Santo Domingo, Dominican Republic
October 22, 1998

Dear Mr. Camdessus:

1.  The Dominican Republic experienced a national tragedy when Hurricane Georges hit the island on September 22, 1998. The hurricane inflicted tremendous loss of human life, washed out roads and bridges, caused severe damage to the electricity and water systems, devastated agricultural crops, and destroyed many homes and buildings, including some tourist facilities. The government's most urgent needs are to provide emergency shelter, food, and medicine to those most affected. Furthermore, the government must find a quick solution to the problem of the hundreds of thousands of homeless, most of them being sheltered in public schools, and the resulting delay in the start of the school year. The next priority is to return the economy to the path of economic growth and macroeconomic stability that was being followed in recent years, and to do so as quickly as possible.

2.  The relief and rehabilitation costs associated with the hurricane are substantial and we will need international assistance, to support our own efforts, to cope with the short-run costs. Accordingly, the Government of the Dominican Republic is requesting an emergency assistance purchase from the IMF equivalent to 25 percent of the Dominican Republic's quota (SDR 39.7 million). The purchase would help meet immediate foreign exchange financing needs, while easing pressures on the international reserve position. The government will continue to cooperate with the Fund in an effort to strengthen its balance of payments position. For this purpose, we have invited a Fund mission to resume policy discussions in early 1999 and to complete the current Article IV consultation process, which was interrupted by Hurricane Georges. This timing will allow a more thorough analysis of the 1998 outturn and of the economy's ability to recover from the hurricane damage. An important element of these discussions would be the formulation of a revised medium-term macroeconomic framework, that could form the basis for a closer relationship with the IMF.

3.  The Dominican economy has performed strongly in recent years, following the stabilization efforts and structural adjustment of the early 1990s. Annual real GDP growth surged to over 7½ percent a year in 1996–97, reflecting solid performances in the construction, communications, free-trade-zone manufacturing, and tourism sectors—a similar outturn was expected for 1998. Inflation has been held to single digits since 1995, and was reduced to under 3 percent in the 12 months to August 1998. The overall deficit of the public sector, including central bank operating losses, has remained low over the past few years, and was projected to decline to 0.7 percent of GDP in 1998. Efforts to improve tax administration have been successful, with revenues increasing by 1½ percentage points of GDP in 1997. On the external front, the current account deficit has also remained low, averaging about 1½ percent of GDP a year during 1996–98, easily financed by foreign direct investment. Net international reserves (NIR) had been on a rising trend in 1996 and 1997, before declining in the first half of 1998, when the Dominican peso came under some pressure in the run-up to the congressional elections of May 1998. However, following a 9 percent devaluation of the official exchange rate in July (bringing it in line with the commercial bank rate), NIR had begun to rebound. The authorities are committed to maintaining weekly adjustments of the official exchange rate, in order to preserve parity with the commercial bank rate.

4.  Since 1990, significant progress has been made in strengthening the public finances; implementing prudent credit and wage policies; reducing exchange, price, and financial distortions; opening the economy; and normalizing relations with external creditors. In addition, a privatization law was passed in 1997, paving the way for the sale or liquidation of public enterprises, including, inter alia, the Dominican Electricity Company (CDE), the State Sugar Company (CEA), and a state holding company (CORDE). All of the above was achieved within the context of our policy to reduce public external debt, which fell by US$1 billion in the seven years to end-1997 (from 70 percent of GDP at end-1990 to 23 percent of GDP at end-1997). It is important to emphasize that, during the two years of this administration, the stock of public sector external debt (in U.S. dollar terms) has fallen by about 10 percent.

5.  In summary, fiscal adjustment, combined with continued tight monetary policy and planned structural reforms was expected to further bolster investor confidence, leading to continued strong growth of foreign direct investment. In the context of a broadly stable external current account deficit, this would have permitted a build-up of reserves of between US$150–200 million in 1999. However, the sudden arrival of Hurricane Georges has meant that, at least in the short run, the outlook has altered sharply.

6.  Hurricane Georges cut a devastating path across the country, leaving approximately 300 persons dead and hundreds of thousands homeless. Based on preliminary damage assessments, the cost of repairs to basic, public sector infrastructure and low-income housing could reach over US$400 million (2½ percent of GDP). Further, the hurricane has severely damaged our farming and livestock production, with total losses estimated to be at least US$400 million during 1998–99. Key exports, including sugar, coffee, cocoa, tobacco, fruits, and manufactures (including from the free trade zones) will be severely affected, as well tourist services. The growth rate of output in 1998 is likely to be about ½ percentage point less than the originally forecast rate of 7½ percent. However, it is expected that most of the lost output will be recuperated in 1999, as a result of our reconstruction efforts.

7.  The hurricane will adversely affect the fiscal, monetary, and external accounts, albeit on a temporary basis. It is estimated that expenditures will need to increase (relative to the previously expected outcome) by about 1¼ percent of GDP a year in 1998–99. As a result of the lower output growth in 1998 and some increased collection problems (as firms and individuals facing large hurricane repair bills may find it difficult to pay taxes), it is estimated that government revenues will be slightly less than previously expected. The government is attempting to secure grants and foreign financing (on appropriate terms), but some domestic financing will be needed in 1998. The government intends to minimize the inflationary impact of domestic financing, and is targeting an inflation rate of no more than 6 percent in 1998 and 4½ percent in 1999. The most significant balance of payments effect will result from a surge in imports associated with the reconstruction effort (private and public), estimated at about US$300 million in 1998 (2 percent of GDP) and US$400 million in 1999 (2½ percent of GDP).

8.  The devastation wrought by the hurricane has only strengthened the government's resolve to press ahead with its structural adjustment program. Accordingly, in the weeks following the hurricane the government sent to congress a wide-ranging set of structural reforms, including inter alia, a securities market law, pension reform, and antitrust and unfair competition legislation. In addition, the government has submitted legislation to allow the issuance of bonds in order to eliminate domestic arrears. Still pending before congress, is the monetary and financial code, which would fully unify the exchange rate. In the coming days, the government proposes to submit to congress draft legislation regarding tax and tariff reform, as well as the free-trade agreements, already signed, with the Central American and Caribbean countries.

9.  Over the medium term, the government sees prudent fiscal policy, complemented by a sound monetary policy and structural reform, as the centerpiece of a macroeconomic framework that would lead to a sustained increase in real GDP, declining inflation, rising international reserves, a gradual reduction of quasi-fiscal losses, and elimination of domestic arrears. Generation and distribution units of CDE are to be privately capitalized this year, with management control going to the private sector. In addition, the Public Enterprise Reform Commission (CREP) will, in the very near future, initiate the process of the sale of assets of CEA and CORDE. The Central Bank of the Dominican Republic (BCRD) has offered for sale all its real estate assets, including Playa Grande and Montellano, which are expected to raise a minimum of US$30 million in 1999. In addition, it has opened competitive bidding for the privatization of the operations of the Rosario Dominicano (a gold mining company owned by the central bank).

10.  The centerpiece of the medium-term macroeconomic framework is fiscal adjustment. However, in light of the hurricane damage, it will be necessary for public expenditure to rise temporarily as a result of the public sector's share of the reconstruction costs. Therefore, the government will allow a temporary widening (relative to pre-hurricane projections) of the overall fiscal deficit of the nonfinancial public sector to 1¾ percent of GDP in 1998, followed by improvement in 1999, before returning to a surplus over the medium term. Similarly, on the external front, the current account deficit will widen as a result of the imports associated with reconstruction efforts. However, after widening to 3 percent of GDP and 4 percent of GDP in 1998 and 1999, respectively, the current account deficit is projected to narrow to no more than 2 percent of GDP in 2000, and to continue narrowing gradually over the medium term. The government estimates that if prudent fiscal and monetary policies are followed, real GDP growth averaging around 6 percent a year can be sustained over the 1999–2003 period. It should also be possible to lower the inflation rate to that of partner countries over the medium term.

11.  The government intends to submit to congress, in the very near future, an import tariff reform. At the same time, in order to fully compensate for the associated revenue loss, it also intends to send a proposal to increase general and selective consumption taxes. The tariff reform will reduce the weighted average tariff from 13.7 percent to 5.2 percent, and reduce the number of tariff bands from eight to four, with the maximum rate falling from 35 percent to 15 percent.

12.  Another important contribution to help defray reconstruction costs was a 5–10 percent salary cut (depending on the salary level) for all public sector employees, effective October–November 1998, which sent a strong signal of the public sector's willingness to bear its share of the adjustment burden. The government will also seek a temporary increase in tax revenues of ½ percent of GDP in 1999 (or equivalent measures), in order to achieve virtual balance in the fiscal accounts that year. Spending priorities are also being reviewed with a view to rearranging expenditure allocations in favor of the reconstruction effort, while protecting key investments in the social sectors.

13.  Other measures that have been taken to assist those who have suffered damage from the hurricane include: (i) a six-month moratorium on amortization and interest payments on loans made by two development funds (FIDE and INFRATUR). This will principally benefit the agricultural, industrial, and small- to medium-scale enterprise sectors. Total debt service involved is RD$220 million (0.1 percent of GDP); (ii) the Monetary Board has made available to the central government US$25 million, to be purchased at the official exchange rate, for the import of food and medicine; and (iii) the BCRD has approved a temporary advance to the Banco de Reservas of RD$500 million, of which RD$350 million will be allocated to support the agricultural sector. Later this year, the government intends to issue RD$1 billion of bonds, of which RD$500 million will be used to repay the BCRD for the advance to the Banco de Reservas. The latter amount will then be placed with the private sector to offset the monetary expansion of the initial advance. The remaining RD$500 million will be placed with the nonfinancial private sector.

14.  In addition to the inflation objectives cited above (paragraph 7), the revised monetary program for 1998–99 targets a modest accumulation of gross international reserves—at least US$84 million during this period—while recognizing the need to build up gross reserves at a faster pace over the medium term. Currency in circulation is projected to expand at 12 percent in 1999, assuming a stable income velocity of currency in circulation.

15.  The BCRD continues to consider inflation reduction as its primary goal, and intends to consolidate the progress made in recent years. Deposit and lending rates of the commercial banks will continue to be market determined, and there will be no resort to direct credit controls. The monetary authorities are also determined to advance further the financial reform program, including placing greater reliance on indirect monetary control. Specifically, once the Monetary and Financial Code has been approved, the BCRD intends to proceed with the implementation of previous technical assistance recommendations from the Fund, including unification of the exchange rate, and competitive auctions of central bank paper. Even if the Monetary and Financial Code is not approved, the BCRD intends to deepen the domestic capital market through the proposed securities law, with a view to facilitating open market operations.

16.  The government recognizes that strict enforcement of banking supervision is critical to the health of the banking system. To this end, the authorities are implementing a program, with the assistance of the IDB, to extend the coverage of banking and supervision norms. Coverage of banking supervision will be extended to all credit cooperatives by end-1999 and the quality of banking supervision will be strengthened (including better analysis of risk management and establishment of an early warning system). A pilot program to supervise 15 cooperatives will be initiated in November 1998, with assistance from the IDB.

17.  In order to assist the poor and minimize the inflationary impact of food shortages, the government intends to promote seeding of short-cycle agricultural crops through technical and limited financial assistance provided by the Agricultural Bank. Moreover, the authorities propose to accelerate the previously agreed schedule with the WTO concerning the liberalization of agricultural goods imports, eliminating any nontariff barriers before 2005.

18.  A number of improvements have been made to improve the statistical base, and the government will continue to strive to make further improvements. The government has made substantial progress in improving the coverage of the balance of payments statistics and ensuring conformity with the guidelines of the fifth edition of the Balance of Payments Manual. We are working toward improving the response rate to surveys being sent out to the free-trade-zone enterprises. A plan is underway to send out surveys to the tourism companies. This information will likely contribute to the reduction of errors and omissions in the balance of payments. The government will publish national accounts on the basis of the 1993 System of National Accounts by end-1999, and a new consumer price index with updated weights by January 1999. The government is working toward improving the system of financial management, with the assistance of the IDB, in order to facilitate fiscal policy analysis. The new system will help to reduce the statistical discrepancy in the fiscal accounts. The authorities are committed to continue providing all the necessary information for Fund surveillance in a regular and timely manner.

19.  It is hoped that the international community will support our reform efforts with financial assistance, on appropriate terms, in order to ease the adjustment burden created by Hurricane Georges. In this context, over the next 15 months, the government expects accelerated and new disbursements from the IDB (US$130 million), the World Bank (US$100 million), and official bilateral donors (US$50 million) to help meet some of the costs of the relief and rehabilitation program. In addition, the government has requested an extension of the payment period from official bilateral creditors for the payments falling due during September 1998–March 1999. As a result of prudent external debt management policies in the past (as explained in paragraph 4), the ratio of external debt to GDP has fallen sharply in recent years. The government attaches high value to the record it has achieved in recent years in normalizing relations with external creditors, and is committed to ensuring that all external debt-service obligations are serviced on a timely basis. In this regard, the government also is committed to continue sending the "oil differential" revenues directly to the central bank, to ensure the availability of resources to service external debt-service obligations.

20.  The government will continue to cooperate with the Fund in an effort to strengthen the Dominican Republic's balance of payments situation. The government does not intend to impose new or intensify existing restrictions on payments and transfers for current international transactions, introduce new or intensify existing trade restrictions for balance of payments purposes, or enter into bilateral payments agreements incorporating restrictive practices with other Fund members.

21.  During the period while the Fund's holdings of the Dominican Republic's currency exceeds 125 percent of its quota, the Dominican Republic will consult with the Fund periodically, in accordance with the Fund's policies on such consultations concerning the progress made by the Dominican Republic in the implementation of policies and measures designed to solve the country's balance of payments problems.