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DE RUEHTG #0518/01 1512114
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P 302114Z MAY 08
FM AMEMBASSY TEGUCIGALPA
TO RUEHC/SECSTATE WASHDC PRIORITY 8211
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY

C O N F I D E N T I A L TEGUCIGALPA 000518 
 
 
SIPDIS 
 
STATE FOR WHA/CEN, WHA/EPSC, EEB/OMA 
TREASURY FOR ANNA JEWEL, SARA GRAY, AND WILLIAM FOSTER 
STATE PASS TO USAID/LAC 
 
E.O. 12958: DECL: 05/29/2018 
TAGS: EFIN EAID ENRG EPET PGOV PREL IMF HO
SUBJECT: HONDURAS: IMF MISSION ASSESSES GOH RESPONSE TO 
EXTERNAL PRICE SHOCKS 
 
REF: TEGUCIGALPA 242 
 
Classified By: Ambassador Charles A. Ford, reasons 1.4 (b) and (d) 
 
¶1.  1. (C) Summary: An IMF team that visited Honduras May 
13-21 left 
satisfied with GOH efforts on the fiscal side to accommodate 
food and fuel price shocks.  Meetings with the Central Bank 
on monetary policy were very tense, but the Central Bank 
followed IMF advice by raising its base interest rate by 25 
basis points May 28 and permitting another micro-devaluation 
and may take further measures to prevent reserve losses and 
reduce inflationary 
pressures.  Following the visit, the IMF resrep is cautiously 
optimistic that Honduras will meet the revised targets under 
its Precautionary Standby Agreement at the first quarterly 
review, which should take place in late 
July or early August.  The IMF believes strict adherence to 
these measures could still result in economic growth of 3-4 
percent this year.  But 
the team left feeling that too much pressure from the IMF 
could be counterproductive and requested USG assistance in 
encouraging the GOH to implement sound economic policies. 
End Summary. 
 
--------------------------------------- 
IMF Team Studies Impact of Price Shocks 
--------------------------------------- 
 
¶2. (C) An IMF team visited Honduras May 13-21 to examine the 
effect of skyrocketing global food and fuel prices on the the 
Honduran economy and specifically on whether Honduras can 
meet the targets in the Precautionary Standby Agreement the 
IMF Board apaproved for Honduras in April.  The trip was 
necessary, in part, because assumptions in the agreement, 
such as USD 85 
per barrel oil, had proved to be too optimistic.  IMF resrep 
Mario Garza told Econoff that authorities in the Finance 
Ministry and the national 
electric company, ENEE, were very open to IMF recommendations 
and appeared willing to continue to reduce unsustainable fuel 
and electricity subsidies. On the monetary side, Garza said 
discussions with Central Bank (BCH) President Edwin Araque 
were tense, even rising to the level of name-calling on one 
occasion.  In the final meeting, however, Araque agreed to 
raise interest rates May 28 and work with the IMF on a plan 
to allow more exhange rate flexibility while avoiding 
excessive volatility and inflation. 
 
---------------------------------- 
Fiscal Policy Responding to Shocks 
---------------------------------- 
 
¶3. (C) Finance Minister Rebeca Santos and ENEE Director Rixi 
Moncada were very amenable to IMF suggestions on fiscal 
policy, recognizing that maintaining the current deficit 
level and making room for emergency spending would depend on 
limiting the cost of fuel and electricity subsidies.  Fuel 
subsidies alone cost the GOH 1.4 billion lempiras (USD 74 
million) through April, compared with 1 billion lempiras (USD 
53 million) for all of 2007.  Santos agreed to continue to 
allow pump prices to rise -- they have already increased 
around 17 percent in nominal terms over the last two months 
for diesel fuel and premium gasoline.  She even agreed 
tentatively to raise the price of kerosene, used for cooking 
and lanterns by poor and isolated rural households.  Garza 
said the price of regular gasoline, still frozen at 64 
lempiras (USD 3.37) a gallon, would also go up soon. 
 
¶4. (C) ENEE Director Moncada told IMF advisors she plans an 
electricity rate hike of 15 percent in June, a surprising 
announcement given it came before IMF 
recommendations were offered.  Electricity rates have already 
been going up in stages since last December, for a cumulative 
increase of more than 40 percent for some customers, and the 
impact on household electric bills has become a major public 
discussion topic lately.  The current price is consistent 
with a fuel oil (bunker) price of USD 82 per barrel, but the 
world price is currently hovering around USD 97.  Fuel oil is 
used to produce about 70 percent of Honduras's electricity. 
Garza said that even after the 15 percent rate increase, ENEE 
would still be losing money on a cashflow basis, although he 
was not sure by how much.  Thus, even as ENEE is paying down 
its old arrears to private power producers, it continues to 
accumulate new debt. 
 
 
------------------- 
Market for GOH Debt 
------------------- 
 
¶5. (C) Working closely with post's resident Treasury/OTA 
technical 
advisor, Santos has been very active in raising money through 
bond auctions to pay off old debt, almost all of which is 
from ENEE arrears.  The GOH is 
currently on track to place bonds for 3.75 billion out of a 
needed 4 billion lempiras (USD 212 million) before the end of 
June.  About 2.8 billion lempiras have already been placed, 
mostly to banks that already have ENEE debt in their 
porfolios and to pension funds.  Due to unconventional 
reserve requirement policies set by the BCH, banks that focus 
on consumer credit have not participated.  Demand for the 
bonds is dwindling and the May 27 auction for 
lempira-denominated bonds raised a paltry 200 million out of 
a hoped-for 1 billion lempiras.  New bonds were offered for 
two, three, four, or five years (previously only three and 
five year bonds had been offered), but the bond rate has not 
been adjusted for inflation and the GOH has not been flexible 
about the yields needed to attract more banks to place bonds. 
The BCH also attempted this week to sell short term notes and 
managed to sell only 80 million out of a hoped for 1 billion 
lempiras.  Banks did purchase more than 600 million lempiras 
worth of seven-day notes, indicating a preference to stay 
liquid.  Subsequent bond auctions between now and June will 
be important measures of investor expectations about 
inflation. 
 
--------------------------- 
Public Investment Faltering 
--------------------------- 
 
¶6. (C) Due to overruns on fuel subsidies, only about 
one-third of the envisaged 
investment took place in the first quarter.  Public 
investment thus not only fell short of the target in the IMF 
Agreement, it was significantly lower than the first quarter 
of 2007.  The IMF team agreed that in order to strengthen the 
safety net, the GOH could reduce investment from 6.5 percent 
to 5.3 percent of GDP.  Half of this cut will be dedicated to 
programs to respond to rising food prices while the remainder 
will go to maintain fuel subsidies.  While the IMF was 
discussing how to ensure spending is targeted and efficient, 
the GOH has already asked the World Bank for an emergency 
loan to address this issue.  The discussion with the World 
Bank is centered on whether to use the loan on the demand 
side (to subsidize consumers) or the supply side (to increase 
food production).  The Bank's preference is conditional cash 
transfers to the poorest and most affected parts of the 
population, while the GOH prefers 
to stimulate food production. 
 
--------------------------------------- 
Central Bank Resists Austerity Measures 
--------------------------------------- 
 
¶7. (C) BCH President Edwin Araque resisted IMF 
recommendations on the monetary front, often suggesting tepid 
substitute measures that Garza compared to closing the window 
against a tsunami.  Araque complained that he would never 
succeed in selling tougher policies to President Zelaya. 
When Araque 
balked at raising the BCH benchmark rate (TPM), the team 
leader explained that consumer price inflation, including 
food, fuel and electricity rates, 
would inevitably exceed 12 percent within two months without 
tighter monetary policy.  The IMF team recognized that 
increasing interest rates during a supply shock can create 
wage pressure that could push inflation to a higher, 
permanent plateau.  But there is evidence that supply is 
starting to react slowly to rising commodity prices, which 
should help to moderate prices. 
 
¶8. (C) Garza said that in the final meeting before the team 
departed May 21, Araque agreed to raise the monetary policy 
rate by 25 basis points on May 28.  Garza worried that the 
lack of a press release might indicate Araque 
would go back on his word, but the rate increase was quietly 
implemented as scheduled. 
 
¶9. (C) On the exchange rate, Araque attempted to impose a new 
 
operational rule within the BCH, in which the exchange rate 
could not move by more than 0.005 U.S. cents (0.11 lempira 
cents) per day.  The IMF team told Araque this went against 
the spirit of flexibility within the exchange rate band, 
which is plus or minus 7 percent, and could create a black 
market or force a large interest rate increase.  The team 
suggested that a reasonable rise in interest rates could help 
meet targets, and has designed a program of flexibility 
without huge day-to-day devaluations, which it shared with 
Araque, but Garza declined to describe the specifics until 
Araque agrees. 
 
¶10. (C) Econoff inquired about the May 3 devaluation, which 
was implemented and retracted in the same day.  Garza said 
Araque had implemented the devaluation by cutting dollar 
availability in auctions to 20 percent of usual levels 
starting April 27 for three days in a last ditch effort to 
meet the target for reserves at the end of April under the 
Standby Agreement.  But he created a panic by calling bankers 
on the May 1 holiday and trying to convince them to buy more 
notes.  Garza chalked it up to poor exchange rate management. 
 Additional small devaluations have taken place in the last 
few days. 
 
¶11. (C) Interim figures suggest the BCH is USD 70 million 
short of its June 
30 reserve target.  Garza said this is not a huge amount. 
 
 
------------------------------- 
Cautious About Pushing Too Hard 
------------------------------- 
 
¶12. (C) The IMF team left Honduras feeling the IMF cannot 
push too hard, because it could result in policy reversals in 
several key areas.  However, the team also recognized that 
the external food and fuel price shock is probably permanent, 
so it will need to help Honduras figure out how to pass price 
increases on to households while mitigating the impact on the 
poor.  This will be especially important among urban 
populations, which benefit most from electricity and fuel 
subsidies and more likely to take to the streets to protest. 
Therefore, the IMF plans to help the GOH design a revised 
strategy that maintains the current deficit target (1.5 
percent of GDP), while making room for emergency spending. 
Garza is pleased with the level of public outreach GOH has 
done to explain the electricity rate increases, and plans to 
talk to private sector and civil society groups to get 
political buy-in for some difficult but necessary decisions 
in the short term. 
 
¶13. (C) The two sides signed an Aide Memoire at the 
conclusion of the mission with revised targets for the 
Standby Agreement, subject to approval by the IMF Board at 
the upcoming quarterly review.  The GDP growth projection for 
2008 has been reduced to 3.5-4.0 percent.  The zero limit on 
non-concessional borrowing would be raised to accommodate 
borrowing for needed port improvements at Puerto Cortes.  The 
GOH is seeking USD 160 million for this project; which is 
twice what the World Bank's IFC thinks it should 
realistically cost. 
 
------- 
Comment 
------- 
 
¶14. (C) The IMF team appears to have succeeded in convincing 
GOH technocrats, even the BCH president, of what needs to be 
done to maintain macroeconomic stability in Honduras. 
Obtaining approval from President Zelaya will be the biggest 
challenge.  Garza requested that the USG praise Finance 
Minister Santos for her public outreach on fiscal policy, 
emphasizing to GOH officials, including Zelaya and Central 
Bank head Araque, that more tough decisions are to come and 
that we recognize the need to consider the effect on the 
poor.  Post agrees that GOH backsliding on fiscal and 
monetary policy is a real possibility.  At this time, the 
revised targets in the Aide Memoire may represent the best 
hope for keeping the GOH on a sustainable financial path. 
However, in reviewing the Aide Memoire, we recommend the USED 
raise questions about the cost estimates for upgrading Puerto 
Cortes and the refusal of the National Port Enterprise, 
headed by Zelaya ally Roberto Babun, to allow private 
investment in the port. 
 
FORD 
FORD