VZCZCXYZ0010
OO RUEHWEB

DE RUEHTG #0084/01 0281841
ZNY CCCCC ZZH
O 281841Z JAN 08
FM AMEMBASSY TEGUCIGALPA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 7582
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE IMMEDIATE
RUEHCV/AMEMBASSY CARACAS IMMEDIATE 0581
RUEAIIA/CIA WASHDC IMMEDIATE
RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE

C O N F I D E N T I A L TEGUCIGALPA 000084 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR WHA/CEN, WHA/EPSC AND EEB/OMA 
TREASURY FOR ANNA JEWEL, SARA GRAY AND WILLIAM FOSTER 
 
E.O. 12958: DECL: 01/29/2018 
TAGS: EFIN EAID ENRG EPET PGOV PREL IMF HO
SUBJECT: GOH SEEKS IMF AGREEMENT TO UNLOCK BUDGET SUPPORT 
 
REF: A. 07 TEGUCIGALPA 1531 
     ¶B. 07 TEGUCIGALPA 1798 
     ¶C. 07 TEGUCIGALPA 1944 
     ¶D. 08 TEGUCIGALPA 57 
 
¶1. (C) Summary:  Honduran Finance Minister Rebeca Santos and 
Central Bank President Edwin Araque will travel to Washington 
January 31 to attempt to lay the groundwork for an IMF 
Standby Agreement that President Zelaya could finalize and 
announce when he comes to town for the national prayer 
breakfast February 7.  Sources here tell us the two sides 
remain far apart over public sector salaries, the last of six 
issues that have held up negotiations.  An agreement could 
provide USD 50 million in IMF balance of payments support and 
potentially unlock considerably more than that in direct 
budget support from other donors, including the World Bank. 
Zelaya probably also wants an IMF deal to provide an implicit 
seal of approval for his proposal to purchase Venezuelan oil 
on credit through Petrocaribe.  Post is concerned that, 
without adequate up-front conditionality, Zelaya will renege 
on any commitments to the IMF, pocket the financial resources 
it unleashes and use them to skate through the remaining two 
years of his term without undertaking serious economic 
reforms, leaving his successor to deal with the consequences. 
 End Summary. 
 
---------- 
Background 
---------- 
 
¶2. (SBU) According to local IMF Resrep Mario Garza, the GOH 
formally approached the IMF last October about resuming 
discussions on a follow-on agreement to the one that expired 
in April 2006.  Garza said this was the first indication of 
seriousness on the part of the GOH in an IMF program since 
President Manuel Zelaya came into office in January 2006. 
Talks to renew the previous agreement were derailed in April 
2006 over IMF concerns about the rapid increase in public 
sector salaries, which caused the 2006 budget to miss IMF 
targets.  An attempt to rekindle discussions in April 2007 
faltered when the GOH team reported Zelaya would not accept 
the IMF's terms.  The breathing room provided by nearly USD 4 
billion in official debt relief and strong revenue gains 
(thanks in large part to U.S. Treasury technical assistance 
to GOH tax authorities) clearly reduced Zelaya's incentive to 
be on an IMF plan. By the summer of 2007, the IMF was 
expressing growing concerns over both the quantity and 
quality of government spending, rapidly expanding domestic 
credit and the potential impact on economic growth and 
financial stability in the medium term (ref A). 
 
---------------- 
Lowering the Bar 
---------------- 
 
¶3. (SBU) In addition to fiscal and monetary issues, the IMF 
has also attempted to engage the Zelaya Administration on the 
need for microeconomic and structural reforms to attract 
investment for long-term economic growth.  In particular, the 
Fund has highlighted the need to reform the energy and 
telecommunications sectors, both characterized by 
inefficiency and corruption, and to implement CAFTA. 
However, after two months of tense discussions following the 
resumption of talks in October, the two sides agreed to leave 
those structural reform issues off the table and pursue only 
a 12-18 month Standby Agreement that would seek only to 
stabilize reserves (which fell by about USD 100 million -- 
about 4 percent -- last year, and would have fallen by more 
if not for a USD 50 million grant from Taiwan that arrived 
late in the year) and achieve fiscal balance.  A three-year 
Poverty Reduction and Growth Facility (PRGF), could follow if 
the GOH is prepared to engage on broader reform issues. 
 
¶4. (SBU) Over the course of discussions, the two sides 
narrowed their differences to six broad policy issues: 
 
-- public sector wage policy 
-- public pension funds (borrowing from) 
-- subsidies (primarily for fuel and electricity) 
-- rationalization of electricity rates, 
-- civil service reform, and 
-- monetary policy. 
 
The overall goal is to keep the fiscal deficit at or below 
one percent of GDP (it was more than 2 percent in 2007) and 
stabilize reserves, expected to come under pressure as 
remittances from Hondurans living in the United States -- 
equal to a quarter of GDP -- slow or decline. 
 
¶5. (C) Garza said the two sides had reached basic agreement 
on all the above issues except wages.  Under current 
policies, he said, which the GOH refuses to change, the 
public sector wage bill is expected to rise 19 percent this 
year, after already rising sharply in the previous two years 
(30 percent in 2007 alone).  The IMF is insisting growth in 
salaries not exceed 13 percent.  The GOH is trying to 
manipulate the issue by changing the metric to percentage of 
GDP, thus reaping the benefit of a recent change in Central 
Bank statistical methodology, which restated GDP upward by 
roughly 20 percent, and assuming  continued strong economic 
growth will stabilize the ratio at around 9 percent.  The IMF 
is not buying. It wants the GOH to show it is prepared to 
resist wage demands from teachers and other public employees 
and to stabilize payrolls. 
 
¶6. (C) On electricity policy, the state-owned electric 
company, ENEE, is losing money at a rate of about 3 percent 
of GDP a year because of a combination of poor management, 
technical losses, theft of electricity and rates that do not 
cover costs (ref B).  The GOH raised rates on industrial 
customers in December and on most residential customers 
(other than those consuming less than 150 kwh a month) in 
January -- an average increase of 16 percent.  It has 
committed to further raise rates, and target existing 
electricity subsidies to the truly needy, resulting in a 
cumulative average increase of 27 percent.  The Fund 
considers these steps to be adequate to "stop the bleeding" 
at ENEE for purposes of a Standby Agreement.  It is not 
requiring any additional steps to restore health to the 
ailing electricity sector or to deal with ENEE's arrears to 
private power producers, which the World Bank estimates total 
6 billion lempiras (USD 317 million) and rising. 
 
¶7. (C) On the monetary front, the IMF is recommending a 
crawling peg that will devalue the lempira -- fixed at 18.9 
to the dollar since 2005 -- by 3 percent by the end of 2008. 
Garza said this would be just sufficient to keep parity with 
the expected difference in U.S. and Honduran inflation over 
the next year.  The IMF also wants the Central Bank to raise 
reserve requirements on banks and increase its base interest 
rate (overnight rate) by a further 150 basis points (it has 
already increased 150 basis points since mid-2007) to 9 
percent. 
 
¶8. (SBU) Garza does not foresee an agreement going to the IMF 
board until late March. He said that under an agreement, the 
IMF would likely provide a one-time USD 50 million balance of 
payment injection to the Central Bank.  But he said 
disbursement would be backloaded, contingent on the GOH 
fulfilling conditions. 
 
---------------------------------------- 
Other Donor Support Potentially at Stake 
---------------------------------------- 
 
¶9. (C) Probably of more concern to Zelaya than the USD 50 
million in balance of payments support that the IMF might 
provide is the impact of an IMF agreement -- even a 
watered-down Standby Agreement -- could have on decisions of 
other donors with respect to direct budget support.  Several 
donors have been holding back budget support because of the 
lack of an IMF agreement.  For example, the World Bank has 
USD 30 million in funds, earmarked for budget support this 
year, that may be reprogrammed in February (probably to 
projects in Honduras) if conditions, including an IMF 
agreement, are not met.  Local representatives tell us the EC 
may have a further USD 20 million to provide, Germany USD 24 
million and Spain USD 6 million.  Garza estimates a total of 
USD 150 million could be at stake. 
 
¶10. (C) In a January 22 donors meeting here, Garza briefed 
donor reps on the Fund's ongoing discussions with the GOH and 
stressed that whether the Standby Agreement it contemplates 
would be sufficient for them to release their support funds 
would be a decision each donor would have to make.  He said 
Finance Minister Santos was focused on what Honduras needed 
to do to unlock those funds during her December 2007 visit to 
Washington. 
 
¶11. (C) In a meeting with Embassy and USAID officers January 
24, Garza suggested organizing a meeting of key multilateral 
and bilateral donors to inform them of the risks, noting that 
they may face tremendous pressure to disburse budget support 
funds if a Standby Agreement is reached. 
 
----------- 
Petrocaribe 
----------- 
 
¶12. (C) Underlying these discussions is the simultaneous GOH 
bid to sign a deal with Venezuela to import fuel on 
concessional terms through Petrocaribe (ref D).  According to 
public statements by GOH officials and briefings provided to 
donors and to the Honduran Congress, such a deal could 
provide the GOH USD 345 million over the first year.  The GOH 
is already banking on USD 285 million for 2008, under the 
optimistic assumption that oil could begin to flow in April. 
Politically, Zelaya and his team are arguing that, without a 
Petrocaribe deal, it will be impossible to maintain the fuel 
subsidies -- currently costing the GOH about 3.6 billion 
lempiras (USD 190 million) a year -- in the face of 
record-high world oil prices.  However, Petrocaribe 
agreements typically require that proceeds be used for public 
investments, not subsidies.  Furthermore, the GOH has already 
committed in its submission to Congress (in part to satisfy 
domestic critics and IMF conditions) that all proceeds will 
be placed in a trust fund at the Central Bank to be used to 
recapitalize ENEE, construct hydroelectric plants and invest 
in social and agricultural projects under the direction of a 
"committee of notables." 
 
¶13. (C) The IMF is urging that this cash, along with USD 80 
million the GOH is expecting to receive from the recent 
auction for a fourth cellular telephone license, be 
sequestered at the Central Bank and earmarked for 
infrastructure projects, preferably to be monitored by the 
World Bank. However, World Bank staff told us that, based on 
previous Honduran experience with "trust funds," they are not 
interested.  Some Honduran experts have commented publicly 
that the Central Bank's charter does not permit it to manage 
funds for infrastructure investments. 
 
------- 
Comment 
------- 
 
¶14. (C) We suspect President Zelaya plans to use his trip to 
Washington February 7 to announce he has reached agreement 
with the IMF on a Standby package, whether he has in fact 
done so or not.  He will then use that supposed agreement to 
claim legitimacy for a Petrocaribe deal, which would be part 
of the agreement, and to pressure other donors to release 
budget support funds that they have been holding back for 
lack of an IMF program.  Although donor reps here have told 
us they plan to base disbursements on actions taken by the 
GOH, their resolve could easily waver in the face of pressure 
here and from their capitals to disburse.  Zelaya's goal, we 
are convinced, is to squeeze enough liquidity out of 
Venezuela, the IFIs and bilateral donors to skate through the 
remaining two years of his term, maintain fuel subsidies and 
teacher salaries, avoid any difficult economic reforms and 
pass the bill onto his successor.  This suspicion is 
supported by his track record of managing the windfall from 
debt relief. 
 
¶15. (C) Whether Zelaya will succeed is another question. 
Finance Minister Santos, in our view, sincerely wants a 
meaningful IMF program to discipline her own boss and create 
conditions that will allow Honduras to maintain the healthy 
growth rates of the last three years beyond the end of 
Zelaya's term.  Donor discipline will be essential to assure 
that her vision, not that of her boss, prevails.   The World 
Bank appears to be divided on the issue.  Country director 
Adrian Fozzard is inclined to support an IMF Standby and 
release budget support funds on the grounds that it would at 
least impose some discipline on Zelaya for the balance of his 
term.  Other staffers think that would be throwing good money 
after bad.  The Bank's stance will be key, as will the USG's. 
 End Comment. 
 
 
FORD