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DE RUEHTG #0242/01 0741420
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O 141420Z MAR 08
FM AMEMBASSY TEGUCIGALPA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 7824
INFO RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC IMMEDIATE 0730
RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEHBR/AMEMBASSY BRASILIA 0177
RUEHMD/AMEMBASSY MADRID 0498

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 000242 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR WHA/CEN, WHA/EPSC AND EEB/OMA 
TREASURY FOR IMF EXECUTIVE DIRECTOR 
MADRID FOR HUGO LLORENS 
BRASILIA FOR SIMON HENSHAW 
 
E.O. 12958: DECL: 01/29/2018 
TAGS: EFIN EAID IMF HO
SUBJECT: GOH NEAR AGREEMENT WITH IMF ON STANDBY 
 
REF: A. TEGUCIGALPA 138 
     ¶B. TEGUCIGALPA 84 
 
Classified By: Ambassador Charles A. Ford, E.O. 12958 Reason 1.4(d) 
 
¶1. (C) Summary: Sources here expect the IMF Board next month 
to approve a Precautionary Standby Agreement with Honduras. 
Under this agreement, which represents a lower level of 
ambition than what was being discussed in January (ref B), 
Honduras is to stabilize its international reserves and 
devalue its exchange rate by means of a crawling peg.  It 
would not endorse limits on luxury imports, which the Central 
Bank was recently pushing.  Honduras will receive no balance 
of payments support from the Fund under this agreement, but 
the GOH will likely try to use it to pry loose budget support 
funds from other donors.  Unless the Board overrules IMF 
Staff, the agreement would also implicitly bless a scheme by 
the Central Bank to finance the debt of the state electric 
utility by manipulating reserve requirements in a way that 
foreign bank representatives here claim is designed to limit 
their market share.  End Summary. 
 
---------------------------- 
Fund and GOH Close to a Deal 
---------------------------- 
 
¶2. (C) IMF ResRep Mario Garza told EconCouns March 3 that the 
Fund was close to closing a deal with the GOH on a 
watered-down Precautionary Standby Agreement that he expected 
to be presented to the IMF Board for approval in April.  He 
said the GOH had accepted the IMF's crawling peg proposal for 
the exchange rate and had already allowed some little-noticed 
microadjustments to the rate as a precondition.  Also as a 
precondition, the GOH is to assure that Central Bank foreign 
reserves at the end of March are no lower than the year-end 
2007 level, which would require them to increase slightly 
from where they stand now.  There will be monthly targets 
thereafter under the agreement.  The GOH must also get an 
acceptable budget approved by Congress and commit to a 
further 11 percent increase in electricity tariffs. 
 
¶3. (U) Press here are reporting that the agreement will be 
approved April 9.  However, at a March 12 meeting between 
G-16 donors and members of the National Congress, Garza said 
the budget would need to be approved at least two weeks 
before the IMF Board could vote on the agreement.  Given that 
the Congress will be in recess next week for Holy Week, 
Congress Vice President Lizzy Flores said that timetable 
would be difficult if not impossible to meet, since the GOH 
has not yet presented the budget to the Congress. President 
of Congress Roberto Micheletti said March 13 that the budget 
would not be approved until April 20, assuming the GOH 
submits it after the recess. 
 
¶4. (C) Garza said the GOH had dropped the idea, being pushed 
last month by Central Bank President Edwin Araque, of 
limiting luxury imports, as the Fund had refused to support 
it.  But the fund has reluctantly acquiesced to Araque's 
scheme to manipulate reserve requirements, conditional on the 
composition of banks' loan portfolios (see below) so as to 
find a market for bonds to bail out the National Electric 
Company (ENEE).  GE and Citibank reps have complained to us 
that the scheme was deliberately designed to limit market 
share of foreign-owned banks. 
 
¶5. (C) Garza told us that under this minimalist agreement, 
Honduras will receive no financial support from the Fund. 
But the GOH wants the agreement as a "seal of approval" for 
its fiscal policy, and probably as an instrument for 
persuading other donors, such as the World Bank, Germany and 
Spain, to release budget support funds.  IMF staff, and local 
World Bank officials, are supporting the agreement because it 
allows the IFIs to continue to monitor GOH fiscal performance. 
 
--------------------------------------------- 
U.S. Banks Concerned about New Reserve Scheme 
--------------------------------------------- 
 
¶6. (U) Araque announced publicly the week of February 18 the 
Honduran Central Bank (BCH) would increase the "obligatory 
investment" requirement (the share of deposits that must be 
backed by government bonds) for lempira deposits from 4 
percent to 9 percent, phased in over three months beginning 
in March.  The clear and stated objective is to create a 
 
TEGUCIGALP 00000242  002 OF 003 
 
 
captive market for the 4 billion lempiras (USD 212 million) 
of bonds the GOH needs to place to pay off the accumulated 
debt of ENEE to private power producers (whose support the 
GOH needs for its plan to purchase heavy fuel oil from 
Venezuela through Petrocaribe).  BCH also probably hopes to 
lower the cost of government borrowing overall. 
 
¶7. (SBU) In fact, since Araque's announcement, the GOH was 
able to place 679,000 lempiras of ENEE bonds at a coupon 
rates as low as 9.5 percent, which is not enough even to 
cover inflation.  Previously, banks had been demanding rates 
of 14 percent or more.  (Annualized inflation the last four 
months as been 11.4 percent) 
 
¶8. (U) To compensate the banks and to avoid inducing an 
economic slowdown, the increased investment requirement is to 
be accompanied by a simultaneous phased reduction of the cash 
reserve requirement for lempira deposits from 12 percent to 7 
percent, and of the obligatory investment requirement on 
deposits in foreign currency (primarily dollars) from 24 
percent to 14 percent.  However, to benefit from the lower 
cash reserve requirement, banks must have at least 80 percent 
of their loan portfolios in "productive investments," defined 
as something other than consumer or commercial credit. 
 
¶9. (SBU) The innocent explanation for this direct portfolio 
mandate is that the BCH wanted to assure that the increased 
liquidity resulting from the lowered cash reserve would not 
further fuel inflation, currently running at double digits. 
(Comment: Treasury OTA analyst does not expect the effect of 
the changes on liquidity to in fact be neutral, since the 
increased obligatory investment will finance bonds that will 
be used to pay off debt to private power producers, who will 
then deposit it back into the banks.  End Comment)  However, 
representatives of U.S.-invested banks strongly suspect that 
the large Honduran banks intervened with the BCH to 
manipulate the rules in such a way as to work to their 
advantage -- and to the disadvantage of foreign banks.  The 
local manager for BAC (majority owned by GE) is also worried 
that the changes will put upward pressure on credit card 
rates -- already 30-60 percent -- reviving GOH talk of 
capping them. 
 
¶10. (U) A survey by the Honduran Banking Association (AHIBA) 
revealed that of its 18 member banks, only one met the 
criteria for the reduced reserve requirement.  However, six, 
all of them local, have portfolios comprising less than 30 
percent consumer and commercial credit.  Those banks have 
told AHIBA they could reconfigure (or relabel) their 
portfolios to qualify.  Meanwhile, seven banks -- almost all 
foreign -- hold more than 50 percent consumer and commercial 
loans. 
 
¶11. (SBU) Maria Solano, executive director of AHIBA, told 
econoff AHIBA is strongly against the proposed changes, which 
 she sees as an unnecessary attempt to control the markets 
and a serious disincentive for transparency among bankers 
(since banks will have an incentive to misrepresent the 
purpose of their loans so as to qualify for the lower reserve 
requirement).  AHIBA sent a letter to Araque February 20 
spelling out its concerns about the new regulations, 
including that they would lead to higher interest rates, that 
the portfolio mandate cannot be enforced (the National Bank 
and Insurance Commission says it does not have the capacity 
to monitor the composition of bank loan portfolios) and that 
Honduras's shadow sovereign bond rating could suffer. 
 
------------------- 
The Fund's Attitude 
------------------- 
 
¶12. (C) Garza said the IMF was in principle opposed to direct 
controls over bank lending policies of the sort Araque is 
proposing.  Other critics have pointed out publicly that 
these sorts of controls were tried unsuccessfully in Honduras 
in the 1980s.  However, Garza said IMF staff were not willing 
to make this issue a deal-breaker for the Precautionary 
Standby Agreement.  Also, he said, the staff had some 
sympathy for the GOH predicament of having to place 4 billion 
lempiras of bonds in a financial market where a small number 
of players can easily collude. 
 
¶13. (C) The Staff report will note reservations about the 
scheme and will likely insist that the policy be reviewed in 
 
TEGUCIGALP 00000242  003 OF 003 
 
 
May.  Staff would also prefer the measures to have a time 
limit.  Garza noted that the Board could insist on stricter 
limits on the measures when it votes on the agreement next 
month. 
 
------- 
Comment 
------- 
 
¶14. (C) The draft Precautionary Standby Agreement, as we 
understand it, is a minimalist package that President Zelaya 
undoubtedly hopes to use domestically to confer legitimacy on 
his fiscal policies and internationally to try to extract 
more direct budget support from donors.  We see some benefit 
to the agreement in that it will give the IMF continued 
leverage -- however small -- over GOH fiscal and monetary 
policies.  But other donors should not be fooled into 
increasing their support based on this agreement.  For one 
thing, we expect the revenue projections and the investment 
plan in the budget the GOH will submit to assume that the GOH 
will receive USD 350 million over the next two years from the 
Petrocaribe deal with Venezuela that the Congress approved 
March 13.  We and other donor reps here consider it extremely 
unlikely that Petrocaribe will yield that much disposable 
cash to the GOH.  Thus, both the fiscal deficit and public 
investment will likely miss their targets.  Also, we 
recommend that the U.S. Executive Director voice strong 
reservations about the BCH reserve requirements and portfolio 
mandate. End Comment. 
FORD