HONDURAS

Memorandum of Economic Policies

I.  Introduction

1.  Our 1999 stabilization and reform program was successful in supporting the recovery and reconstruction following Hurricane Mitch, and in laying the basis for sustained growth in many areas. The decline in real GDP of 1.9 percent was less than anticipated, end-year inflation fell to 10.9 percent, and gross international reserves reached a comfortable level equivalent to 4.3 months of imports. The central government fiscal deficit was contained at 4.1 percent of GDP, and public savings reached 5.5 percent of GDP. Structural reforms continued, especially with privatization and financial sector reform.

2.  Despite these developments, faster growth is clearly needed given that more than half of Hondurans live in poverty. We are firmly committed to consolidating macro-economic stability and to undertaking more ambitious structural reform to achieve higher, poverty-reducing growth. To this end, we will increase the emphasis on growth-enhancing policies in the framework of the medium-term program for March 1999-February 2002, for which the IMF is providing financial support under the PRGF Arrangement. The remainder of this memorandum details the macroeconomic and structural objectives and measures for the period ahead. A summary of the measures is in the attachment. We believe that the policies set out below will be sufficient to achieve the program's objectives, but are ready to take additional measures and seek new understandings with the IMF should the program diverge from its specified targets.

3.  We believe that 5-6 percent economic growth and single-digit inflation are achievable in the medium-term. In 2000, growth is expected to be 4-5 percent of GDP while inflation would stay between 9-11 percent. Regarding the balance of payments, we will aim at limiting the current account deficit in 2000 to 9 percent, and for a decline to 6-7 percent in the following. Foreign investment and inflows of official finance would help maintain reserves at four months of imports in the medium term. The overall public sector deficit in 2000 is expected to reach about 4 percent of GDP and be fully financed from external sources. The deficit would decline to about 3 percent of GDP in the following years. Public savings would attain 5.5 percent of GDP in 2000 and increase to over 6 percent in the medium term. High public sector savings will release resources to the private sector and help foster long-term growth.

4.  To achieve the ambitious growth and inflation objectives, we will continue our prudent fiscal and monetary policies and intensify the structural reform process. Fiscal policy will aim at containing current expenditures while allowing an increase in social expenditures, and reconstruction outlays. Monetary policy will remain prudent to achieve the program's inflation target. Structural reform will aim at fostering private sector initiative, investment, and conditions for robust sustained growth. The priorities in the structural area will include continued progress with privatization, financial sector reform, and deregulation. We are also committed to developing a comprehensive strategy to improve governance, including measures to increase transparency in fiscal and monetary policies, and that reduce the potential for corruption. With these measures we expect to continue to receive adequate support from the international community to make the achievement of our ambitious goals feasible.  

5.  The task of fiscal policy will be to create a basis for medium-term fiscal viability with higher social expenditures. In 2000, we will aim at containing the central government deficit at about 7 percent of GDP, while allowing social expenditures to increase from 9 to over 11 percent of GDP and capital expenditure from 6 to 9 percent of GDP between 1999 and 2000. These objectives are within reach, because we expect revenue performance to remain strong and the growth of nonsocial current expenditure to be contained. If revenue performance is below program projections, we stand ready to curtail nonsocial current expenditures beyond those programmed.

• On the revenue side, we will maintain our efforts to improve tax administration to maintain central government current revenue above 18 percent of GDP. Over the program period the Internal Revenue Office will ensure (i) a firm application of the penalties available under the 1997 tax code (including heavy fines, temporary closures of businesses, and imprisonment); (ii) expanding the coverage of large tax payers register to establish better control, thereby reducing tax evasion; (iii) increasing access to third-party sources of information for cross-checking of purchases and tax returns; and (iv) review the structure of indirect taxes with a view towards reducing the number of tariff bands to reduce incentives for fiscal fraud. Moreover, by end-June 2000 legislation will be submitted to congress aimed at further improving the income tax system and bringing it in line with international standards by clarifying income and cost definitions.

• On expenditures, we will persist in containing nonsocial current expenditures. During 2000, we will limit current transfers unrelated to social and poverty programs and continue to apply the regulations issued in August 1999 which place strict limits on expenditure on fuel, travel, and the purchase of vehicles to limit expenditures on goods and services to 2.4 percent of GDP. The increased capital spending during 2000 and 2001 reflects the continuation of reconstruction projects initiated in mid-1999 and the strengthening of social programs. They are expected to be financed mostly by grants, concessional loans and debt relief.

• The central government wage bill will not exceed 9 percent of GDP in 2000 and 9.3 percent of GDP in 2001. Based on redundancies identified in the study commis-sioned as part of the modernization of state, several existing vacant posts will be cancelled in 2000 and 2001, voluntary early retirement with adjustment aid will be conducted before end-June 2000, and the retrenchment of civil servants at the administrative level will take place during 2001 yielding savings of about 0.2 percentage points of GDP. To maintain the central government wage bill at a sustainable level in the future, we will undertake the following actions. We will approve legislation in October 2000 to reform the civil service and establish a comprehensive and uniform civil service wage policy in time to be effective for the 2001 budget. The law will include clear and objective criteria for annual wage increases based on comparable average increases in private sector wages, productivity and/or merit. We will provide a draft of the wage-setting criteria before the IMF Board discussion on the second review of the arrangement under the PRGF, and a draft legal text of the uniform principles of wage policy and wage-setting criteria by end-June 2000. We will accelerate the civil service reform program in 2000 with World Bank and IDB collaboration by (i) completing the reclassification of jobs, and the profiling and auditing of each position by end September 2000; (ii) preparing an action plan for retrenching redundant personnel, mostly at the administrative levels by end-October 2000; and (iii) completing the wage scale reclassification by end-June 2001 to decompress the salary structure and incorporation of factors such as responsi-bility and seniority by June 2002. We will also undertake a comprehensive assess-ment of public expenditures, and review plans for the hiring of new teachers in 2000 in collaboration with the World Bank. The results of the civil service retrenchment, public expenditure and education policy reviews, and their potential implications for the 2001 wage bill will be discussed during the next review of the program.

• On other expenditures, we will maintain the annual value of public transport subsidies at no more than L 114 million, and electricity subsidies at L 280 million. We will improve the targeting of existing subsidies towards the poor by increasing the progressivity of the electricity subsidy structure by end-June 2000 and reviewing the subsidies to public transport in Tegucigalpa by December 2000. Electricity tariffs will be increased by 16 percent before end-April 2000 to maintain the marginal cost pricing system for the electricity company. To improve expenditure control, the government will continue to simplify the government accounts at the central bank by end-December 2000 and continue with the outside monitoring of external assistance and regular audits of external inflows.

6.  Social security and pension reform will be a key component of our social policy framework. Creating a sound pension system will help reduce poverty among the elderly, contribute to the development of the financial system by increasing the availability of long-term funds, and foster economic growth by allowing more long-term private investment. As a first step for reform, an action plan will be approved by end-April 2000 for separating (operationally and on an accounting basis) the IHSS pension fund from the health fund, and a separate plan for restructuring the institution. We will also establish immediately a working group to settle pending claims between the government and the IHSS by end-March 2000. Moreover, by end-June 2000, another working group will be created to analyze options for longer-term pension reform, and a draft law will be submitted to congress to regulate private pension funds by end-December 2000. Supervision of existing public pension funds will be improved. We will take concrete steps to implement the recommendations of the inspections to increase the transparency and efficiency in the operations of the funds.

7.  We are also committed to improve fiscal transparency and accountability. The focus of our efforts in this area has been the establishment of mechanisms that would ensure the full accountability of resources combined with simplified and transparent procedures for public sector procurement. We are committed to improving the budget process by evaluating domestic practices against the IMF's Code of Good Practices on Fiscal Transparency by December 2000.

8.  Reducing inflation to single digits in the medium term is one of the principal objectives of our macroeconomic stabilization program. Lower inflation contributes to a less volatile exchange rate, and facilitates business and investment decisions, which enhances the economy's growth potential. Moreover, price stability directly benefits the poor who because of their greater reliance on cash holdings suffer disproportionally from the inflation tax. The inflation objective will be pursued mainly through a tight control of base money.

• We intend to reach this year's inflation objective mainly by auctioning monetary absorption certificates (CAMs) to ensure adequate liquidity of the banking system, but also expect help from the contractionary effect of expected decreases in net public sector credit. Net international reserves at the end of the year will remain above US$1000 million, while the growth of broad money is expected to decelerate to 15.3 percent in 2000. Base money is expected to decline by -0.9 percent due to the planned reduction in mandatory investment requirements (see below). Net domestic assets of the banking system are projected to grow by 21.5 percent in 2000, of which credit to the private sector would expand by 21.7 percent.

• Reaching the medium-term inflation and growth targets of the program will be facilitated by increased efficiency in monetary policy. Consistent with our overall strategy of minimizing the distortions associated with our interventions in the economy, we are determined to gradually shift from direct controls such as mandatory investment requirements to market-based instruments of monetary policy, notably the issuance of CAMs at market interest rates. We will thus lower the mandatory investment requirements (MIR) for commercial banks from 13 percent of deposits to 7 percent in December 2000. This will facilitate the establishment of a more indicative market-based reference interest rate for the economy, deepen the market for CAMs, increase the transparency of monetary operations and the efficiency of financial intermediation, and potentially reduce the spread between lending and deposit rates.

• To strengthen the CBH's independence to conduct monetary policy, we will review options for resolving the financial burden on the central bank deriving from the zero interest bond it received in 1997 in compensation for exchange rate losses on government loans.

• To increase the efficiency of financial intermediation, we are committed to improve the payments system. As a first step we will speed up the development of an electronic, fully integrated check-clearing system to make it operational in December 2000. The norms governing this system and regulating its administration by the private sector will be introduced by end-June 2000. This system will greatly reduce the time and costs involved in settling payments, and could be used as the basis for a future interbank market in foreign exchange and a more efficient market for public securities.

9.  We are committed to continue strengthening financial regulations and prudential supervision. A sound financial system is a prerequisite for efficient intermediation, macroeconomic stability and growth. The establishment of clear rules for financial operations is important to lower risks and spreads.

• Regulatory frameworks for insurance and reinsurance companies and for the stock exchange plus an incentive-compatible deposit insurance system (that replaces the existing full coverage system) will be approved in 2000. We will also submit to congress before end-2000 legislation to regulate private pension funds.

• On prudential supervision, the banking commission (CNBS) will complete its program of on-site inspections of all banks by end-June 2000. The minimum risk weighted capital asset requirement will be increased to 10 percent by end-December 2000. In the given case of banks not meeting the prudential standards, the CNBS will require those banks to complete a timed recovery program agreed with the CNBS, involving corrective measures necessary to ensure sound banking practices-including the suspension of the distribution of profits and of the opening of new branches, and the introduction of tighter controls over their lending practices and the sale of assets. The program of on-site inspections will be further extended to finance companies and saving and loans institutions, which will permit the CNBS to insist on corrective actions that will strengthen these financial intermediaries. These steps are expected to be completed by end-December 2000.

• The CNBS will continue to strengthen the technical capabilities of its inspectors and analysts through participation in domestic and international seminars and courses.

10.  Achieving higher poverty-reducing growth will be difficult without increasing the level and productivity of investment. Given the limited resources of the country, attracting foreign investment is one of our priorities. We will place priority on consolidating and accelerating privatization, which will be key to achieving higher growth, and to reducing regulations and simplifying administrative procedures. We also intend to improve the current international perception of high corruption in Honduras, since this hurts the investment climate and compounds the poverty problem. Furthermore, the prevalence of poverty especially in the rural areas calls for greater attention to removing obstacles and improving incentives for agricultural production and exports.

11.  We are committed to enhancing our good governance policies. This is a complex problem that must be attacked from many sides: emphasizing prevention as much as legal prosecution. We will prepare a comprehensive good governance policy to deal with these concerns. In a globalized environment, transparency of policies is also critical to retaining the trust of the country's external financial, trading, and development partners.

• One principal element of the new policy will be to minimize potential corruption by reducing the discretionary powers public officials can exercise in their exchange with the public. We will therefore critically review all government regulations having to do with internal and external commerce. We will also seek to streamline and simplify the tax and subsidy systems. In light of the especially serious problems in the customs administration, this effort will be initiated with a working group that will produce proposals for simplifying the tariff system, especially by reducing the number of rates.

• Another element of this strategy will be increased transparency of policies. We will gradually strive for compliance with the codes for transparency in fiscal policy and monetary and financial policies that have been published by the International Monetary Fund. In the first instance we will evaluate our domestic practices in light of these codes.

• To support economic policies generally, and especially for implementing the Poverty Reduction Strategy, there is great need for compiling more and better economic and socio-demographic statistics. We intend to establish a separate agency for Statistics and Census, and approve the relevant law that has already been submitted to congress. We will also consider committing to the IMF's General Data Dissemination System (GDDS), which is a tool to develop a coherent strategy for improving statistics with emphasis on coverage, periodicity, timeliness, quality, and integrity and access to information by the public. More accurate information about the country's economy contributes to lower country risk and improves investment climate.

• We are also committed to reform the country's legal system to make it more efficient by implementing the new penal and procedural codes in February 2002.

12.  We shall initiate measures to improve competitiveness and the investment climate.

• To improve competitiveness of nontraditional agricultural exports, and to improve governance, we will simplify the licensing and regulatory regime for cargo transport by extending the annual operator license from 1 to 5 years by December 2000. Furthermore, we are committed to further liberalize the transport sector in the medium term.

• We will also simplify regulations to attract more domestic and foreign investors. We are reviewing existing procedures and have prepared a draft law that would simplify requirements for company establishment, replace the requirement of prior auditing with ex-post auditing, and eliminate the "judicial qualification". This draft law will be submitted to congress by June 2000. We shall also establish a public/private sector working group to review all unnecessary licenses and regulations to reduce incentives for corruption and lower cost of doing business in Honduras. Once the regulatory framework has been simplified we shall reactivate the one-stop window for invest-ment approvals in 2001  

13.  We are determined to speed up privatization in 2000. We will conclude the sale of the telecommunications company Hondutel by end-June 2000. The concessioning of the country's four international airports was done in March 2000. These should provide an important boost to investment and to the program's growth targets. To speed up privatization of electricity distribution, the Framework Law on the Electricity Sector will be approved in October 2000. A contract with the IFC is expected to be approved by congress by end-December 2000, designating the latter as investment banker for the planned privatization of electricity distribution. To advance the privatization of ports, we will work with the IDB to design a proposal to incorporate the private sector in the management, operation, and financing of ports. The study is expected to be completed in end-October 2000. To facilitate private concessions in the provision of water and sewage services we shall approve the Framework Law for the Water and Sewage Sector by end-December 2000.

14.  The expected interest proceeds of Hondutel privatization will be used for invest-ments in the education, health, and social sectors as stipulated in Decree 244-98 and Decree 89-99. The funds will be deposited in an account abroad and invested together with the country's foreign reserves in international capital markets. Annual interest proceeds from the fund will be used for social investment as stipulated by the decree. Rules and regulations governing the account will be drafted by end-June 2000.

15.  On foreign exchange rate policy, we shall continue the crawling band system. To improve competitiveness of exports we shall eliminate remaining export taxes and submit to congress a plan to restructure the coffee sector. We shall continue to manage debt prudently and abstain from market-related loans. We shall also conclude remaining bilateral negotia-tions with Paris Club creditors on Mitch-related reschedulings by June 2000. We will continue to work towards reaching the HIPC decision point in 2000.