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There seems to be no political will to enforce the law that criminalizes electricity theft and fraud. (Photo: Edeeste)
Wednesday, February 26, 2014

Dominican Republic: Bond Issue Imminent

The issuance of $1.5 billion in global bonds is expected imminently as the country improves its fiscal accounts but continues to struggle with electricity problems.  


Growth momentum is poised to stay strong. Real GDP expanded by a relatively robust 4.1 percent in 2013, higher than the 3.0 percent longstanding official forecast, bolstered by the mining (particularly gold), financial services, and construction sectors. Much of the expansion materialized in the latter part of the year, with real growth printing at an impressive 7.2 percent in Q4, after barely inching up 0.3 percent in Q1. Apart from mining, which is widely expected to continue to fire on all cylinders, increased dynamism in the tourism, construction, agriculture, free-trade zone, and telecommunications sectors should underpin real GDP growth of 4.5-5.0 percent in 2014, close to the 5.0 percent potential estimated by the central bank. 

Electricity sector is likely to remain a drag. Recent official efforts to fix the electricity sector crisis have emphasized a shift away from fuel dependence for generation purposes, something that the government hopes will considerably reduce the average production cost and, therefore, the country’s total electricity bill. While this has indeed cut fuel-dependent power generation in half to around 40 percent of the total, only marginal progress has been made at improving collection levels, which many observers regard as the root cause of the problem, with close to 40 percent of the electricity currently being generated still going unpaid. This has resulted in sizable financial deficits that the government has had to cover, with subsidies to the electricity sector averaging $1.25bn (2.0 percent of GDP) over the last two years. Despite the magnitude of the transfers, which accounted for almost 80 percent of last year’s fiscal deficit, there seems to be no political will to raise tariffs to better reflect production costs or to enforce the law that criminalizes electricity theft and fraud. With no permanent solution to the electricity crisis in sight, the sector is expected to remain a significant drag on the country’s economy.  

Fiscal breather is set to follow a sharp adjustment. The Medina administration made good on its promise to lower the fiscal deficit to 2.8 percent of GDP last year from a massive 6.6 percent in 2013. The considerable consolidation was accomplished despite revenues falling short of expectations, which forced the government to make severe adjustments to its overall expenditures, particularly capex. Although the government’s multi-year public sector plan calls for the shortfall to narrow to 1.5 percent of GDP in 2014, the budget for this year targets a deficit of 2.8 percent of GDP instead, with President Medina arguing that the country is due for a fiscal break after enduring a draconian adjustment in 2013 that saw the consolidated public sector deficit plunge from almost 8 percent of GDP in 2012 to only 4.5 percent last year. 

Issuance of a new global bond is imminent. The 2014 budget calls for the issuance of $1.5 billion in global bonds to partially offset the government’s nearly $4.3 billion in total financing needs ($3.5 billion external + $762 million internal) for this year. As with any public debt issuance, the government has to secure congressional approval before any new bond is contracted. A new session of congress is due to start legislating on February 27, and approval of the external bond sale is expected to follow shortly thereafter. In anticipation of the green light to issue, the government has reportedly already taken all the necessary steps to price the new bond without delay. While market appetite will ultimately determine the terms under which the new bond is floated, the government is hoping to issue for at least 10 years and, if possible, sell the full $1.5 billion in securities at once.  

Elimination of PetroCaribe poses only a modest financial risk. According to official sources, PetroCaribe continues to run smoothly and there is no indication that its current (original) favorable terms (1 percent interest rate and 25-year repayment period) may be changed by Venezuela anytime soon. That said, with PetroCaribe representing approximately $600 million in external financing for the Dominican Republic every year, the elimination of the concessional scheme, which may happen at any point and without warning, would force the Dominican government to search for alternative sources of funding. While the government recognizes that any alternative source would likely entail a higher financial cost, it is not overly concerned about securing access to it—be it multilateral or market, external and domestic, in nature—given the country’s improved fiscal standing and relatively low public debt burden. Indeed, PetroCaribe covers less than 15 percent of the government’s total financing needs, suggesting that, while meaningful, the financing scheme is not critical for the country to maintain its financial health. Moreover, the political importance of the program is deemed to be quite high for Venezuela, and the regional negative backlash that would ensue from its elimination is not something that most observers in the Dominican Republic believe the Maduro administration can afford to sustain, at least in the near term.  

Gold boom boosts fiscal and external accounts. Completion of Barrick’s investment phase in the Pueblo Viejo mine and commencement of the extraction phase in late 2012 has prompted a substantial increase in gold exports, which rose from only $175 million in 2012 to nearly $1.2 billion in 2013. This has contributed to a sharp drop in the current account deficit from $4 billion (6.7 percent of GDP) in 2012 to $2.7 billion (4.5 percent of GDP) last year, with official forecasts putting the shortfall at less than $2.6 billion (4.0 percent of GDP) in 2014, supported by an increase to $1.5bn in gold exports. The increase in gold production and exports has also triggered a significant boost in government revenues, with de-facto windfall taxes totaling around $300 million (0.5 percent of GDP) last year and expected to remain at around that level in 2014. With a projected life of more than 30 years, the Pueblo Viejo mine is one of the largest gold deposits in the world. 

Foreign reserves are deemed adequate, or are they? While at 7.3 percent of GDP the Dominican Republic’s net international reserves (NIR) are low by regional standards, local authorities argue that they are indeed adequate, noting that they represent more than three months worth of national (i.e., excluding free-trade zone) imports. Private sector pundits disagree, however, noting that relatively low reserve levels continue to constrain the country’s credit ratings and make its currency vulnerable to both external and domestic shocks. Although there is disagreement on the proper level of foreign reserves that the country should maintain, it is the monetary authorities who ultimately decide policy, so there is little hope that the alleged “under-reserved” situation may change much in the near future. 

Franco Uccelli is an analyst with JP Morgan Chase. This column is based on recent trip report from the Dominican Republic. Republished with permission.cles in : Perspectives

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