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RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC IMMEDIATE 0783
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C O N F I D E N T I A L SECTION 01 OF 04 TEGUCIGALPA 000772 
 
SIPDIS 
 
STATE FOR WHA AND EEB 
TREASURY FOR SARA SENICH AND WILLIAM FOSTER 
STATE PASS TO USAID/LAC 
 
E.O. 12958: DECL: 08/21/2018 
TAGS: EFIN EAID ENRG EPET PGOV PREL IMF VE HO
SUBJECT: FAINT HOPE FOR IMF STANDBY AGREEMENT IN HONDURAS 
 
REF: TEGUCIGALPA 518 AND REFTELS 
 
Classified By: Charge D'Affairs Simon Henshaw for reasons 1.4 (b) and ( 
d) 
 
¶1. (C) Summary. After a reluctant IMF assessment visit August 
12-15, the IMF officially concluded that fiscal policies are 
broadly on track, while advising the GOH to strengthen its 
monetary and exchange rate policies.  Underlying the terse 
public statement was a private 
consensus among IMF officials that the Precautionary Standby 
Agreement is all but dead, with only faint hope it can be 
revived.  According to IMF ResRep Mario Garza, abysmal 
monetary policies are the real problem, not ballooning public 
sector wages as claimed by the press. Compounding the 
frustration of IMF officials is a complete lack of urgency on 
the part of the GOH economic team to draft practical fixes to 
problematic policies, and Garza does not expect any serious 
attempt to get the program back on track.  End Summary. 
 
---------------------- 
Monetary Policy Had a Stronger Effect Than External Shocks 
---------------------- 
 
¶2. (C) An International Monetary Fund (IMF) assessment 
mission reluctantly visited Honduras for the first official 
review of April's Precautionary Standby Agreement August 
12-15.  The mission's reluctance was based on a well-founded 
belief that Honduras was unlikely to complete 
its review at this time, which was proven right.  A terse 
August 18 press release commending fiscal policies as broadly 
on track, while advising the GOH to strengthen its monetary 
and exchange rate policies was a face saving measure, 
according to IMF ResRep Mario Garza.  He said there was a 
surprising amount of distance between IMF and GOH officials. 
IMF officials articulated that poor monetary and exchange 
rate policies are the primary reason Honduras is not 
completing its agreement.  By contrast, Central Bank (BCH) 
President Edwin Araque flatly stuck to his position that 
deviations in the program resulted solely from external 
shocks, namely domestic demand pressure, and it was therefore 
unwise to "overreact."  IMF officials reminded Araque that 
they had advised Honduras in May to consider the shock 
permanent (reftel), therefore eliminating international 
reserves as a possible temporary fix.  They also acknowledged 
the unexpectedly strong effect of external shocks - about 
four percent of GDP - but also pointed out that simultaneous 
positive shocks such as remittances and the attractive 
price of exports resulted in a net negative effect on the 
terms of trade of only about two percent.  Araque could only 
respond that President Zelaya will not allow him to react on 
monetary and exchange rate policy. 
 
¶3. (C) The IMF mission was careful not to tell the GOH 
outright that its monetary policy is expansionary, instead 
suggesting the GOH is creating a "strong impulse" to 
inflation by allowing the external current account deficit to 
grow rapidly.  While the program originally envisioned this 
deficit at nine percent of GDP, IMF expects it will reach 15 
percent by the end of the year if not addressed.  Araque 
simply repeated his claim that external shocks were squarely 
to blame.  Garza lamented that while the IMF had focused on 
finding out what the GOH intended to do to get back on track, 
GOH officials were more focused on potential press reaction. 
In the end, the economic cabinet agreed to review the aide 
memoire and discuss options with the President, only 
half-heartedly committing to discuss its ideas in Washington 
in September.  Garza noted a complete lack of urgency among 
GOH officials to develop revised monetary policies and he 
expects neither a constructive nor timely response. 
 
¶4. (C) The mission also pointed to the huge deviation in 
international reserves from the original targets. The 
Agreement called for an increase in reserves from USD 2.473 
billion to USD 2.726 billion by the end of 2008.  Reserves 
have instead fallen to USD 2.3 billion, USD 100 million of 
which was lost in the last three weeks.  This represents a 
deviation of USD 230 million from original targets, and it 
could reach USD 400 million by the end of the year without 
appropriate action.  Despite the precipitous decline in 
reserves, the GOH was not prepared to discuss policy 
responses.  Araque dismissed the acceleration in losses as 
seasonal, claiming that the seasonality will become favorable 
 
TEGUCIGALP 00000772  002 OF 004 
 
 
in the fourth quarter. 
 
¶5. (C) Garza believes the monetary side of the program is off 
track for a combination of reasons that boil down to lack of 
political will: 
 
- President Zelaya was not committed to the program from the 
beginning. 
- The GOH economic team, comprised of BCH President Araque 
and Finance Minister Rebeca Santos, is weak and is not 
informing Zelaya that the program is off track, or of the 
implications. 
- Though a capable technician, Araque is first and foremost a 
Zelaya political loyalist who, like all of Zelaya's cabinet, 
finds it difficult to advise the President, especially when 
the advice means changing the current course.  He is 
constantly in "response" mode and lacks strategic vision of 
where to take the program.  This, combined with his tendency 
to see everything as political, makes it very hard for Araque 
to counter Zelaya's wild ideas with practical suggestions. 
- Zelaya does not see the IMF program as congruent with his 
increasingly close relationship with Venezuela.  Ministers 
seem to be buying into this trend as well - Finance Minister 
Santos, who often appears willing but politically unable to 
pursue rational policies, asked the IMF mission to justify 
why it is in Honduras' interest to save the program. 
- Division within the economic cabinet prevents a practical 
approach.  Previously, various Ministers of the Presidency 
have been key participants in IMF discussions.  The present 
minister, Enrique Flores Lanza, is completely disengaged. 
Santos has openly stated to IMF officials she does not like 
Araque. 
 
------------------- 
IMF says Fiscal Policy Not as Dire as Press Reported 
------------------- 
 
¶6. (C) In spite of failing monetary policy, the fiscal side 
is broadly on track.  As it told the GOH in May (see reftel), 
the mission is willing to accommodate some deviations in 
current spending because the oil price shock was much bigger 
than expected.  Additionally, fuel subsidies have been 
virtually eliminated and electricity subsidies are now 
targeted.  Garza said the IMF feels the current electricity 
tariffs are almost consistent with cost recovery and IMF and 
World Bank energy experts have agreed to meet in Washington 
to discuss another possible tariff increase of about ten 
percent.  Despite rampant press reports that the IMF is 
singularly focused on ballooning public wage spending, Garza 
denied having made statements to the press to that effect, 
and he suspects Araque is placing the stories in order to 
divert attention from 
monetary policy.  On the other hand, Garza thought the 
misreporting could provide enough steam for Rebeca Santos to 
get the wage bill she wants, which could help address serious 
overruns in hiring, especially for teachers, which could 
account for losses of 0.3 percent of GDP for the year (about 
USD 60 million). 
 
----------------------- 
Bank Supervision Needed 
----------------------- 
 
¶7. (C) Garza commented that bank supervision is a weak point 
of the IMF program, and that banks seem to be operating with 
increasing freedom in Honduras, signaled by the credit boom 
over the last year.  He sees anecdotal indications that that 
lenders are finding it increasingly difficult to collect on 
their loans.  The IMF suggested to Banking and Insurance 
Commission (CNBS) head Gustavo Alfaro that the CNBS should be 
taking a closer look at individual banks.  Garza explained to 
econoff that the current practice is for most public sector 
entities to deposit revenues in private local banks, rather 
than the Central Bank.  Because the BCH does not offer market 
rates and because BCH does not have control over its monetary 
policy, public sector enterprises have incentive to put this 
liquidity into private banks, which offer higher rates.  In 
turn, those banks can (exponentially) expand credit 
portfolios.  For example, deposits from state-run telecom 
company Hondutel were recently shifted from Citibank to Banco 
Continental, a bank owned by media-magnate Jaime Rosenthal, 
who is in turn using the funds to expand credit "like crazy." 
Garza said under Araque, the GOH has intensified the existing 
 
TEGUCIGALP 00000772  003 OF 004 
 
 
practice of letting public sector institutions deposit 
revenues in private banks.  Though 
shifting public sector deposits to the BCH would be 
relatively simple, and could solve the international reserve 
deviation, Araque complains it would be too hard to enforce. 
In fact, Garza suspects Araque knows that taking these 
deposits away from some banks that could cause a hard landing 
if the credit situation worsens in Honduras. 
 
---------------------- 
What Should Be Done? 
---------------------- 
 
¶8. (C) Garza acknowledged that it would not be easy to get 
the Precautionary Standby Agreement back on track, but said 
it is theoretically possible by year's end.  With concrete 
action and political will in the short term, IMF is willing 
to give the GOH some breathing room by pushing back the 
deadline to March or even June of 2009.  He said the mission 
was careful to leave the solution to the GOH, offering tools 
such as the monetary policy rate (TPM) and reserve 
requirements.  Garza did, however, present his personal ideas 
to econoff, which were not articulated by the mission to the 
GOH: 
 
- The policy interest rate, which is currently negative, must 
increase substantially (note: Garza noted that Araque 
consistently responded to this suggestion by pointing out the 
United States currently has a negative interest rate as well. 
 End Note.) 
- Increase reserve requirements for private banks by three 
percent and increase the TPM by 200 basis points.  (Note: 
Since April the GOH has raised the TPM by 125 points, while 
inflation has gone up from nine percent to 13.8 percent 
year-on-year.  End Note.) 
- The practice of placing public sector deposits in local 
private banks should stop, in favor of the BCH. If the 
lempira-denominated deposits were used to purchase dollars, 
this could eliminate the international reserve level 
deviation, since public sector deposits currently stand at 
about USD 230 million, almost exactly the amount of the 
reserve losses. 
- The GOH should gradually devalue the exchange rate. 
 
¶9. (C) On the exchange rate devaluation, Garza was remarkably 
frank, saying there was a key difference in opinion between 
his preferred approach and that of his Washington colleagues. 
 Evidently, the IMF team was authorized to suggest an 
exchange rate devaluation of eight 
percent, based on its belief that the terms of trade shock 
had resulted in overvaluing of the currency by eight percent. 
 Garza himself talked the assessment team out of making that 
politically-charged suggestion more than once, and told 
econoff there was a higher chance of selling the Hondurans on 
gradual adjustments.  Garza said the commercial banks would 
support increases in interest rates and reserve requirements. 
 Losing GOH deposits would be another matter.  Garza 
acknowledged the danger of cutting back credit growth too 
rapidly. 
 
¶10. (C) Garza said the options now are for Honduras to take 
quick action to get its program on track or move to Article 
IV consultations that would end the program.  Garza said that 
for all intents and purposes, the IMF feels the program is 
dead, but chose to say publicly the program 
review is continuing on the dim possibility that Vice 
Minister of Finance Hugo Castillo will convince President 
Zelaya to make practical policy changes.  In the mean time, 
Washington's IMF office is planning to gracefully put 
distance between itself and the GOH, canceling trips of 
advisors on various issues.  If Article IV consultations 
prove necessary, the IMF would do them as late as possible, 
probably in December.  This would allow a board review in 
February 2009, followed by discussions with the Presidential 
candidates later in the spring.  Garza acknowledged that if 
the GOH asks the IMF for an assessment letter, it will have 
to say the program is off track. 
 
------- 
COMMENT 
------ 
 
¶11. (C) The GOH is using the assessment to pat itself on the 
 
TEGUCIGALP 00000772  004 OF 004 
 
 
back for its economic success. President Zelaya, with Finance 
Minister Santos and BCH President Araque by his side, 
interrupted all local and cable airwaves on the night of 
August 18 to give the people of Honduras an "economic 
report."  The team announced that the IMF assessment had been 
"extremely positive."  They pointed to "solid" economic 
growth of six percent for the last several years, 
rising employment and a stable exchange rate.  Despite the 
IMF Press Release, newspapers have also gotten it wrong, 
focusing instead on burgeoning wage spending.  We agree with 
Garza's suspicion that Araque is purposely trying to shifting 
the public discussion of the IMF report from the monetary 
problems to fiscal problems.  Because of his past attempts to 
manipulate the press in his favor and his loyalty to 
President Zelaya, we believe he may have a longer term goal 
of setting up the IMF as the scapegoat when unpopular, and 
inevitable, restrictions are placed on public sector hiring 
and wages. 
 
¶12. (C) Given President Zelaya's apparent attempt to solidify 
his friendship with Venezuela at any cost, the odds of a 
miraculous recovery of the IMF Precautionary Standby 
Agreement are close to nil.  Post was surprised at Garza's 
candor in the conversation, considering that he was under 
instruction from Washington not to brief bilateral and 
multilateral missions until the August 27 board meeting.  His 
bosses did not want a repeat of the extremely tense recent 
World Bank food security budget support meeting in 
Washington, the readout of which Garza said was leaked to the 
GOH.  The probable death of the Agreement until at least the 
inauguration of a new administration in January 2010 will 
make it easier for donors, who are increasingly skeptical of 
the Zelaya administration's willingness to use multi-lateral 
and bi-lateral assistance to improve his country's economy, 
to argue against budget disbursements.  For example, the 
World Bank has told us that if the program goes off track, 
Development Policy 
Credit (budget support) of USD 30 million would not be 
approved.  The IMF may have to toughen its message in order 
to convince more lenient donors - such as Spain and the IADB 
- that Honduras is unwilling to take needed measures to help 
its economy stabilize in the long term.  Garza, too, said the 
IADB should do its own thorough macroeconomic assessment.  We 
share his concern that the IADB will attempt to bend the 
rules in order to continue providing budget support as the 
IMF program fails.  End Comment. 
HENSHAW