Publish in Perspectives - Wednesday, September 3, 2014
Mining -- especially gold exports from Barrick Pueblo Viejo (photo) -- is boosting the Dominican economy. (Photo: Barrick Gold)
The economy is firing on all cylinders, but electricity remains a drag.
BY FRANCO UCCELLI
Although general elections are not scheduled until May 2016, the ruling PLD party appears well-positioned to emerge victorious for a fourth consecutive time, as President Medina remains highly popular, the economy is firing on all cylinders, broad macro stability is prevalent, fiscal efforts are paying hefty dividends, and, perhaps more importantly, the key opposition party (PRD) is deeply divided and becoming increasingly irrelevant as an alternative political force. While under current rules Medina is banned from pursuing reelection, he has recently tempered his anti-reelection rhetoric, opening up the possibility that he may indeed consider seeking a second consecutive term in office. That said, there is a fair amount of skepticism about Medina’s true intentions, with some local pundits arguing that the softening of his tone amounts to no more that political maneuvering to neutralize former-President Fernandez’s desire to secure the PLD’s presidential nomination, and that his real plan is to leave office at a high in August 2016 and attempt a comeback in 2020. For now, and until the evidence suggests otherwise, our baseline is that Medina will not attempt to amend the constitution, for which he would need a two-thirds legislative majority, to seek consecutive reelection in 2016. The full election cycle is expected to commence by the end of this year.
Growth consistently exceeds expectations. A recent revision of the national accounts methodology whereby the base year has been changed to 2007 from 1991 shows that real GDP expanded by a robust 7.2 percent in 1H14, rather than the 5.2 percent initially reported. Either way, the economy has been consistently tracking higher than the 4.5 percent official growth forecast for 2014, suggesting that real GDP is likely to surge by more than 5 percent instead. Much of the strong performance has been supported by a buoyant tourism sector, booming mineral (gold) exports, and rising remittances. While the rebasing warrants a recalculation of the country’s growth potential, the authorities believe that the current output gap will probably not be fully closed until late 2015.
Pace of depreciation slows considerably. The Dominican peso (DOP) has depreciated by less than 2 percent so far this year, a fraction of the 6 percent depreciation it posted during the same period of 2013. Three contributing factors are generally identified to explain the significant slowdown. First, the monetary policy rate has been lifted 200bp over the past 12 months, thus moderating expectations. Second, performance from all the key generators of foreign exchange has been better than expected, which has in turn lessened the need for the authorities to intervene in the FX market. And third, fiscal consolidation has eased upward pressure on all basic prices, including the domestic currency. While most observers expect a steady and orderly depreciation of the DOP in the 4 percent to 5 percent range per annum over the next couple of years, some warn that the future may be a lot less certain beyond 2016 and that much will depend on the outcome of the elections.
ELECTRICITY: DRAG ON ECONOMY
Electricity sector remains a major drag on the economy. Lack of material progress sorting out the long-standing electricity sector crisis is viewed by many as the biggest disappointment with regards to the current administration. Indeed, critics of the government’s plan to tackle the issue from the generation side by building two coal plants that will lower average production costs and ultimately official subsidies to the sector, rather than from the distribution side by increasing the prevailing dismal collection levels, is inadequate and misguided. Indeed, they note that financial troubles and elevated uncertainty regarding the outlook for the sector have resulted in considerable underinvestment in maintenance of current facilities and development of new ones, and has forced companies to carry out blackouts as a mechanism to control operational costs, not the most efficient way to run a business.
Fiscal consolidation continues, but more is needed. The central government deficit narrowed sharply to 2.8 percent of GDP in 2013 from 6.8 percent in 2012, and while a shortfall of 2.8 percent is once again budgeted for 2014, preliminary results, including a deficit of only 0.6 percent of GDP for 1H14, suggest that fiscal outperformance is likely in the near term. Indeed, President Medina is seemingly determined to close the year posting a “roughly balanced” primary result, which added to an interest bill of 2.5 percent of GDP would produce a nominal central government deficit of 2.5 percent of GDP. Should official expectations materialize, there will be added pressure to lower the deficit even further in 2015, as Medina has indicated that the shortfall should remain on a downward path through the end of his administration in 2016. While this is generally regarded as good news, some local observers believe that, absent additional fiscal measures, as indicated by Medina, more should be done to boost revenues, including the elimination of some key tax exemptions, which total as much as 6 percent of GDP. In fact, a proposal to lower exemptions to 3.5 percent of GDP, a much more reasonable level, would virtually do away with the current government deficit altogether. To guarantee fiscal sustainability going forward, the government is hoping to negotiate a comprehensive fiscal pact, which would include a fiscal responsibility law, with a number of societal groups sometime in 2015.
Public debt burden may not peak until 2016. The non-financial public sector (NFPS) debt burden has been steadily trending higher, more than doubling since before the global crisis from less than 19 percent of GDP in 2007 to a projected 41 percent by the end of this year. On a consolidated basis, that is including the central bank debt but excluding intra-government debt, the increase was not as substantial, with the ratio relative to GDP rising from 33 percent in 2007 to a projected 49 percent this year. Official estimates view the consolidated public debt burden inching up over the next couple of years to close 2016 at 52 percent of GDP, before gradually moderating after that. How high the debt burden and how fast it declines will depend of course on nominal GDP growth and the primary result in the near term, two areas where the government is particularly hopeful. More than promoting growth per se, a key priority of the Medina administration is to lower the debt burden.
DOP global issuance plan may be revisited in 2015. Although the budget for 2015 has not been tabled just yet, the government is already toying with the idea of resurrecting failed plans to cover part of its financing needs for next year through the issuance of DOP-linked securities. Indeed, on a preliminary basis, officials are mulling the issuance of $1 billion in international markets next year, down from $1.5 billion this year. The difference between the two tallies would be a direct reflection of a decline in amortization payments to $1.6 billion in 2015 from $2.1 billion in 2014. The government hopes that at least half of the $1bn total will be in the form of DOP-linked paper that would be floated under New York law and would be free of any tax obligations. If every goes according to plan, the country’s debut Global DOP bond would be Euroclearable and all of its associated cash flows would be denominated in USD.
Recapitalization of the central bank is
running under budget. Central
government transfers to recapitalize the central bank are budgeted to total
approximately 1.2 percent of GDP per year. However, current transfers are
tracking only 0.7 percent of GDP. While the central bank does not appear overly
concerned about such deficiency, noting that by not transferring the full
amount the government is simply extending the recapitalization period, some
critics of the ongoing practice describe it as a way for the government to
finance itself—not to be confused with the central bank financing the
government, which it is legally precluded from doing—presumably to finance
education spending. Naturally, the argument goes, this does not comply with
best (i.e. fully transparent) fiscal practices.
Franco Uccelli is Executive Director of Emerging Markets Research at JP Morgan. This column is based on a recent trip report. Republished with permission.