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

C O N F I D E N T I A L SECTION 01 OF 04 TEGUCIGALPA 000232 
 
SIPDIS 
 
TREASURY FOR U/S TAYLOR 
TREASURY ALSO FOR RAMIN TOUOUI 
STATE FOR WHA/CEN, WHA/EPSC, EB/IFD/OMA, AND DRL/IL 
STATE PASS AID FOR LAC/CEN 
DOL FOR ILAB 
 
E.O. 12958: DECL: UPON SIGNATURE OF THE HONDURAN LETTER OF INTENT 
   OR DECL OF 03 TEGUCIGALPA 2792 (WHICHEVER COMES FIRST) 
TAGS: EFIN ECON PGOV EAID ETRD EINV EPET ELAB HO
SUBJECT: HONDURAS IMF AGREEMENT FULL STEAM AHEAD -- PRIOR 
CONDITIONS NOW FULFILLED AND BOARD APPROVAL OF PROGRAM 
SCHEDULED FOR FEBRUARY 18 
 
REF: A. 03 TEGUCIGALPA 2792 
 
     ¶B. 03 TEGUCIGALPA 1581 
     ¶C. PARIS 674 
     ¶D. 03 TEGUCIGALPA 2915 
 
Classified By: Ambassador Larry Palmer for reasons 1.5 (b) and (d). 
 
¶1. (C) Summary.  The Honduran government has fully completed 
the prior conditions listed in the preliminary Letter of 
Intent (LOI) for a three-year Poverty Reduction and Growth 
Facility Program (PRGF) agreed to with the IMF mission on 
November 25.  In addition, the GOH has put to rest two new 
IMF concerns prompted by the flurry of measures taken in the 
last days of 2003.  On January 20, the Congress modified 
significantly a problematic price control law and, also in 
mid-January, the government made further changes to the 
administration of the new fuels tax to comply with concerns 
by the principal oil product importers and distributors. 
Based on this progress, the IMF staff has negotiated a few 
remaining changes in the program, and the final Letter of 
Intent is due to be signed in Tegucigalpa on February 2. 
Honduras' PRGF will be considered by the IMF Board on 
February 18.  Embassy recommends USG support for this 
hard-fought and long-awaited program.  End Summary. 
 
--------------------------- 
Key Elements of the Program 
--------------------------- 
 
¶2. (C) As described in ref A, the central government deficit 
targets in the Honduran PRGF program are: 3.5 percent of GDP 
in 2004, 3.0 percent of GDP in 2005, and 2.5 percent of GDP 
in 2006.  For the consolidated public sector, the deficit 
targets in the LOI are: 3.0 percent of GDP in 2004, 2.5 
percent of GDP in 2005, and 1.7 percent of GDP in 2006. 
Central government wage bill targets are 10.6 percent of GDP 
for 2004, 10.4 percent of GDP for 2005 and 10.0 percent of 
GDP for 2006.  Public sector wage bill targets are 10.4 
percent of GDP in 2004, 10.0 percent of GDP in 2005, and 9.6 
percent of GDP in 2006.  The program also includes 
requirements for adoption of new financial sector reforms, 
overall civil service reform, a new tax code, and a 
prohibition on new agricultural debt bailouts. 
 
--------------------------------------------- ----------- 
The GOH's Concerted Efforts to Meet the Prior Conditions 
--------------------------------------------- ----------- 
 
¶3. (C) The Letter of Intent listed four prior actions, with 
which the Honduran government has now complied: adoption of a 
government salary law that reestablishes executive branch 
control of central government wage policy; adoption of a 
fiscal package of expenditure cuts and revenue measures that 
results in fiscal savings of one percent of GDP (about USD 60 
million); adoption of a budget for 2004 that is consistent 
with expenditure reduction commitments in the program; and 
adjustment of the Poverty Reduction Strategy to reflect 
spending targets.  The IMF also privately insisted upon the 
publication of a previously-decided hike in electricity rates. 
 
The Long-Awaited Reining in of Government Wages 
--------------------------------------------- -- 
 
¶4. (SBU) On December 19, 2003, the Congress adopted Decree 
220-2003, the Law on Restructuring of the Compensation System 
of the Central Government.  It was signed by President Maduro 
on December 31, 2003, and published in the official La Gazeta 
on January 12, 2004.  This law establishes executive branch 
control of public sector wage policy, folds the teachers into 
the unified civil service salary policy by January 2008, 
freezes the collateral benefits for public sector teachers at 
December 2003 levels, and freezes salaries for medical 
personnel in 2004 (with future increases tied to the rate of 
inflation).  Planned salary increases for teachers for 2004 
and 2005 have been reduced by half and stretched out over a 
three-year period (2004-2006).  The legislation explicitly 
overrides any previous legislation, effectively repealing the 
economic clauses in the special professional statutes that 
have resulted in the unsustainable growth in the central 
government wage bill in recent years.  Decree 220-2003 
directs the Finance Ministry to decide each year on 
government wage increases, based upon the availability of 
budget resources, using the projected rate of inflation as a 
guideline. 
 
¶5. (SBU) The Congress changed the final law to put creation 
of a unified wage scale for teachers (to include basic salary 
plus benefits) in the hands of a special bipartite 
government-teacher commission.   The IMF has added language 
to the program, explicitly requiring that the work of this 
commission be carried out in a manner consistent with the IMF 
program.  The repeal of the economic clauses of the teacher 
and doctor statutes represents a major success by the GOH, as 
it is a basic structural reform that has been urged by the 
IMF and World Bank, and a few Honduran commentators, for 
years. 
 
Austerity Measures 
------------------ 
 
¶6.  (SBU) Also on December 19, the Congress passed the Law of 
Rationalization of Public Finances, a new fiscal package of 
revenue and expenditure measures.  It was signed by President 
Maduro on December 31, 2003, and published in the official La 
Gazeta on January 12, 2004.  It includes steps that will 
reduce government spending and ensure better tax policy 
implementation.  It freezes the number of government 
positions, except in health, education and security.  It 
establishes a monthly salary cap of 60,000 lempiras (USD 
3,300) for all public sector employees, including their 
collateral benefits.  It freezes salaries in 2004 for 
employees with monthly salaries over 30,000 lempiras (USD 
1,650).  It directs government reorganization and cutbacks, 
including in the Honduran Foreign Service.  Mining royalties 
and lottery proceeds will go directly to the government 
treasury. 
 
¶7. (SBU) In early December, the government decided not to 
include in this law an increase in the tax on fuels in the 
fiscal package, but instead to reimpose a customs duty 
(between 10 and 12.5 percent, depending on the product) on 
fuel products by executive decree.  This decree was put into 
place on December 31. 
 
¶8. (SBU) The revised 2004 budget was adopted by the Congress 
on December 30 and published on December 31.  It stayed 
within the expenditure constraints agreed upon by the IMF 
staff and GOH in late November.  The fourth prior action, the 
revision of the poverty reduction plan and adoption of a 
monitoring process, was also completed in December.  The IMF 
agreed to allow funds spent for salaries of public sector 
teachers and doctors to be counted in the tallying of the 
Poverty Reduction Strategy Paper (PRSP) spending, which 
brings government spending on these essential social services 
in alignment with the PRSP targets.  The GOH also published, 
in December, the electricity commission's increase in 
electricity rates (as promised to the IMF). 
 
------------------------ 
The Fuel Tax Controversy 
------------------------ 
 
¶9. (SBU) The IMF has had strong reservations about the GOH's 
decision to raise the fuel tax instead of other broader 
revenue measures, primarily because of the impact on Honduran 
competitiveness and probable public outcry for this 
regressive tax.  And, in fact, in an ill-advised attempt to 
avoid putting all the pressure on consumers and to avoid 
public criticism, close advisors to the President decided at 
the last minute to include in the fuel tax executive decree 
some unilateral changes to the formula used to determine the 
price of a gallon of fuel at the pump.  The reference price 
used to estimate product cost was summarily changed from the 
Caribbean posting to the Gulf posting plus two cents.  This 
simplistic move had been previously urged in August 2003 by 
former Minister of Industry and Trade Juliet Handal. 
Chevron-Texaco and Exxon reps told EconOffs that the Gulf 
posting price underestimates their costs by six cents, and 
thus this change pretty much wiped out the long-standing 4.7 
cent per gallon margin that has been used in the formula for 
years.  The companies were willing to reduce their margin 
somewhat, but were not able to accept an imposed arrangement 
that implied they would work for close to breakeven. 
 
¶10. (C) Intense negotiations over the first two weeks of 
January resulted in a deal between the GOH and the oil 
companies in which a new decree was issued on January 23 that 
puts the reference price back to the Caribbean posting for 
three months while the GOH and oil companies negotiate a 
final settlement.  In the meantime, Handal has been attacking 
the GOH in the press for leaving the impression in the press 
that the change in the pump price formula she had proposed 
was the cause of the jump in gas prices (covering up the 
import duty).  The GOH, after some obfuscation, has now 
satisfied the IMF staff that the revenue targets from the oil 
tax will meet revenue projections.  The oil companies have 
purportedly agreed to absorb half of any price increase that 
may be required by the new formula during the first month. 
 
--------------------------------------------- --------------- 
A Problematic Price Control Decree Rolled Back Substantially 
--------------------------------------------- --------------- 
 
¶11. (SBU) Another complication developed on December 19, when 
the Honduran Congress decided to soften the blow of the 
fiscal measures by enacting a price freeze for six months on 
about 180 products (mostly foodstuffs).  The Congress did not 
consult with the responsible Ministry, the Ministry of 
Industry and Trade, prior to the enactment of the measure. 
The Ministry currently monitors the prices of only 40 
products and, with only twelve consumer protection 
inspectors, has little capacity to implement a price control 
system throughout the country.  However, the IMF staff (and 
other economists) were concerned about the poor precedent set 
by this measure.  Newspapers carried daily reports of price 
increases in the covered products and government's inability 
to curb them, putting the GOH under constant attack.  The IMF 
immediately responded that a price control program was 
contrary to the letter and the spirit of the program, and 
insisted upon a rescinding of the law or drastic cutback in 
the number of products.  Finally, on January 20, the Congress 
cut back the number of products covered to about 38, and the 
GOH agreed to a provision in the Letter of Intent agreeing to 
refrain from any further price controls for the life of the 
PRGF program. 
 
--------------------------------- 
Other Key Elements of the Program 
--------------------------------- 
 
¶12. (C) The GOH committed to enactment of a Financial Sector 
reform by June 2004 that will include a series of vital 
reforms for this very fragile banking system.  The GOH will 
implement consolidated supervision of all financial 
intermediaries.  Banks will be required to increase 
capitalization and provisioning for bad debts.  There will be 
reforms to the Central Bank's role as a lender of last 
resort.  This ambitious set of reforms is key to financial 
sector stability in October 2004, when the 100 percent 
government guarantee of bank deposits ends.  The World Bank 
is implementing a financial-strengthening project to achieve 
these recommended reforms. 
 
¶13. (C) The LOI includes mention of enactment of overall 
civil service reform in 2004.  This is a key measure that was 
also included in Honduras' last PRGF program, and is a prior 
action for World Bank program loans.  The IMF staff will be 
working closely with the World Bank to ensure the requirement 
is handled in a way that doesn't conflict with rules on 
cross-conditionality. 
 
¶14. (C) The program requires enactment of a new tax code in 
2004 that, among other things, provides harsher sanctions for 
tax evasion.  The GOH has been working on the text of this 
law for some time.  The GOH is also working with the Supreme 
Court to establish two special tax courts by the end of 2004. 
 
¶15. (C) The IMF has also included a provision requiring the 
GOH to add more flexibility to its foreign exchange price 
band system, so that it could be used to cushion the economy 
from unanticipated shocks in the future if necessary.  In 
recent years, the Central Bank has consistently bought and 
sold foreign exchange at a previously announced crawling peg 
rate, instead of letting the rate vary within its band. 
 
¶16. (C) The final significant program requirement is a 
prohibition on new bailouts for agricultural loans and a 
limitation on expenditures to implement the 2003 Agricultural 
Credit law.  The law authorized expenditures of up to two 
billion lempiras for agricultural debt forgiveness, but the 
GOH has committed to limiting the cost to 1.2 billion 
lempiras (USD 66 million) (shared between the GOH and the 
banks) and paying the smaller farmers first. 
------- 
Comment 
------- 
 
¶17. (C) Final evaluation of the program will have to await a 
review of the actual text of the Letter of Intent. However, 
it appears that after two long years, the Government has 
finally put together a credible macroeconomic program and the 
IMF has provided as much flexibility as is prudent and 
responsible.  President Maduro, Congress President Pepe Lobo 
and the macroeconomic team can be justifiably proud of the 
work on reestablishing control over public sector salaries, 
increasing government revenues and making progress toward the 
goal of having the Honduran government live within its means. 
 The program will help avoid further ill-advised 
Congressional mandates, such as price controls and massive 
debt forgiveness for large agricultural interests, that have 
plagued government finances up to now.  Protests resulting 
from congressional passage of these controversial measures 
have, to date, been muted (although a sizable demonstration 
on these issues is planned for February 5 (septel)).  While 
not perfect (the heavy reliance on fuel taxes is one 
example), this program puts Honduras well on the way toward a 
period of stability, growth and investment in poverty 
reduction.  Embassy recommends USG support at the February 18 
board meeting.  End Comment. 
 
PALMER