Dominican Republic - Urgent Import Requirements For Hurricane Reconstruction Project

Document of F COPY The World Bank FOR OFFICIAL USE ONLY Report No. P-2640-DO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DOMINICAN REPUBLIC TO FINANCE URGENT IMPORT REQUIREMENTS FOR HURRICANE RECONSTRUCTION November 29, 1979 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  DOMINICAN REPUBLIC URGENT IMPORT REQUIREMENTS FOR HURRICANE RECONSTRUCTION CURRENCY EQUIVALENTS Currency Unit = Peso (RD$) US$1.00 = RD$1.00 US$1,000,000 = RD$1,000,000 WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 mile (mi) 1 kilogram (kg) = 2.2 pounds (lb) 1 hectare (ha) 2.47 acres ABBREVIATIONS BTN - Brussels Tariff Nomenclature NFS - Non-factor services IDB - Inter-American Development Bank IMF - International Monetary Fund FISCAL YEAR .January 1 - December 31  FOR OFFICIAL USE ONLY DOMINICAN REPUBLIC LOAN TO FINANCE URGENT IMPORT REQUIREMENTS FOR HURRICANE RECONSTRUCTION LOAN SUMMARY Borrower: The Dominican Republic Agent: Central Bank-of the Dominican Republic Amount: US$25 million Terms: Seventeen years including four years of grace aL a 7.95 percent per annum interest rate. Loan Description: The purpose of the loan is to support the reconstruction effort of the Dominican Republic by helpinig to f [naice imports of raw materials, semi-manufactured and final goods necessary to restore national production id' goods and services. The loan would reimburse to tlhe (overnlnent of the Dominican Republic foreign exchange used to pay for imports of chemical products; plastics and rubber; wood and wood products; manufactures of stonie, gypsum, ceramics and glass; base metals and manufactures; machinery and equipment. Imports arriving on and after October 1, 1979 would be eligible for reimbursement. Estimated Disbursement: The loan is expected to be totally disbursed dIturing Bank fiscal year 1980. Economic Rate of Return: Not applicable. Staff Appraisal Report: This is a combined President's and Staff Appraisal Report. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DOMINICAN REPUBLIC TO FINANCE URGENT IMPORT REQUIREMENTS FOR HURRICANE RECONSTRUCTION 1. I submit the following report and recommendation on a proposed loan equivalent to US$25 million to the Dominican Republic to finance urgent import requirements for hurricane reconstruction. The loan would have a term of 17 years including a grace period of 4 years. It would bear an annual interest rate of 7.95 percent. The Central Bank of the Dominican Republic would be the agent. PART I - THE ECONOMY 2. The last economic report, "Current Economic Memorandum on the Dominican Republic", (Report No. 2492-DO) was distributed to the Executive Directors on May 11, 1979. Relevant social and economic data are presented in Annex I. This section describes recent economic trends prior to the onslaught of hurricanes David and Frederick in August/September 1979. Part III analyzes the economic impact of the hurricanes. 3. During 1968-74, the Dominican economy experienced an unprecedented average annual increase in GDP of 10.5 percent. In 1974-1977, however, economic growth slowed to only 5.3 percent per year. In 1978, preliminary estimates indicate a further decline to 3.6 percent, while in 1979 growth may be negative because of the hurricanes. 4. Economic growth during 1968-74 was led by exports of sugar, minerals, and tourism and by a high level of both private and public investment. During that period, the Dominican Republic was able to increase substantially the volume of sugar exports, start the exploitation of ferronickel deposits, undertake vigorous industrial expansion (mostly in import substitution indus- tries), and establish itself in the Caribbean tourism market. The main reasons for slower growth in recent years were poor agricultural perfonnance, partly as a result of droughts in 1975 and 1977, increases in petroleum prices since 1974, the drop in sugar prices after 1975, and--more recently--the depressed world market for ferronickel and bauxite. Manufacturing, oriented mainly to the domestic market and heavily dependent on imported intermediate and capital goods, had been particularly affected by the slow growth of the economy and by slhortages of electricity. Industrial expansion during 1975-78 averaged 4.7 percent per year, compared with the 1968-74 average rate of 13.7 percent. 5. The country's balance of payments, like that of most energy imporL- ing, primary products exporting countries, deteriorated in the latter part of this decade. Between 1973 and 1978, the cost of petroleum imports in relation to the value of sugar exports increased from 24 percent to 92 percent and is expected to reach 109 percent in 1979. In 1974 the cost 6f petroleumn imports increased by over US$100 million and was largely responsible for the deficit  - 2 - in the balance of payments in that year. Steep increases in the price of sugar created a surplus in 1975; but since then, sugar prices hlave tallen, the demand for ferronickel and bauxite has been weak, and the production of coffee and cocoa has stagnated, with the result that the deficit- on current account has widened. The balance of payments has also become sensitive to flows of capital from private sources; which in turn reflect the perception abroad of factors affecting risk and uncertainty in the Dominican economy. Because of -a de facto dual exchange rate system and the openness of the economy, the weakness in the balance of payments is partly reflected in the 20 percent premium at which the U.S. dollar trades in the parallel market. There was an unprecedented overall balance-of-payments deficit of US$95 million irl 1978, reflecting an estimated increase in the current accoun' (leficit from US$2' .4 million in 1977 to US$377 million in 1978 due to a continued (lecine in stugar prices, a drop in coffee and cocoa prices, a substanti-lL reduction of the volume of coffee and ferronickel exports; and a decline in net capital i.fLows. Because of the massive increase in petroleum prices, the curr-ent accouLnt deficit in 1979 was expected to reach US$480 million before thle hurlricanes. 6. Inflation, which was minimal during the 1960s, accelerated in the 1970s. The average annual increase in the Santo Dominlgo consumer price index during 1971-77 amounted to 11.8 percent. This same index indicates a reduction in the rate of inflation during 1978 to 3.5 percent, refLecting a fall in food prices following the recovery of domestic food production fron the effects of drought in preceding years, and stable housing costs. These categories account for almost two thirds of the weight in the index, and have been the sources of upward pressure on prices during most of Lhe dfcrade. Recent increases in gasoline prices, electricity rates, and wages, have generated more upward pressure on prices during 1979. 7. Past fiscal policy was cautious. In 1968-7i, current budget surpluses averaged 6 percent of GDP (varying between 3 percent in 1968 andi 10 percent in 1975) and financed, on average, 98.5 percent of Lhe Ce;ltr;l Government's capital expenditures. Although the Government's long-term savings performance was impressive, it was achieved at the expense of Low growth of current expenditures, especially wages and salaries. During 1968-77, the average annual growth of recurrent expenditures was about 1.6 perceent in real terms, and average real salaries of government employees dropped consider- ably. This austerity limited the Government's ability to operate and maintain the country's economic and social infrastructure as well as to attract and retain capable personnel in government service. 8. In 1978, the fiscal situation deteriorated, with an overall Central Government deficit estimated at RD$114.5 million, mainly as a result of a lower current surplus of RD$175 million, compared with RD$278.4 million in 1977. The reduction in the current surplus was attributable to wage increases granted to public employees, to a reduction of about RD$40 million in revenues due to lower value of sugar exports, the temporary suspensioni of export taxeXs on cocoa and coffee, and subsequent reduction by 50 percent of export taxes on coffee.  - 3 - 9. The Governlment which took office in August 1978 proposes to adopt measures to strengthen thie balance of payments and public sector finances, stimulate export growth and reduce price distortions unfavorable to agricul- ture and employment creation. Althouglh a comprehensive package of economic measures has not yet reached the stage of implementation, it is clear that the Government has recognized the need for appropriate adjustments in policy. It has resisted pressure to launch an ad hoc public works program to palliate the country's acute unemployment problem. The Government has recently secured thie approval by Congress of an Export Promotion Law - providing tax incentives to exports, and allowing those engaged in non-traditional export activities to sell their foreign exchange earnings in the parallel market, which usually trades at a premium over the official exchange rate. The Congress is also considering legislation providing special incentives for agro-industry. The Government is seeking to strengthen the fiscal situation by channelling the plethora of earmarked taxes and special funds, which formerly put a large part of public sector resources beyond the allocation decisions of the annual budget, into a single consolidated fund and by improving administration of income taxes and customs duties. Taxes on liquor and cigarettes were increased earlier this year, while the tax on gasoline was increased when the prices of petroleum products were adjusted to reflect the rise in crude oil prices toward the end of June. It is expected that draft tax legislation including value added and sales taxes, and modifications in the real estate tax, will shortly be put before Congress. Also, measures are being taken to strengthen the autonomous agencies such as the electricity company, for which an increase in rates was approved earlier this year, and the sugar corporation, which was relieved of the burden of a cross subsidy to the electricity company. The Government's ability to secure approval by Congress of the draft tax legisla- tion will be critical to its success in improving public sector finances. Its willingness to apply the Export Promotion Law in a flexible manner, and to adopt an appropriate monetary program - as soon as the hurricane emergency permits - will be critical to its efforts to diversify exports and strengtlhen the balance-of-payments. 10. Creditworthiness has recently become of some concern. The large balance-of-payments' deficit in 1978 resulted in the depletion of the coun- try's already low net reserves. The level of gross reserves fell to less thani the equivalent of two months of imports, and the prospect is for further reserve loss in 1979. Arrears in current payments, a periodic phenomenon in the Dominican Republic, are increasing once more. While the Administration is aware of these problems, its ability to implement appropriate corrective measures has suffered from legislative delays. These considerations adversely affect the country's ability to obtain financing from commercial sources even thouglh the level of the public external debt in relation to GDP -- 15.3 percent at the end of 1978 -- and the ratio of public external debt service .to exports -- 10.2 percent in 1978 -- are not high in comparison to other developing countries. The impact of the hurricanes (discussed in detail below) will add only one-half percentage point to the debt ratio which was expected to rise to 18 percent in 1979 because of bunched repayment obligations, before declining to 15 percent in 1980. The country's future borrowing requirements, however, will be quite large, and will necessitate both conces- sionary and non-official funds. The Government has indicated that it will  - 4 - implement the needed economic measures while addressing the country's social problems. Because of limited export prospects, the recent petroleum price increase, and the additional economic constraints resulting from hurricane damages, there will obviously be difficulties in harmonizing these goals. As we continue the dialogue on economic policy, we will be monitoring closely tlhe Government's response to the challenges it faces. We consider that the Dominican Republic will continue to be creditworthy for Bank lending provided the Government expeditiously implements policy measures which have recently been approved by its Congress and others which it is now preparing. PART II - BANK OPERATIONS IN THE DOMINICAN REPUBLIC II. The Bank Group began operations in the Dominican Republic in 1969. Except for an enclave mining project, lending to the Dominican Republic was on IDA terms prior to FY1975. Since then lending has been on Bank tenns, including two Third Window operations. Two loans, for a tourism infrastruc- ture project and a second education project, were approved in FY1975 and two loans, both on Tlhird Window terms, for highway rehabilitation and maintenance and population and family health, were approved in FY1977. Two loanis, for irrigation (Nizao Irrigation Project) and tourism (Second Puerto Plata TouL-ism Project), were approved in FY1979, and a sugar rehabilitation project was approved in the first quarter of FY1980. Total Bank loans and IDA credits outstanding amount to US$135.1 million, of wlhich US$88.7 million are undis- bursed. Annex II contains a summary statement of Bank Group loans and credits as of October 31, 1979 and notes on the progress of ongoing projects. 12. IFC has financed two operations in the Dominican Republic, an investment in a cement plant approved in 1974, and a line of credit [or sinall and medium scale industry approved in 1978. Other projects are under consideration by IFC. 13. In the absence of adequate project preparation and of clear invest- ment priorities, the Dominican Republic did not in the past make full use of official long-term external assistance. Total lending of this type amounted to US$335 million during 1970-77. The present Government has recently approved a three-year public investment program which is expected to permit all increase of long term funding from external development agencies. Assistance from IDB has included agriculture (credit programs and irrigation); power (two multipurpose hydroelectric projects and rural electrification); water supply anid sewerage; and higher education. U.S. long-term assistance consisted mainly of food (PL480) and loans for agriculture, health and education. Long-tenn assistance from IDB for the next three years is expected to includle agriculture (with a major emphasis on agrarian settlement programs anld credit), potable water, irrigation and power. AID assistance would concentrate on agricultural credit, integrated rural development and rural road maintenanllct