This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 TEGUCIGALPA 000010 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CEN, WHA/ESPC, DRL/IL, EB/IFD/OMA 
STATE PASS AID FOR LAC/CEN 
STATE PASS USTR, EXIM, OPIC 
STATE PASS USED IDB, USED WB, USED IMF 
TREASURY FOR JOHN JENKINS 
 
LABOR FOR ILAB, ROBERT WHOLEY 
PANAMA FOR CUSTOMS 
 
E.O. 12958: N/A 
 
TAGS: EFIN ECON EAID ETRD ELAB PGOV HO
SUBJECT: GOH Starting to Get Serious About Getting An IMF 
Program 
 
Ref A: Tegucigalpa 3149 
Ref B: Tegucigalpa 3479 
Ref C: Tegucigalpa 3491 
 
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Summary 
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¶1.  (SBU) Honduran government officials are working hard to 
close the gap with the International Monetary Fund over a 
new three year Poverty Reduction and Growth Facility (PRGF) 
program.  With plans for new revenue measures of usd 175 
million and planned reduction in costs (primarily personnel 
cuts) of usd 35 million, the government believes it can 
reduce the central government deficit to three percent of 
GDP for 2003, down from 5.6 percent in 2002.   The GOH is 
already implementing recommendations by the Fund in the 
financial sector and working closely with the World Bank-IMF 
evaluation of the financial sector.   A delegation of 4-6 
IMF directors will visit Honduras January 17-21.  The GOH's 
macroeconomic team will return to Washington after that 
visit to review tax reform legislation before sending it to 
Congress in early February.   The GOH hopes that the IMF 
mission would return to Honduras in March, after approval of 
the legislation to sign off on a letter of intent, and that 
the program could go to the IMF Board in April.  The IMF's 
insistence on major reductions in public sector salaries as 
percent of GDP continues to be the main sticking point, 
along with the associated timing of the folding-in of 
teachers into a planned civil service reform program.   End 
Summary. 
 
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Significant Revenue Measures Planned 
------------------------------------ 
 
¶2. (SBU) The Ministry of Finance has identified new revenue 
measures that will raise central government income by 2.8 
percent of GDP (about usd 175 million).  These measures 
include: elimination of exemptions from the sales tax, an 
implementation of withholding taxes designed to reduce 
evasion of sales and income taxes, broadening of the base 
for income tax to include a higher percentage of bonuses and 
benefits packages, and the taxing of the retirement income 
above a specified level.  The government plans to introduce 
a decree to eliminate the tax exemption for diesel used in 
the production of electricity (this exemption is believed to 
be the source of enormous tax evasion); the state-owned 
power company ENEE would be charged with negotiating an 
adjustment to the price paid to private electricity 
generation companies to cover this tax change.  The Finance 
Ministry plans to direct credit card companies to send sales 
tax payments directly to the tax authorities (the DEI) in 
order to avoid evasion of sales tax and help collect the 
planned withholding taxes.  Vice Minister William Chong Wong 
noted that this type of measure has been extremely 
successful in El Salvador and other countries.  The Finance 
Ministry also wants to require audits for companies with 
more than ten million lempiras (approx. usd 593,000) in 
sales annually, and to make financial officers of companies 
and accounting firms more accountable for intentional tax 
evasion.  Chong Wong is heading up the effort to draft 
reforms to the income tax law and tax code.  The GOH plans 
to review these draft legal changes with the IMF in mid to 
late January. 
 
--------------------------------------------- - 
Wage Bill Reductions - Sticking Point with IMF 
--------------------------------------------- - 
 
¶3. (SBU) On the expenditure side, the GOH has identified 
some one-time measures that will reduce government spending 
and the wage bill by 0.6 percent of GDP in 2003.  Six 
thousand teachers who are over 65 years old will be retired 
in early January (an overdue legal requirement) and will be 
replaced by younger teachers with lower salaries.  Similar 
measures will be taken among state-employed medical staff. 
The government is also cleaning up its payroll records (to 
be completed by February) and expects to be able to achieve 
savings of 200 million lempiras (approx. usd 11.9 million) 
per year by reducing ghost workers and individuals receiving 
multiple full-time salaries. 
 
¶4. (SBU) According to Finance Minister Alvarado, however, 
the IMF is pushing for additional reductions in the wage 
bill as a percent of GDP: 
 
     2002     10.7 percent 
     2003     10.1 percent 
     2004      9.1 percent 
     2005      8.1 percent 
 
The GOH does not see how they can meet these targets. 
Alvarado (strictly protect) has now proposed to the Cabinet 
a public sector wage freeze for 2003.  There is some 
interest but the government remains stymied over the idea of 
freezing teacher salaries only months after reaching a 
settlement on teacher wage increases for 2002-2005. 
 
¶5. (SBU) During the December 16-17 consultations between the 
GOH macroeconomic team and the IMF in Washington, the 
government finally shared its draft Civil Service Framework 
bill.  Discussion focused on Article 110, which currently 
says that the teachers will be folded into overall state 
wage policy by 2006, indicating that the salary provisions 
of the estatutos (laws governing particular professions) 
will be eliminated that year.  Alvarado said that IMF staff 
are insisting that the teachers be covered by the civil 
service reform immediately upon adoption of the law.  The 
GOH has commented that the World Bank is more understanding 
of their stance on this issue. 
 
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The Results: Sizable Projected Reduction in Government 
Deficit Based on Reforms That Could Get Through Congress 
--------------------------------------------- -------------- 
 
¶6. (SBU) The central government deficit for 2002 is 
estimated to be 5.6 percent of GDP.  This deficit is 
projected to decline to 5.1 percent in 2003 if no further 
measures are implemented.  The IMF mission in November 
estimated that the reforms envisioned by the GOH would bring 
down the central government deficit to 4.0 percent of GDP. 
Finance Minister Alvarado is now saying that he can get it 
down to 3.0 percent of GDP. 
 
¶7. (SBU) The government is determined, however, to go to the 
Congress only once more on major fiscal reforms.  For this 
reason, they want to be absolutely sure the IMF is on board 
with all legislative proposals before they are sent to the 
legislature.  At the same time, the GOH is certain that any 
further changes to the agreement with the teachers would 
undermine congressional approval.  On the expenditure side, 
they believe they've gone as far as they can go.  Minister 
Alvarado noted, in a meeting with Econ Counselor and AID 
economist on December 31, that the GOH wants to be sure it 
can deliver what it promises.  He alluded to problems that 
Nicaragua is already having in getting its program approved 
by the legislature. 
 
¶8. (SBU) The GOH was heartened by the Honduran Congress' 
easy acceptance of the austerity budget for 2003 on December 
¶4.  The budget was virtually unchanged from the 2002 budget 
in nominal terms, with the exception of usd 262 million in 
needed infrastructure projects, meaning that most ministries 
will face cuts in real terms of about eight percent after 
accounting for inflation.  The Congress identified new 
funding for all of these infrastructure projects. 
 
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Public Enterprises Still A Concern 
---------------------------------- 
 
¶9. The declining surpluses in the key public enterprises 
(electricity utility ENEE, phone company Hondutel, and the 
Port Authority) remain a concern.  Finance Minister Alvarado 
acknowledged that while ENEE's financial picture should 
improve by 2004-2006 when high cost power contracts are 
replaced by new low-cost Lufussa and AES projects (see ref 
b), 2003 is going to be a very tough year for the state- 
owned electricity utility.  The government plans a series of 
privatization and liberalization initiatives in 2003 and 
2004, including privatization of some port facilities, the 
postal system and some roads.  This may help increase 
government revenues in the short run and efficiency in the 
long run.  Privatization of Hondutel, a twice failed 
undertaking, remains a politically charged issue, with the 
government in denial about the true low value of the utility 
to an outside investor and the fairly strong union trying to 
fight any changes.  A GOH requested study of liberalization 
of the telecom sector in Honduras has been approved by the 
U.S. Trade Development Agency and should begin in the first 
half of 2003.  In the power sector, the GOH has the results 
of a USAID sponsored white paper on modernization.  To 
depoliticize the issue, the GOH is no longer talking about 
privatization of ENEE, but rather the unbundling of its 
generation, transmission and distribution activities. 
 
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Financial Sector: Actions Underway 
---------------------------------- 
 
¶10.  (SBU) As reported in Ref C, Banking and Insurance 
Commission President Ana Cristina Mejia de Pereira 
apparently is making strides in meeting prior action 
requirements of the Fund in the financial sector.  Banco 
Capital was liquidated on December 19.  The GOH needed to 
tap into about usd 30 million of Hondutel cash to cover the 
deposit insurance for this failed bank; the Minister of 
Finance indicated to emboffs on December 31 that this is the 
last time he will authorize use of those funds to cover a 
bank failure.  The Commission has ordered an appraisal of 
the value of Banco Sogerin, the other bank which the 
government took over in May, and hopes to be able to sell it 
in February (three potential purchasers have shown 
interest).  The Commission is working closely with five 
additional banks to ensure they meet the higher 
capitalization requirements.  Two or three of these banks 
will probably be sold to larger banks; in the remaining 
cases, the shareholders are providing the needed additional 
capital. 
 
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The Road to a Program 
--------------------- 
 
¶11. (SBU) The GOH has invited interested IMF executive 
directors to visit Honduras January 17-21.  Alvarado, 
Minister of the Presidency Luis Cosenza and Central Bank 
President Maria Elena Mondragon plan to return to Washington 
right after that visit to provide IMF staff with detailed 
proposals and projections and to review their drafts for new 
legislation.  The new laws would be submitted to Congress 
upon their return for adoption in February and to enter into 
force on March 1.  The GOH hopes that the IMF mission would 
then return to Honduras to complete a letter of intent on a 
new three-year PRGF, and Honduras' program would go to the 
IMF board in April.  Speed is vital at this point.  Quite a 
few World Bank, Interamerican Development Bank, and 
bilateral aid programs are on hold until Honduras gets back 
on track with an IMF program.  Honduras is off track for 
HIPC debt relief and is now accumulating new arrears in its 
service of its Paris Club debt (arrears estimated at over 
usd 70 million at this point).  USG agencies should track 
this carefully, as the Brooke Amendment could come into 
force as early as March 31, forcing agencies such as USAID 
to begin drawdown plans. 
 
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Comment 
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¶12. (SBU) If the government adopts the identified measures 
and is successful in reducing the central government deficit 
to three percent of GDP (i.e. a 2.5 percentage point 
reduction over the passive expected level), that will be a 
substantial achievement.  Similarly, adoption of the long- 
awaited civil service reform that would provide the GOH with 
control over wage policy and create a career civil service 
would be important moves.  If real progress is made in these 
areas in the next month, the GOH will have a much stronger 
hand with which to convince the IMF to accept a slower 
timetable on inclusion of the teachers in the civil service 
reform. 
 
¶13. (SBU) The other possible development that could help the 
fiscal imbalance is a resumption of economic growth.   It 
will be important for the GOH to start focusing on measures, 
other than tax incentives, which can be taken to attract 
investment and improve the business climate. 
 
Palmer