal frameworks (especially numerical rules) need to balance the so-called “trilemma”: sustainability, stabilization, and simplicity (October 2021 Fiscal Monitor and Debrun and Jonung, 2018). Conventionally, fiscal rules are introduced to help ensure long-term debt sustainability by controlling policy discretion and deficit biases. However, they should also contribute to policies that stabilize economic activity (counter-cyclical policy) and should aim for functional simplicity to ensure broad support and compliance verification by politicians, markets, and the public (Lledo and others, 2018). That is, while various fiscal rules exist (debt anchors, deficit rules, expenditure rules or a combination), some elements are important to consider when designing them. For example, some rules can reduce the procyclicality of fiscal policy but are harder to monitor (e.g., cyclical/structural balance rules), and others may score high on stabilization but might leave too much room to increase debt (e.g., simple expenditure rules).

3. Fiscal rules could be adopted in several aspects in the Dominican Republic. For example, setting a debt ceiling for the public sector would help anchor medium-term fiscal policies, ensure sustainability, and anchor market expectations. Operational targets, to support the debt target, could also be designed to reduce procyclicality of fiscal policy. At the same time, strengthening supportive institutions, including a medium-term fiscal Framework (MTFF) would enhance credibility and successful implementation of the rules.

4. The analysis presented in this note focuses on three principles: (i) Debt anchor calibration; (ii) rebuilding fiscal buffers; (iii) operational rule simulations.

A. Debt Anchor Calibration

5. A public debt level is considered safe if is it plausible to expect the government to stabilize or reduce debt under most circumstances through a prudent fiscal policy. This requires a good understanding of (i) the uncertainties surrounding the main determinants of debt dynamics (interest rate, growth, direct shocks to debt or the budget), and (ii) the government’s capacity to generate and sustain primary balances at or above their debt stabilizing level (Debrun and others, 2020).

6. Experience points to maximum sustainable debt levels in emerging economies at about 70 percent of GDP. While no upper bound of the safe debt zone (i.e., the debt limit beyond which it is believed that a debt distress episode will occur with heightened probability) cannot be derived from economic theory, past research suggests that the maximum sustainable debt level to be around 60-85 percent of GDP. However, it varies by country. For emerging market economies, the IMF Debt Sustainability Analysis (DSA) framework for Market Access Countries uses benchmarks of 70 percent of GDP. In the following simulations, to compute the safe debt level for the Dominican Republic, the debt limit is set at 70 percent (close to the highest debt ratio ever recorded in 2020).

7. Gross public debt (percent of GDP)Under current debt levels, there would be a high probability of reaching the 70 percent threshold. Given that uncertainty could remain acute in the years ahead, the fan charts in Figure 1 (calibrated to the Dominican Republic) project where the current debt ratio (61 percent of GDP in 2021) could end up in the medium term if the fiscal position is hit by a series of shocks. The central projection shows a downward debt trajectory through the debt path projected by staff, reaching a debt ratio close to the pre-pandemic level. Despite this, there is a high probability of exceeding the 70 percent debt ratio over the medium term (with a probability of close to 30 percent in 2027), given the uncertainty conditioned in the model.

Figure AIX.1.
Figure AIX.1.

Public Debt Trajectories Under Uncertainty

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculationsNote: VAR model with stochastic shocks, calibrated to the Dominican Republic, stimulates debt anchor assuming a debt limit of just above 70 percent. The distribution is projected over the medium-term using historical and recent outcomes based on staff projections for the primary balance and key macroeconomic variables.

8. The safe debt anchor for the Dominican Republic is calibrated to be a debt ratio of about 50 percent of GDP.2 Figure 2 calibrates the safe debt level for the Dominican Republic, assuming a debt limit of just over 70 percent for the consolidated public sector debt. This prudent debt level captures the initial debt ratio in the first projection year that ensures that under different shocks, debt will not exceed the maximum debt limit over the medium term at a 10 percent tolerance criterion. The safe debt level is estimated to be close to 50 percent (red line). That is, a debt level of less than 50 percent of GDP would ensure (with 90 percent of probability) that debt would remain below the 70 percent debt limit under various shocks over the medium-term. This debt anchor constitutes the floor of the safety margin below the debt limit.

Figure AIX.2.
Figure AIX.2.

Calibration of Debt Ancor for the Dominican Republic

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations.Note: VAR model with stochastic shocks, calibrated to the Dominican Republic, stimulates debt anchor assuming a debt limit of just above 70 percent. The distribution is projected over the medium-term using historical and recent outcomes based on staff projections for the primary balance and key macroeconomic variables.

B. Rebuilding Fiscal Buffers

9. The simulations suggest that it would be prudent to rebuild fiscal buffers. Given the increasingly uncertain environment, reducing the current debt ratio towards the 50 percent anchor over the medium term would be prudent as this would allow the fiscal policy to adjust gradually to shocks, as illustrated in Figure 2.

10. To shed light on the fiscal challenges ahead, a simple exercise based on the debt accumulation equation is presented in Figure 3. The exercise (akin to the one presented in the October 2021 Fiscal Monitor) quantifies the multiyear increase in the primary balance that would be needed to reduce debt ratio to the simulated debt anchor of 50 percent by 2030 and by 2035, respectively. The exercise takes as given the primary balance, growth, and real interest rate in staff baseline projections for 2022–23 and then computes the average primary balance needed in 2024–30 or 2024–3035 to reduce the debt ratio to 50 percent by 2030 or 2035.

11. Primary balance (percent of GDP)The results show efforts needed to rebuild fiscal space would involve running an average primary balance of close to 1 percent of GDP. Under the baseline assumptions (constant effective interest rate of 4.5 percent and real growth of 5 percent), the average primary surplus required to reduce debt to 50 percent of GDP by 2030 would be 0.9 percent of GDP (average for 2015–19 was 0.7). The results are, however, very sensitive to the macroeconomic assumptions. For example, if the average real effective interest rate is set higher, at 5 percent i.e., parity of r and g, the primary surplus needed to reduce debt to 50 percent by 2030 would be 1.2 percent. While it increases to 1.7 percent if (r – g) turns positive3. These efforts are less demanding if the time horizon is extended to 2035.

Figure AIX.3.
Figure AIX.3.

Average Primary Surplus Needed to Reduce Debt to 50 Percent by 2030–35

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations.Note: Calculations based on the debt accumulation equation, decomposing the change in gross debt ratio into its key drivers of: (i) the “snowball effect”, i.e., the real effective interest rate minus the growth rate (r-g) multiplied by the debtto-GDP ratio in the previous period; (ii) the primary budget balance (surplus) ratio; (iii) Stock-flow adjustment including the impact of depreciation (set to zero).

C. Operational Rule Simulations

12. The choice of an operational rule to attain the safe debt target asymptotically in the long term or over a shorter horizon is country specific and should reflect social preferences.4 However, some common elements exist and ideally the policy makers should strike the right balance in the “trilemma“. Evidence from the years after the GFC suggests that design of rules has moved toward stabilization but at the cost of becoming more complex (e.g., cyclically/structurally adjusted balance rule).

Figure AIX.4.
Figure AIX.4.

Operational Rule Simulations Under Baseline

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations.Note: The bars show staff baseline projections. Lines show debt paths conditioned on adopting an operational rule (primary budget balance rule, constant primary balance rule or expenditure ceiling rule) - starting from 2023 through to 2030.

13. The most common form of fiscal rules has been a combination of a debt anchor together with operational limits on expenditures and/or budget balance (IMF WP, Davoodi and others, 2022). Assuming their adoption from 2023 and calibrated to staff baseline projection of fiscal and macroeconomic variables for the Dominican Republic, Figure 4 presents simulations of debt paths for three types of operational rules: nominal expenditure rule in line with past revenue growth (set at 11 percent based on the average of 2017–19 growth rate of revenues), primary budget balance rule5 and constant primary balance rule. As illustrated in the previous exercise, it is not surprising that a constant primary balance of 1 percent would reduce debt to below 50 percent by 2030, while a budget balance rule would stabilize debt downwards around the current level.

14. The nominal expenditure ceiling appears to be the least effective operational rule to guide debt to the prudent level. This result is not surprising as a simple expenditure ceiling does not necessarily correct a tendency towards excessive deficits (e.g., large tax cuts or the systematic overprediction of revenues) and as such is not linked directly to the debt sustainability objective.

15. Public Debt (percent of GDP)Despite this, expenditure rules often have strong countercyclical features and can be calibrated to guide the debt level towards the anchor. Figure 5 presents simulations of debt paths during boom-and-bust cycles, based on a hypothetical’ illustrative scenario that does not represent staff projections during 2022–30. A more prudent expenditure growth of 8 percent is imposed which reduces the debt ratio closer to the 50 percent mark. Importantly, the table in the chart, reporting the cumulative procyclical impulses over the period, shows that the expenditure ceiling is the only countercyclical rule.

Figure AIX.5.
Figure AIX.5.

Operational Rule Simulations Under Boom-and Bust Cycles

Citation: IMF Staff Country Reports 2022, 217; 10.5089/9798400214196.002.A001

Source: IMF staff calculations.Note: The bars show simulated output gap defined as 2 percentage points deviation from the potential of 5 percent. Lines show debt paths under the three rules in boom-and-bust cycles. The table shows cumulative improvements in the primary balance during bad times (against staff baseline) – and deterioration of the primary balance in good times (against staff baseline), scaled by the magnitude of the simulated output gap. The higher the indicator, the more procyclical the rule.

16. Setting a binding upper limit on expenditure growth as a key operational focus is appealing, since: (i) it directly addresses distortions leading to excessive spending and can also curb the tendency to increase public spending during good times; (ii) it does not automatically lead to a procyclical fiscal stance because stabilizers on the revenue side are free to operate (revenues often fluctuate more than expenditures over the economic cycle); (iii) it is easy to explain to the public and market participants and relatively easy to monitor since it can be set over several years (relative to a realistic MTFF) with a review embedded in the electoral cycle. An independent fiscal council can also be tasked with monitoring fiscal performance and compliance with the rule; (iv) escape clauses, which allow for deviations from the rule in times of need, could be specified and activated only for events beyond the government’s control, such as severe recessions, natural disasters, or pandemics.

17. Specific design features can be embedded in the expenditure rule to make it more prudent and flexible. For example, expenditure could be allowed to grow above the limit if higher spending is matched by increases in discretionary revenues to encourage tax reform and other revenue mobilization efforts. Caution is warranted as this enhanced flexibility could complicate enforcement during the budget process and limits the rule’s ability to anchor expectations on debt sustainability. The rule can also include an error correction mechanism to accommodate for period with high debt, while ensuring that growth-enhancing capital investment spending does not bear the brunt of the adjustment.

D. Conclusion

18. In summary, a multi-year expenditure ceiling rule (linked to the debt anchor) could be a more practical and desirable option for the Dominican Republic. To be effective and credible, this would require strengthening of medium-term fiscal management, reduction of budget rigidities (e.g., spending on electricity subsidies and revenue earmarking), and rebuilding fiscal buffers in the transition period (ideally towards the debt anchor).

References

  • Baum, A., Eyraud, L., Hodge, A., Jarmuzek, M., Kim, Y., Mbaye, S. and Ture, E., 2018. How to calibrate fiscal rules: a primer.

  • Davoodi, H.R., Elger, P., Fotiou, A., Garcia-Macia, D., Han, X., Lagerborg, A., Lam, W.R. and Medas, P.A., 2022. Fiscal Rules and Fiscal Councils: Recent Trends and Performance during the COVID-19 Pandemic. IMF Working Papers, 2022(011).

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  • Debrun, X. and Jonung, L., 2019. Under threat: Rules-based fiscal policy and how to preserve it. European Journal of Political Economy, 57, pp. 142-157.

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  • Debrun, X., Jarmuzek, M. and Shabunina, A., 2020. Public debt: Safe at any speed?. Economic Review, (ii), pp.97-130.

  • International Monetary Fund. Fiscal Monitor, October 2021. Chapter 2. Strengthening the Credibility of Public Finances. R. Espinoza (Lead), H. Adan, C. Alonso, B. Battersby, C. Goncalves, G. Hong, A. Lagerborg, R. Perrelli, and A. Sayegh, with support from A. Womer.

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  • Lledo, V. D., Dudine, P., Eyraud, L. and Peralta-Alva, A., 2018. How to Select Fiscal Rules; A Primer (No. 2018/001). International Monetary Fund.

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  • Mauro, P. and Zhou, J., 2021. r-g< 0: Can We Sleep More Soundly?. IMF Economic Review, 69(1), pp. 197-229.

Annex X. Governance Reforms: Rule of Law and Regulatory Framework55

The rule of law and a sound regulatory framework can serve important roles—in particular, controlling corruption and enabling and facilitating the provision of public goods, such as effective public administration and a conducive business environment. Past reports on these issues have pointed mainly to the need to strengthen the independence of the judiciary and the prosecutor, and to simplify the regulatory framework. Recent steps to appoint an attorney general and high court members free of political ties, strengthen the transparency and integrity of public administration, and further trade facilitation and competition are contributing to the Dominican Republic’s on-going progress in strengthening the rule of law and regulatory framework to support sustainable and inclusive growth. The staff believes that timely implementation of ongoing initiatives—including plans to entrench prosecutorial and judicial independence in the legal framework—will be critical going forward, as they have the potential to mitigate risks in these areas.

A. Rule of Law

1. Overview: Governance, which is broadly defined as institutions, mechanisms, and practices through which government power is exercised,56 impacts the government’s ability to deliver good quality public administration and inclusive growth.57 Good governance helps to support growth and stability—preventing misallocation of resources and increasing trust in government.58 Further, growth based on private investment and higher value-added business relationships requires fair, predictable, timely and cost-effective enforcement of property and contractual rights. To both control corruption and protect property rights, governance frameworks should insulate these from government interference and private influence as well as provide sufficient transparency.

2. Judicial and prosecutorial systems. The 2017 UN Human Rights Council Report – Concluding observations on the sixth periodic report of the Dominican Republic (paragraphs 27–30) on independence of the judiciary and corruption pointed to two key areas with potential for improvement: (i) strengthening mechanisms and safeguards to ensure the independence, competence, and integrity of the judiciary; and (ii) reducing the incidence of corruption and impunity of some cases.59 Recommendations to overcome these issues included (i) ensuring judicial selection and appointments are carried out by an independent body; and (ii) stepping-up efforts to fight corruption and impunity, particularly through investigation of cases by the public prosecutor (attorney general).

3. The authorities are taking steps to strengthen institutions, mechanisms, and practices:

  • Enhancing Independence of the Public Prosecutor (Attorney General) and Judiciary. In a break from the past, the Attorney General appointed in 2020 was free of political and party affiliation, with a strong professional profile—a long career in the judiciary, including serving on the Supreme Court of Justice. Further, recent appointees to the Constitutional Court and Superior Electoral Court, were also politically independent with high professional merit.

    • To further institutionalize the political independence of the office, President Abinader proposed constitutional amendments—currently being discussed by the Economic and Social Council (CES)60 —such that the Attorney General would not be appointed directly by the President and would not be part of the National Council of the Judiciary, which appoints the High Court Judges.

  • Stepped-up efforts to fight corruption and impunity: Under the current Attorney General, the Specialized Prosecutor’s Office for the Prosecution of Administrative Corruption (PEPCA) has initiated four major criminal proceeding involving officials—both past and present—civilians, and the military. Also, institutions responsible for monitoring the management of public finances were strengthened with regard to controlling administrative corruption and referring cases: (i) the General Directorate of Public Procurement (DGCP) for the first time sent 10 cases to the Attorney General due to indications of crimes; and (ii) the Chamber of Accounts (independent auditor), which had previously focused on financial audits, shifted to special audits that have been used by PEPCA. Decree 674-20 required new officials to uphold ethical commitments, including by declaring their assets, or else the employment would be terminated. Decree 499-21 created a public trust for recovery of illicitly diverted public funds.

    • To further strengthen the state’s powers to control administrative corruption and other illicit activities (e.g., money laundering and drug trafficking), the government has submitted to Congress a law on civil asset forfeiture, whereby the state can confiscate assets derived from illicit activity through a court order (without requiring a criminal conviction, which lowers the burden proof and thus makes them easier to obtain).

  • Transparency and accountability. The authorities have highlighted transparency and ethics as control mechanisms: (i) Decrees 713–21 and 9–22 created the first multi-stakeholder forum on open government with a view to strengthening mechanisms that encourage civil society and non-governmental organizations to participate in holding government accountable; (ii) Decree No. 791–21 created the Government Integrity and Regulatory Compliance Commissions (CIGCN) as an operational instrument, a necessary step to the creation of a National Integrity System; and (iii) Decree 103–22 on the National Open Data Policy follows the recommendations of the United Nations Convention Against Corruption (UNCAC) for development of modern mechanisms to prevent, detect, sanction and eradicate corruption.

4. Protection of property and contract rights. Weaknesses appear due mainly to: issues with land registry, lack of sufficient transparency and effectiveness of courts, and lack of effective enforcement that hinders the timely recovery of claims.61,62

5. Recent steps to strengthen the protection of property and contract rights include:

  • Implementing Law 141–15 on Asset Restructuring and Liquidation. This law allows managing the bankruptcy processes and guaranteeing the protection of the rights of creditors in the face of debtors’ financial difficulties and insolvency. It offers a framework for companies in difficulty to remain operational. While the law was passed in 2015 and the implementing regulation issued in 2017, the specialized court was established only in 2019.

  • The movable property guarantee law (45–20) provides better access to credit for micro, small and medium-sized companies (MiPyMes)—i.e., allows using machinery, equipment, accounts receivable, intellectual property and any other good or right as a guarantee. The law also allows for extrajudicial execution—by auction, direct sale or transfer—of the encumbered asset, which may speed timely recovery of debts. Implementation has been on-going—in particular the creation of the electronic registry—including because COVID-19 disrupted the work plan.

  • The authorities are working to strengthen the administration of public real estate assets, which includes streamlining the titling process and reducing informality in land tenure.

B. Regulatory Framework

General Characteristics—Public Administration

6. Overview: The quality of public administration is associated with control of corruption, which in turn affects the business climate. Important elements in this area are related to the governance of (i) public sector employment, and (ii) public procurement.

7. Public employment. The Mechanism for Follow-Up on the Implementation of the Inter-American Convention against Corruption (MESICIC) 2017 report recommended to strengthen public sector appointments, in particular: (i) strengthening the legal basis with regards to access to public employment on the basis of key principles (of openness, equity, and efficiency); (ii) carrying out a comprehensive review of recruitment and selection regime; and (iii) strengthening the Ministry of Public Administration by providing it with the necessary human and financial resources.

8. The authorities took steps to strengthen public administration and employment policies:

  • In April 2021, President Abinader issued Decree 149-21 on the General Plan for the Reform and Modernization of Public Administration and Decree 262, which specified that promotion and advancement mechanisms developed by public bodies must be based on the fundamental principles that govern the public function, such as personal merit, equal access, stability in career positions, equal pay, organizational flexibility, mobility and judicial protection.

  • In early 2022, public discussions began on a proposal to reform the Public Administration Law—modifying provisions on human resources, labor relations and the rights and duties in public administration.63 The authorities also unveiled ethics education programs for public employees to set principles, values and standards of conduct that will serve as reference framework for public servants.

9. Public procurement. The Mechanism for Follow-Up on the Implementation of the Inter-American Convention against Corruption (MESICIC) 2017 report identified three issues in the Procurement Law (340-06):

  • It is not a “public order” law, which results in a dispersion of regulations among agencies, making conflict of interest different from one entity to another.

  • Lack of sufficient operational autonomy of the General Directorate of Public Procurement (DGCP).

  • Lack of transparency on the performance of government contracts for procurement of goods and services, as information was not widely available or published.

10. There have been several recent initiatives to improve public procurement. The procurement system has gone through a modernization phase that allowed for real-time public access to information, throughout the procurement cycle. Under President Abinader’s administration, developments in government procurement regulations and policies extended to include:

  • Issuance of decree No. 434-20, which makes the public–private partnership (PPP) law (47-20) fully operational by widening the scope of the regulations.

  • Issuance of decree No. 36-21, which calls for the creation of a government procurement compliance program that uses International Organization for Standardization (IOS) standards and includes anti-bribery provisions.

  • Issuance of new policies concerning different stages of the procurement process by the DGCP, including use of digital forms in tender documentation and principles that contracting agencies must follow in the preparation of submissions following requests for proposals.64

  • Issuance of guidelines on the selection of experts participating in the evaluation process.

  • Removal from the supplier list of companies linked to legislatures and other elected officials.

  • In terms of enforcement, the DGCP will draft regulations to the contracting units of the different government agencies and create a National Committee of Public Compliance Officers. Recent progress includes the creation of a special fraud unit at the Comptroller General and a new monitoring system and a transparency portal, providing information on transaction amounts, status of contracts, individual suppliers and contract details.

  • In April 2021, the authorities presented a legislative proposal to strengthen public procurement by making it a public order law. Enactment of this legislation to modernize the procurement systems would allow a shift to a more modern and efficient procurement system, elimination of loopholes that gave place to corruption and fraud, and expansion of access to public procurement by SMEs.

Trade and Competition Policies—Regulating Markets

11. Overview. The regulatory framework should be conducive to entrepreneurship and competition rather than to rent-seeking and corruption. An onerous business regulatory environment inhibits investment and privileges established and large firms over entrants and small firms. A system that relies on discretion—rather than rules-based procedures—increases the scope for bribery and corruption, hindering competition and entrepreneurship.

12. Overall Regulatory framework. Previous assessments of the Dominican regulatory framework pointed to room for improvement in (i) trade facilitation,65 (ii) business climate,66 and (iii) effectiveness of anti-monopoly and pro-competition policy.67

13. Trade facilitation. The Dominican Republic has been hindered by inefficient and discretionary customs procedures. This has arguably hindered growth and export diversification, becoming an obstacle in the authorities’ intentions to become a logistics and nearshoring hub.

14. Recent measures have been taken in terms of trade facilitation. A comprehensive new customs law (Ley 168-21)—which replaced the 68-year old customs law (Ley 3489)—modernizes and expedites customs procedures, reducing discretion and increasing transparency, which are important for controlling corruption. Among other changes, the law establishes:

  • Advance rulings: a reduction in time to receive advance rulings from 150 days to 30 days (or 45 days in exceptional cases).

  • Authorized Economic Operator status (Operador Económico Autorizado, or OEA). Qualifying agents will obtain OEA certification, reducing scrutiny and processing times.

  • 24-hour dispatch. A reduction in time to dispatch containers from nearly 7 days to 24 hours.

  • Non-invasive inspections. The customs authority is granted the authority to perform non-invasive (X-ray) inspections, expediting routine inspections.

  • Reduced discretion. The law formally and clearly stipulates customs procedures, reducing opportunities for corruption and increasing transparency.

15. Business climate. The Dominican Republic economy has also been constrained by onerous and slow bureaucratic procedures for formalizing and operating businesses.

16. Several measures have been taken improve the business climate. The Zero-Bureaucracy law (Ley 167–21) aims at modernizing and simplifying bureaucratic procedures. The law improves government procedures and imposes requirements on how new regulations are crafted and evaluated, including public consultation and both ex ante and ex post impact assessments. The Ministry of Public Administration is in the process of drafting its regulations. Zero-Bureaucracy specifies that 150 procedures in 41 public institutions are to be reformed. Reforms underway center on the creation of single windows (ventanillas) to speed bureaucratic procedures:68

  • Business Formalization Window (Ventanilla de Formalización de Empresas). The goal is to reduce the time it takes to formalize a business to 24 hours. This will be achieved by consolidating paperwork into a single form that can be processed in parallel by the various institutions involved, as well as facilitating communication between institutions to expedite approval.

  • Construction Permits Window (Ventanilla Única de Construcción). The goal is to reduce the time for approval of construction projects, to 60 days (120 days) for simple (complex) projects.

  • Health Code Permits Window (Ventanilla Única de Servicios del MSP). The goal is to reduce the time to obtain health code permits from 6 months to 14 days. This involves the revision and modification of regulations on cosmetics, personal hygiene products, and food and beverages.

  • Foreign Investment Window (Ventanilla Única de Inversión). The goal is to facilitate and expedite the procedures required of foreign investors. It involves the centralization and simplification of the required procedures, achieved through increased automation and interoperability between relevant institutions.

17. Competition Policy. The Dominican Republic needs to improve competition in product markets. The primary government agency tasked with encouraging competition—established by the 2008 Competition Law (Ley General de Defensa de la Competencia, Ley 42-08)—ProCompetencia, was not enabled until 2017.

18. Further steps could be instrumental to improve competition policies. While ProCompetencia’s powers remain limited—it lacks legal authority to block mergers or break up companies69 and there are limits on the sanctions it can impose, which do not scale with the revenues of the sanctioned firm—an executive decree from July 2020 enhanced the agency by specifying more clearly the way in which Ley 42-08 should be applied. Going forward, ProCompetencia is working towards strengthening their mandate to allow for larger and more preemptive sanctions, such as for anti-competitive mergers and acquisitions.
1

DR’s rating outlook was upgraded to stable by Fitch and S&P in December 2021.

2

In particular, fuel prices were smoothed, requiring subsidies of 0.2 percent of GDP.

3

One-offs include advances (0.5 percent of GDP), collections from law 46-20 providing for tax amnesty and payment plans (0.5 percent of GDP), and other extraordinary revenues (0.1 percent of GDP).

4

The transitional tariff scheme has been aided by a hedge on gas prices contracted by the authorities in 2021, which extends to 2023.

5

From March, the basic fuel prices would be frozen if the WTI remained between US$85-US$115; if WTI were to exceed US$115, then the price change would be passed-on but without the ad-valorem tax. The Authorities recently proposed amendments to the Hydrocarbons Law to provide an explicit legal basis for more transparent smoothing and related subsidies.

6

Decree 3-22 on rationalization and spending control. This mostly impacts purchases of motor vehicles and international travel: https://presidencia.gob.do/noticias/presidente-abinader-reitera-por-decreto-la-racionalizacion-del-gasto-publico-por-medio-de

7

The authorities requested TA on proposals for suitable fiscal rules as part of their wider FRL agenda.

8

In June 2021, Presidential Decree 377-21 transferred programs from Progressing with Solidarity (PROSOLI) to the newly created Supérate Program, whose aim is to reduce poverty through capacity development, productive inclusion, and economic empowerment of vulnerable groups. https://www.superate.gob.do/wp-content/uploads/2021/09/Decreto-377-211.pdf

9

Other in-depth climate change aspects have been covered in the 2021 Article IV report.

10

The evaluation will be conducted by the Financial Action Task Force of Latin America (GAFILAT).

1

Prepared by Nicolas Fernandez-Arias.

2

“A Practical Model-Based Approach to Monetary Policy Analysis—Overview”, 2006, by A. Berg, P. Karam, and D. Laxton, IMF, WP/06/80. The model was customized and calibrated to the Dominican Republic with the assistance of staff from the IMF’s Institute of Capacity Development.

3

The simplicity of the assumed Taylor rule—which, for example, does not consider the discrepancy between domestic and imported inflation—means that the analysis cannot definitively assess the optimality of monetary policy. It nonetheless helps to quantify the drivers of inflation, including the difference between the actual interest rate and the one implied by the Taylor rule. Combined with other analyses and economic judgment, the results in this annex can complement a full assessment of the optimality of monetary policy during the pandemic.

4

To clarify, shock decompositions can also be performed on raw variables. We focus on deviations from steady state as this analysis is concerned with explaining the deviation of inflation from its target.

5

Throughout this note, “inflation expectations” refers to model-implied inflation expectations: we do not observe inflation expectations directly, e.g., through a survey of market participants.

6

The inflation target for a CPI component in general differs from headline CPI target (of 4percent per year) due to relative price trends, specifically an upward relative price trend in food and a downward trend in the relative price of services. Thus, the core inflation target is lower than 4 percent and the non-core food inflation target is higher than 4 percent. The target for energy inflation is the same as the target for headline inflation.

7

Note that the depreciation in 2021Q4 manifests as a less negative contribution from the exchange rate shock (rather than a positive one) due to the cumulative nature of the shock decomposition.

8

Green plantains, whose price increased by 304 percent, contribute 11.4 percent to non-core food inflation, accounting for more than half of the shock. Onions, whose price increased by 122 percent, contributed 2.5 percent to non-core food inflation.

9

For example, Green plantains experienced deflation of 21 percent in 2020Q4, contributing -1 percent to non-core food inflation. Onions experienced a deflation of 59 percent, contributing -1.4 percent to non-core food inflation.

10

In fact, chicken was the leading contributor to non-core food inflation, with a contribution of 6.4 percent (price increase of 45 percent), due to substitution away from pork. The latter was due both to reduced supply of pork, as many pigs were slaughtered, as well as reduced demand for pork from consumers avoiding exposure to disease.

1

Prepared by Pamela B. Madrid and Nicolas Fernandez-Arias.

1

Prepared by Pamela Madrid Angers and Bennett Sutton.

2

For annual output data, lambda was set at 6.25 following Ravn and Uhlig (2002).

3

This follows Blagrave et al (2015). In the model, potential output growth and NAIRU can deviate from their assumed steady-states for extended periods as the impact of shocks fade gradually.

4

We are grateful to Kadir Tanyeri (ITD) for sharing the IRIS scripts to run the MVF.

5

See Box 1 for a more detailed description of the estimation procedures, which broadly follows the OECD methodology described by Chalaux and Guillemette (2019) whereby some employment components are cyclically adjusted before filtering to reduce end-point problems.

6

The 2019 gap was based on running the MVF with data until 2019; the estimate of the gap was similar to the gap estimated by Hernandez (2020) and Ramirez (2019). This gap was also consistent with the evolution of inflation and monetary policy at the time.

7

A similar tune was employed for the example of Canada in Blagrave et al (2016)—see p. 27, “How additional information is applied to the raw filtered output”.

8

The results take the average of the HPF, Tuned-MVF, and PFA. MVF estimates of potential are impacted by the assumption on the relative size of shocks to the output gap versus potential: if the former dominates—as is usually assumed for advanced economies—estimated potential growth is smoother (e.g., MVF_2); while if the latter dominates—as is assumed for many emerging market countries—potential growth is closer to actual (e.g., MVF 4). For the Dominican Republic, the latter tracks more closely with the PFA until the crisis.

9

Initially, in addition to a curfew and physical distancing requirements, the borders were close from March-July 2020. By mid-2021, the Dominican Republic had one of the highest vaccination rates in the region, as it had secured enough doses to vaccinate the entire population. The government achieved its objective of fully vaccinating 60 percent of the target population (18 years and over) by October 2021, at which point government did not renew its emergency powers that had allowed it to impose curfews

10

The various approaches, and in particular the Tuned-MVF, also picked-up the output gap in 2012-2013 that followed from tightening of domestic policies.

11

Of note, the output gap would likely have been larger in 2020 if the authorities had not been able to support liquidity, credit and incomes as they did.

12

Since 2000, the fertility rate has declined 18 percent. Data on emigration is limited, however we see a gradual downward trend in the share of the prime working age population (15-59 years old).

13

To mitigate the impact of lockdown on the poor and the most vulnerable, the government expanded social assistance programs, e.g., creating the “Quédate en casa” (“Stay at home”) program, which provided more generous cash payments to poor and vulnerable households.

14

It is difficult to disentangle from the simple model used to estimate the NAIRU, but it is possible that there was even an increase in NAIRU during COVID. In the DR, during 2020 there was a large increase in people available to work but not searching, which could reflect both government support programs as well as personal decisions about the relative risks of returning to work, which could have led to an increase in the NAIRU.

1

Public sector guarantees of private sector debt are negligible. Based on the latest report (March 2022), explicit guarantees of the external debt of two private sector NGOs amounted to US$5.4 million (less than 0.01 percent of GDP). According to Law 174-07, the Ministry of Finance can guarantee domestic bank credits to the FTZs up to RD$1.2 billion—according to the latest information, the exposure was RD$21.4 million (US$0.3 million).

2

The proposed legal amendments aim to overcome issues with the existing framework (based on Law 176-07), which has fallen short of its objectives.

3

As the starting point for projections, we include the entire stock of central bank certificates as of end-2021 even though some of these have been issued for monetary policy purposes.

5

The MAC-DSA framework is described in http://www.imf.org/external/np/pp/eng/2013/050913.pdf

6

In 2021, there were advance tax payments of about 0.5 percent of GDP.

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

1

Prepared by Mario Mansilla.

2

Adrian, T., Boyarchenko, N., and Giannone, D. “Vulnerable Growth.” Federal Reserve Bank of New York Staff Report 794, 2016.The methods used for this exercise are based on Prasad et al. (2019), "Growth at Risk: Concept and Application in IMF Country Surveillance", IMF working paper; and Lafarguette, R. (2019) “Growth at Risk Tool: Technical Appendix.” mimeo, International Monetary Fund.

3

Bespalova, O. and Rousset M. “Macrofinancial linkages and Growth at Risk in the Dominican Republic”. IMF Working Paper WP/19/246. November 2019.

1

Prepared by Hassan Adan (FAD), Pamela Madrid Angers and Nicolas Fernandez-Arias with contributions from Evelyn Carbajal (all WHD).

2

The Electricity Pact (Pacto Eléctrico) was initially drafted in 2017, building on an accord by all stakeholders in the sector. A Presidential decree (651-21) was issued in October 2021, establishing revised timelines for implementation of the Pact.

3

The CDEEE had acted for decades as a state corporation that managed and signed contracts on behalf of the distribution companies, controlled the performance of the state’s transmission companies, and exerted great influence on general policies in the sector.

4

Summarized in the World Bank’s Electricity Reform for Sustainable Growth DPF, 2022

1

Prepared by Hassan Adan (FAD)

2

Based on a methodology developed by Baum and others (IMF, 2018)

3

A surge in (r-g) can generate large economic costs and can put public debt on an unsustainable path (Mauro and Zhou 2019).

4

Lledo and others (IMF2018) provides guidance on the selection of fiscal rules.

5

A primary budget balance rule excludes interest payments and is thus more directly under the control of policymakers. Given the relatively high interest bill in the Dominican Republic, an overall balance rule would be more effective in terms of sustainability but at the cost of stabilization as interest bills are often countercyclical.

55

Prepared by Pamela Madrid Angers, Nicolas Fernandez-Arias and Hassan Adan (FAD)

56

IMF (2017), The Role of the Fund in Governance Issues, https://www.elibrary.imf.org/view/journals/007/2017/004/007.2017.issue-004-en.xml

59

The 5th round (2017) Mechanism for Follow-up on Implementation of the Inter-American Convention Against Corruption (MESICIC) Report provides further specific recommendations to strengthen competence and integrity at all levels of the judiciary (paragraphs 155-157 and 179). The authorities’ responses are posted: http://www.oas.org/en/sla/dlc/mesicic/paises-rondas.html?c=Dominican%20Republic&r=6

60

The CES is as a consultative body created to ensure the organized participation of employers, workers and civil society in strengthening of social peace, as established in article 251 of the Dominican Constitution. The constitutional reform is being discussed as part of a broader dialogue on enhancing transparency and institutionality: https://ces.gob.do/transparenciainstitucionalidad

61

These findings are supported by scores from the World Justice Project (WJP) Rule of Law Index, specifically the sub-factors on due process, delays, government influence, and enforcement, whose results weigh on the Dominican Republic’s scores for regulatory enforcement and civil justice. Please note that these indices are perceptions-based, and the accuracy of the index can be biased by the respondent’s views instead of facts on these factors. Questionnaires are administered to experts annually and to the general public every few years. The general public survey for the Dominican Republic was last conducted in 2018, thus recent changes may not yet fully show up in scores. Non-IMF indicators provide qualitative information. They do not represent the IMF’s assessment of the situation in the Dominican Republic.

62

While there have been reports about issues with expropriation—in particular as a legacy of agricultural reform and due to weaknesses in the title registration system—indicators related to expropriation are not particularly low: for the relevant WJP sub-factor the score is above the overall score for regulatory enforcement. However, complaints are often related to the delay of compensation for expropriations.

64

In particular, in 2021 DGCP launched the first stage of the Preventive and Reactive Alert System (SAPR), which allows identifying which institutions have incurred in violations of the public procurement law.

65

As supported by the OECD Trade Facilitation Indicator, 2019 (weaknesses identified in advance rulings, fees and charges, documents, automation, and efficiency of procedures); World Bank Group & Turku School of Economics (WBGTSE) Logistics Performance Index (LPI), 2018 (efficiency of clearance process, quality of trade and transport infrastructure, ease of arranging international shipments, quality of logistics services, tracking and tracing consignments, and timeliness of shipments); World Economic Forum (WEF) Global Competitiveness Survey (GCS), 2019 subindices on trade openness sourced from the WEF Executive Opinion Survey (EOS) (prevalence of non-tariff barriers) and the International Trade Centre (trade tariffs, complexity of tariffs). Note that the LPI and EOS are constructed from surveys of market participants and therefore must be interpreted with caution as they can be biased by experts’ views; they do not represent the IMF’s assessment of the situation in the Dominican Republic.

66

As supported by in the World Bank Global Indicators of Regulatory Governance, 2017-2018 (transparency of rulemaking, impact assessment, ex-post review, and challenging regulations) and the WEF GCS, 2019, subindex on burden of government regulation based on the WEF EOS.

67

As supported by in the WEF GCS, 2019, sub-indices: indicators of domestic market competition (distortive effect of taxes and subsidies on competition, extent of market dominance, competition in services) based on the WEF EOS.

68

The improvements resulting from these reforms will be studied and presented to the public in August 2022.

69

Except in certain industries where the relevant regulator has been endowed with such powers – such as telecommunications, financial services, and hospitals – in which case Ley 42-08 states that ProCompetencia will work in tandem with said regulators.

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Cover IMF Staff Country Reports
Dominican Republic: 2022 Article IV Consultation-Press Release; and Staff Report
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2022: Issue 217
Publisher:
International Monetary Fund
ISBN:
9798400214196
ISSN:
1934-7685
Pages:
104
DOI:
https://doi.org/10.5089/9798400214196.002

Bond Amortizations

(In RD$ bln.)

Consolidated Public Sector Debt1

(In percent of GDP)

Poverty Rates

(percent)
Figure 1.

Dominican Republic: Real Sector Developments
Figure 2.

Dominican Republic: Fiscal Developments
Figure 3.

Dominican Republic: Monetary Policy and Inflation
Figure 4.

Dominican Republic: Exchange Rates and Sovereign Spreads
Figure 5.

Dominican Republic: External Sector Developments
Figure 6.

Dominican Republic: Financial Sector Developments

Contributions to Headline Inflation

(Equation Decomposition, in percent, QoQ)

Contributions to Core Inflation

(Equation Decomposition, in percent, QoQ)

Shock Decomposition of Core Inflation

(Deviation from target, in percent, QoQ)

Shock Decomposition of Core Inflation Expectations

(Deviation from target, in percent, QoQ)

Contributions to Non-Core Food Inflation

(Equation Decomposition, in percent, QoQ)

Shock Decomposition of Non-Core Food Inflation

(Deviation from target, in percent, QoQ)

Contributions to Energy Inflation

(Equation Decomposition, in percent, QoQ)

Shock Decomposition of Energy Inflation

(Deviation from target, in percent, QoQ)
Figure AII.1.

Dominican Republic: External Debt Sustainability: Bound Tests 1, 2

(External debt in percent of GDP)

Direct Trade Linkages: Tourism and Commodities

Inflation

(percent)

Bond Amortizations

(In RD$ bln.)

Potential Growth and Output Gaps

Output and Employment Gaps

(In percent)

Production Function – Growth Decompositions

Estimates of Potential Unemployment (NAIRU) and Labor Force Participation

Cyclical Adjustments to Labor Force Participation Rate and Labor Efficiency
Figure AV.1.

Dominican Republic: Public Sector Debt Sustainability Analysis – Baseline Scenario

(In percent of GDP, unless otherwise indicated)
Figure AV.2.

Dominican Republic: Public Debt Sustainability Analysis Risk Assessment
Figure AV.3.

Dominican Republic: Public Debt Sustainability Analysis—Realism of Baseline Assumptions
Figure AV.4.

Dominican Republic: Public Debt Sustainability Analysis—Stress Tests
Figure AV.5.

Dominican Republic: Public Debt Sustainability Analysis—Composition of Public Debt and Alternative Scenarios

Quarterly T-skew Quantile Fit for 12/31/2021 Growth Rate Forward 4

Quarterly T-skew Quantile Fit for 12/31/2021 Growth Rate Forward 4

Quantile Regressions Coefficients

Quarterly T-scew Forecast for Growth Rate

Scenario Test for 12/31/2021 Growth Rate Forward 4

Electricity Sector Deficit

(In percent of GDP)

Electricity Generation Matrix

(In percent of total generation)
Figure AIX.1.

Public Debt Trajectories Under Uncertainty
Figure AIX.2.

Calibration of Debt Ancor for the Dominican Republic
Figure AIX.3.

Average Primary Surplus Needed to Reduce Debt to 50 Percent by 2030–35
Figure AIX.4.

Operational Rule Simulations Under Baseline
Figure AIX.5.

Operational Rule Simulations Under Boom-and Bust Cycles