Press Release No. 03/147

Press Release: IMF Approves Two-Year US$600 Million Stand-By Arrangement for the Dominican Republic

August 29, 2003

The Executive Board of the International Monetary Fund (IMF) today approved a two-year SDR 437.8 million (about US$600 million) Stand-By Arrangement for the Dominican Republic to support the country's economic program through August 2005. The approval opens the way for the release of SDR 87.6 million (about US$120 million) under the arrangement.

Following the Executive Board discussion, Agustin Carstens, Deputy Managing Director and Acting Chairman, said:

"After a decade of strong growth and broad economic stability, the Dominican economy is now facing major challenges. The failure of a large bank because of fraud has hurt confidence in the banking system and, together with the adverse effects of a succession of external shocks, has weakened the economy. Output has contracted, the currency has depreciated sharply and pushed up inflation, and the historically low public debt-to-GDP ratio has nearly doubled.

"The Fund welcomes the government's commitment to addressing these challenges through a comprehensive economic program that focuses on strengthening confidence in the banking system, reversing the recent deterioration in the public finances, and implementing a tight monetary policy to reduce inflation and the immediate pressures on the currency.

"The strategy to restore confidence in the banking system has four main planks. The first, already implemented, focused on resolving the problems of identified weak banks. The second, now under way, aims to assess the situation of the banking system as a whole through internationally-assisted audits of all banks, and to identify further necessary measures. The third will put in place a legal and regulatory framework to deal with systemic banking problems. The fourth plank is the enhancement of prudential regulations and supervision.

"The Dominican Republic's tradition of sound fiscal policies and low public debt needs to be restored. A key objective of the program is to raise the fiscal primary surplus over the next three years to a level that would allow a gradual reduction in the public debt ratio over the medium term. In the near term, the fiscal effort relies on expenditure compression and temporary revenue measures. These initial steps will give way to a broader reform of the tax system and of spending, as well as asset sales to reduce public debt. Improved debt management also will help reduce vulnerabilities, with greater emphasis on the domestic market to meet the government's borrowing needs, and less reliance on foreign currency debt.

"Monetary restraint will help contain pressures on the currency and inflation. The flexible exchange rate regime is being strengthened, with full unification of the dual exchange rate markets expected by the end of the year.

"Over the medium term, efforts to open up the economy further, including through trade liberalization, and to eliminate infrastructural bottlenecks, especially in the power sector, will help boost growth. At the same time, the authorities are making additional efforts to reduce poverty, with improvements in the efficiency and targeting of social programs. They have sought to avoid cuts in social programs, and low-income households have effectively been exempted from planned increases in electricity prices. The authorities' program should lay the basis for restoring the Dominican Republic's strong record of high growth and economic stability," stated Mr. Carstens.

ANNEX

Recent economic developments

With real GDP growth averaging 6 percent in the 1990s, the Dominican Republic was one of the fastest growing countries in the region. The rise in oil prices combined with the events of September 11, 2001 —and the ensuing slowdown in the world economy— dented this strong record. Exports and tourism receipts began falling in the second half of 2001, and the overall balance of payments shifted into deficit.

The fiscal and monetary response of the authorities dampened the economic slowdown, but exacerbated macroeconomic imbalances. Despite some tax measures, the public sector deficit was allowed to widen by a half-percentage point to 2.6 percent in 2002, with a sharp increase in capital expenditure. Monetary conditions were also eased as reserve requirements were reduced and the central bank extended large liquidity assistance to a private bank, Baninter, that began to experience liquidity problems. The failure to sterilize liquidity support, and regulatory forbearance, contributed to the continued expansion of credit, which grew by 20 percent in 2002. The result was that real GDP growth picked up slightly to 4 percent, but the peso depreciated by 20 percent and inflation doubled to 10 percent. The central bank lost about half of its foreign reserves. The defining moment of the crisis was the failure of Baninter, the third largest private bank, in the spring of 2003. Once accounting malpractices and fraud were discovered, the bank was intervened. The central bank kept Baninter open to prevent a systemic run and financed the payout of its deposits, which fell some 80 percent. Problems soon extended to other banks, Bancrédito and Banco Mercantil, which were also affected by accounting malpractices and mismanagement. Central bank assistance to problem banks contributed to a near doubling in public debt.

As confidence weakened, so did macroeconomic indicators. Real GDP in the first half of 2003 fell by about 1 percent, year-on-year, as a decline in output in domestically driven sectors was only partially offset by a strong recovery in exports and tourism. The peso fell by 42 percent in the first seven months of the year and 12-month inflation rose to nearly 30 percent by July.

Program summary

The Dominican Republic's program aims to restore confidence in the banking system and in the overall policy framework. The program centers on a comprehensive banking strategy, steps to limit the deterioration in the fiscal deficit, and a fully flexible exchange rate policy accompanied by a tight monetary policy. Real GDP is expected to contract by 3 percent in 2003 and to recover only by 0.5 percent next year. Inflation is projected to reach 35 percent in 2003 but to recede to single digit levels in 2004. With domestic demand weak, the external current account balance is projected to shift into surplus in 2003-04.

The strategy for the banking sector addresses the root causes of the current bank problems, including the resolution of Baninter, a solution for the problems of other weak banks, the implementation of an improved bank resolution framework, and the reinforcement of prudential regulation and banking supervision. To uncover any remaining financial and governance problems in the banking sector, the authorities have launched an internationally-assisted audit of all banks, and the legal framework for dealing with bank problems is being strengthened.

The program's fiscal policy aims to begin reversing the recent jump in the public debt ratio. Stabilization of the debt requires a major fiscal effort, given that the cost of servicing the debt will more than triple to 4½ percent of GDP in 2003 and rise further to nearly 6 percent of GDP in 2004. The program envisages a number of measures that would contain the combined public sector deficit to 3.5 percent of GDP in 2003 and 2.5 percent of GDP in 2004. The authorities are also determined to keep expenditure under control.

On exchange rate and monetary policies, the program envisages a full unification of the foreign exchange markets by end-2003. Full unification by end-December would eliminate the possibility of engaging in multiple currency practices arising from a divergence of more than 2 percent at any given time between the official and market exchange rates. Reducing inflation will also be a key objective of monetary policy.

The Dominican Republic joined the IMF on December 28, 1945; its quota is SDR 218.9 million (about US$300 million). Its outstanding use of IMF credits totals SDR 4.96 million (about US$6.8 million).