Honduras: Economic Financial Policies

I. RECENT DEVELOPMENTS AND PERFORMANCE UNDER THE PROGRAM

1. The economy of Honduras is slowly recovering from the depression caused by the global economic crisis and the domestic political impasse of 2009. Following a 2.1 % decline in 2009, real GDP grew by 2.8 percent in 2010, above program projections
(2.4 percent), driven by a surge in domestic demand. Last December, headline inflation reached 6.5 percent, (year-on-year) close to the upper limit of the programmed range of 5.5¬6 percent (+/-one percentage point), mostly due to the impact of higher food, fuel, and energy prices, and weather-related domestic supply shocks. However, core inflation, which excludes energy and food prices, declined to 4 % in 2010.

2. In the Honduran external sector, the current account deficit widened but was more than offset by capital inflows. According to preliminary data, imports rebounded more strongly than exports; however, the current account deficit (6.2 percent of GDP) was as programmed, financed by large private capital inflows, especially at end-2010. This boosted the gross international reserves to a historic record of US$2,931 million (equivalent to four months of non-maquila imports).

3. Fiscal consolidation is generally proceeding as envisaged, despite higher infrastructure spending related to damage from tropical storms in 2010. The control mechanisms we have put in place have helped keep current spending within the budgetary limits. However, despite tax administration improvements, revenues were below target because even though the April 2010 tax reform (Decree 17-2010) yielded the anticipated results, the strengthening of the tax administration has taken more time than foreseen. In this context, the central government deficit was 0.3 percent of GDP higher than projected. However, performance in the rest of the public sector was better than envisaged, more than offsetting the central government deficit. The estimated deficit of the combined public sector was 2.9 percent of GDP, compared with the programmed 3.7 percent of GDP.

4. All end-December 2010 quantitative performance criteria were met by wide margins. Also, our structural reform commitments through March 2011 were either already implemented by the time of the program review (Tables 1 and 2) or had advanced considerably toward completion:

• The Banking and Securities Commission (CNBS) issued new rules on loan classification, reserve coverage, and liquidity risks in October 2010. In January 2011, the CNBS approved new standards for appraisers. In December 2010, the Early Warning Committee, which meets on a quarterly basis, was reactivated. Also, the Chamber of Commerce and Industry of Tegucigalpa established a register of movable collateral in January 2011, as a first step toward implementation of the “secured transactions” law.
• The contract with an international firm to audit public sector arrears to the private sector was signed in December 2010, and the draft of the final report was presented in March 2011. On the basis of the audit results, a plan will be formulated to regularize all legitimate arrears. We have made progress in settling central government domestic arrears. By end-2010, most of the intra-public sector arrears had been paid.
• In February 2011, the CNBS completed drafts of the laws and regulations to reform the public pension funds (INPREMA, INJUPEMP, and INPREUNAH), modifying the parameters of contributions and benefits with the aim of strengthening the actuarial position of these funds, and the respective boards of directors have duly discussed the drafts. Also, in December 2010, the CNBS revised the regulations for the investment of public pension funds, to diversify the financial instruments for investment, with proper limits to ensure their liquidity, profitability, and security.
• Control over the education sector payroll was effectively transferred to the Ministry of Finance last December and has been fully incorporated into the integrated financial management system (SIAFI). Furthermore, as of January 2011, any modification to the budgeted central government payroll requires prior approval of the Ministry of Finance.
• Efforts are under way to improve human resource management and administrative capacity at the tax collection agency (DEI). In March 2011, the job and pay description manual for the hiring and evaluation of qualified personnel in the Large Taxpayers Unit (LTU) was approved.
• The financial position of the electricity company (ENEE) improved considerably last year, reflecting the increase in electricity tariffs and due to more hydroelectric power was available than anticipated. In March 2011, the arrears to private suppliers were settled. Until January 2011, electricity tariffs were adjusted in line with fuel costs, as envisaged. In February 2011, electricity tariffs for the public sector were increased by 3.63 percent.
• At end-2010, the number of households covered by the conditional cash transfer program (Bono 10 mil) reached 161,368. The original target of 150,000 households was thus surpassed.

II. MACROECONOMIC POLICIES FOR 2011-12

5. The macroeconomic outlook for 2011-12 remains broadly as envisaged under the program. A gradual economic recovery is under way, and real GDP growth is projected at 3.5 percent for 2011 and 4 percent for 2012. Year-on-year inflation is expected to rise to 8 percent in December 2011, due to a higher-than-expected increase in oil, energy, and food prices, but a decline in inflation is expected in 2012. The external current account deficit in 2011 is projected to increase to 7.2 percent of GDP, mainly because of the increase in fuel and imported food prices. However, given the still weak state of economic recovery and the control of core inflation, the overall policy stance will be maintained. Furthermore, the accumulation of the net international reserves in 2011 will be broadly as originally programmed, while the stock will possibly exceed the original targets. Fiscal consolidation
will continue, while the monetary policy stance will be adjusted if there is evidence of second-round effects of the commodity price increases or if external sector objectives are threatened. A less favorable external environment would constitute a factor of considerable risk in the process of economic recovery.

Fiscal Policy

6. Our fiscal policy will continue to aim at reducing the public sector deficit to 2 percent of GDP in the medium term, consistent with a debt-to-GDP ratio of less than 30 percent, and on improving the quality of public expenditure. In line with these objectives, the 2011 public sector budget targets a deficit of 3.1 percent of GDP. This target is consistent with a central government deficit equivalent to 3.5 percent of GDP. Furthermore, the 2012 budget we plan to submit to Congress by September 2011 will target an overall deficit of the central government at about 2.5 percent of GDP, consistent with a consolidated public sector deficit of 2 percent of GDP.

7. During 2010, we managed to reduce the public sector fiscal deficit, control current expenditure, and settle the domestic payment arrears. Nevertheless, important challenges lie ahead. In particular, during 2011 it will be essential to broaden the tax revenue base, establish firm control over employment and the wage bill in the public sector, and improving domestic debt management to ease the liquidity pressures facing the government.

8. On the revenue side, we plan to fully implement the tax measures approved in 2010 and strengthen the DEI. In particular, we will continue strengthening the LTU, implement electronic tax filing, and prohibit firms with tax arrears from obtaining government contracts. In addition, we are advancing preparations for a census of taxpayers, expected to begin in September 2011. The operations of the LTU will improve once it is focused on a number of taxpayers accounting for 80 percent of total tax revenue. We will continue to implement the tax reform of April 2010 and the controls to verify its proper enforcement. In addition, by December 2011 we will complete a comprehensive review of tax exemptions and create a franchising and tax exemption unit in the Ministry of Finance by July 2011, which should help enforce tax compliance. We expect to send to Congress, in April 2011, the final version of the preliminary draft law against tax evasion. These measures are intended to increase the tax revenue of the central government to 15.4 percent of GDP (from 14.8 percent of GDP in 2010).

9. We will continue to exercise firm control over public sector current spending and give priority to high-impact capital investment projects and well-targeted social spending, in part to mitigate the effects of the food and fuel price increases on the most vulnerable segments of the population. To this effect, it will be essential to maintain government expenditure strictly within the ceilings established in the 2011 budget. We will also identify low-priority expenditure which could be deferred in the event of insufficient revenue or of higher spending in priority areas, so as to ensure observance of the 2011 targets for the overall deficit of the consolidated public sector. These measures, combined with the positive impact of the ongoing reforms of public sector enterprises and public pension funds, will help us meet the fiscal deficit targets, strengthen the financial position of the public sector, and improve the composition of expenditure.

10. One of the key elements of our expenditure policy for 2011 is control of the wage bill. In line with our commitment to tighten payroll control, regarding existing positions, the process of employment verification in the education sector was completed in March 2011, and in the health sector completion is envisaged for December 2011. As a follow up, the Government Audit Office (TSC) will implement remedial measures based on the census and the audit of teaching positions by end-March 2012. At the same time, the Ministry of Finance, the Ministry of Planning and External Cooperation, and the Ministry of Education will take action to screen the payroll, seeking to eliminate all the redundant and irregular positions identified in SIAFI and the educational human resources integrated management system (SIARHD). It is envisaged that this process will be completed by October 2011, and the TSC will be kept informed for all pertinent purposes. A centralized unit was created in the Ministry of Finance last year for payroll control, which incorporated into the SIAFI the payroll management modules of the Ministry of Education, and by October 2011 it is planned to incorporate into the SIAFI payments by bank transfer to day laborers.

11. Our budget financing strategy aims at reducing reliance on domestic resources and not using central bank credit to the public sector. For that purpose, our 2011 financial plan includes external budget financing of US$170 million. In addition, last September we contracted a nonconcessional loan with the Central American Bank for Economic Integration (CABEI) for US$280 million, which remains within the limit on the contracting of nonconcessional external debt (US$350 million). We will not incur external arrears at any time during the program period.

12. Our budget plan provides that if tax revenue were to be higher than projected, we will use up to 50 percent of the excess revenue to repay domestic debt and allocate the remainder to social investment projects. Also, should external budget support loans exceed the amount projected in the program for 2011, the floor of the NIR target will be raised (the ceiling on the central bank’s net domestic assets will be lowered) by the excess amount (TMU, paragraph 14).

13. The government has recently adopted a new a debt management strategy to extend the maturity profile of public domestic debt and lower its cost. In the first operation of this kind, completed in January 2011, existing bonds (1.2 percent of GDP) were swapped on a voluntary basis for 3-7 year instruments carrying 9-12.25 percent coupon rates. In addition, the Guidelines for Public Sector Borrowing for 2011-14, aimed at building public debt management capacity and to link government borrowing plans to a multiyear fiscal framework, were updated in April 2011.

Monetary and Exchange Rate Policies

14. The government is committed to seeking price stability while keeping core inflation under control and maintaining an adequate level of international reserves. The monetary program for 2011 takes into account the impact of rising oil, energy, and food prices. Accordingly, in 2011 we will seek to keep annual inflation in the range of 8 percent (+/- one percentage point), whereas the accumulation of net international reserves is projected at US$227 million. However, if inflation continues to accelerate and external reserves target becomes at risk, we will tighten monetary policy, as appropriate. We commit to maintain the policy of not extending central bank credit to the nonfinancial public sector or to public banks. We will assess the appropriateness of interest rate levels throughout the program period and will adjust the policy rate (TPM) as necessary to achieve the inflation target and protect the external position. The monetary program will be kept consistent with a prudent expansion of credit to the private sector.

15. The central bank will reform the operational framework for conducting monetary and exchange rate policy. The central bank will take measures to foster the development of an active interbank market and secondary markets for central bank and government paper, refine monetary instruments, and enhance policy signaling. The reform program we have devised includes: (i) adopting a system of daily liquidity forecasting and management;

(ii) improving repo operations for liquidity management, (iii) ensuring that the TPM functions as a tool for signaling the monetary policy stance; and (iv) strengthening the structural auctions of central bank paper to allow for price discovery by market participants. We are committed to maintaining an exchange policy that is consistent with the objective of safeguarding competitiveness and strengthening the external position.

16. To enhance the central bank’s ability to pursue effective monetary policy, we will develop a plan for its recapitalization and institutional strengthening by December 2011. We intend to request technical assistance from the IMF for this purpose.

III. STRUCTURAL REFORMS

17. Successful modernization of the Honduran economy requires the sustained implementation of structural reforms in the public and financial sectors. During 2011, the government’s reform efforts will center on the following areas:

• Strengthening the operating balances of key public enterprises. The tariff adjustment is a key factor in the financial sustainability of the ENEE. Accordingly, we are committed to adjusting the tariffs as required by law. HONDUTEL has concluded an alliance with a U.S. company to improve its services. In December 2011, the ENEE and HONDUTEL will present comprehensive plans to restore their financial viability and enhance their operational efficiency.

• Strengthening the financial position of public pension funds. In March 2011, we submitted for review and approval the INPREUNAH Regulations to the institution’s Board of Directors. In the case of the INJUPEMP and INPREMA, we anticipate that the draft laws will be submitted to the National Congress later this year.

• Improving the management and fortifying the financial position of the Honduran Social Security Institute (IHSS). The Ministries of Finance, Labor and Social Security, and the CNBS, with technical assistance from the Inter-American Development Bank (IDB) will prepare an administrative, technical, and financial assessment of the IHSS, including actuarial studies and a thorough assessment of the situation of the Disease and Maternity System.

• Reform of the civil service law. With the assistance of the IDB, we have prepared the Terms of Reference for hiring an expert to review the current regulations and procedures for the selection and recruitment of employees at all levels of public administration. Based on the expert’s report, a plan to amend the Civil Service Law will be presented to Congress by December 2011.

• Financial sector policies. The government is committed to continue improving the regulatory framework and supervisory practices in the financial system and to strengthen the financial safety net. In line with our commitments in the program, much progress has been made in the process of establishing adequate regulations for bonded warehouses, credit bureau, and extraordinary assets. Also, the process has been initiated to revise regulations to promote transparency, disclosure, and the protection of users of financial services. We will strengthen the risk-based supervision framework for savings and loans associations and, for that purpose; we plan to issue new regulations by February 2012. The restructuring of Banco de los Trabajadores is well advanced, and the only outstanding task is that of establishing the trust that will be responsible for collecting doubtful assets. At BANADESA, the CNBS is conducting a study to assess the actual position of the bank, to be completed in December 2011, for the purpose of preparing an institutional strengthening and financial plan.

• Social investment. Poverty reduction is one of the strategic objectives of the government. With this purpose, the 2011 budget allocates 1.5 percent of GDP to all social investment programs. In addition, the government will continue improving the targeting of subsidies to allocate savings to ease the impact of the rise in food and fuel prices on the most vulnerable segments of the population. With the assistance of multilateral banks and in accordance with the established procedures, the government is fully committed to a gradual expansion of the coverage of the conditional cash transfer program (Bono 10 mil) to include 300,000 households by end-2011, to the monitoring and strict control of proper program implementation, and to expand the provision and access to health and education services to the program’s beneficiaries.

IV. OTHER PROGRAM ISSUES

18. Safeguards Assessment. An IMF mission visited Honduras last December to update the safeguards assessment of the Central Bank of Honduras. The central bank is committed to fully implement the recommendations resulting from that assessment.

19. Program Monitoring. The program will continue to be monitored through regular quarterly reviews, quantitative performance criteria, and structural benchmarks. The second program review will be completed on or after May 15, 2011; the third one, on or after August 15, 2011; the fourth one, on or after November 15, 2011; and the final one, on or after February 15, 2012. The quantitative performance criteria proposed for June, September, and December 2011 are shown in Table 3. The structural benchmarks are shown in Table 2. The date for the submission of the law reforming public pension funds will be changed from the original December 2010 date to March 2011 for INPREUNAH (presentation of statute to that institution’s Board of Directors), and for INJUPEMP and INPREMA, the draft laws will be submitted to the National Congress later in 2011. We propose to add a new benchmark on improving the management of the IHSS and strengthening its financial position. The definitions and reporting procedures are specified in the attached Technical Memorandum of Understanding.