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Honduras: Honduras Economy Profile 2012

2012/03/13

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Honduras Economy Profile 2012

Even though a benign external environment, spikes in foreign direct investment and remittances inflows, and substantial debt relief contributed to episodes of high growth in Honduras over the past decade, the country remains one of the poorest countries in Central America with limited progress in establishing conditions for sustained long-term growth. In part, these outturns may be explained by the fact that many successful economic reforms undertaken in the first half of the 2000s, which justified the completion of the Highly Indebted Poor Countries and Multilateral Debt Relief Initiative programs by the international community, were abandoned or even reversed in the latter part of the decade.

During 2009, the economy of Honduras was strongly affected by the global slowdown and a period of severe political turmoil. Real GDP fell by about 2 percent, while lower world oil and food prices contributed to a sharp decline in end-year headline inflation to 3 percent (10.8 percent in 2008). The fiscal position deteriorated significantly, and the overall public sector deficit widened from 1.7 percent of GDP in 2008 to 4.6 percent in 2009, reflecting lower tax revenues (driven by the economic slowdown) and a large increase in current expenditure (mostly public sector wages). The fiscal deficit was financed largely with costly domestic bonds, central bank credit, and accumulation of domestic arrears.

Since late 2008, monetary policy has been largely accommodative. Central bank’s policy rate and reserve requirements were lowered, and credit to the public sector expanded significantly, contributing to a loss of international reserves. As in the rest of the region, weak external demand and rising unemployment in the United States resulted in a sharp fall in exports and remittances. Imports fell even more, on account of lower international commodity prices and weak domestic demand. As net capital inflows fell more than the current account deficit, gross international reserves declined to US$2.3 billion by end-2009 (3½ months of imports) from US$2.7 billion at end-2008 (4¾ months of imports), and the decline in net international reserves was even larger.

A gradual recovery in economic activity is expected in 2010. A pickup in foreign direct investment (mostly in the maquila and telecommunications sectors) and a rebound in agriculture are expected to result in real GDP growth of 2¾ percent. Headline inflation is projected to increase to about 6 percent, mostly reflecting rising international oil prices and domestic utility tariff adjustments. Meanwhile, the economic recovery and rising oil prices are expected to widen the external current account deficit to about 6 percent of GDP. The overall deficit of the public sector is expected to narrow slightly to about 4 percent of GDP, as revenue gains from tax measures approved earlier in the year would be partially offset by higher domestic expenditure.

For 2010, economic growth is anticipated to recover to some 2¾ percent, while the central bank expects to contain inflation at 6 percent. In the fiscal area, the mission acknowledged the importance of the tax reform approved in April and recommended its swift implementation. The authorities agreed that the revenue gains from this reform need to be complemented with decisive actions to regain control over public current spending. To this end, it is key to contain the growing wage bill (which used up over 90 percent of tax revenue in 2009) and ensure that subsidies be targeted only to the poor. The mission supported the authorities’ efforts to strengthen the finances of public enterprises and recommended developing a comprehensive policy to recover the financial viability of public pension funds. The goal of the government’s fiscal strategy is, in the short term, to reduce the public sector financing needs for 2010-11, and in the medium term, to ensure the sustainability of public finances.

In the monetary area, the mission agreed with the official inflation projection for 2010, and recommended that the central bank contains the expansion of liquidity to strengthen foreign reserves. In the financial sector, the priority should be to further improve bank supervision to secure the soundness of the loan portfolio and strengthen financial intermediation. Looking ahead, the mission supported the authorities' plans to develop a structural reform agenda that includes greater private sector participation in infrastructure investment, to improve medium-term prospects for economic growth and poverty reduction.