Honduras - Economic position and prospects

FILE COPY Report No.Wa-HO The Economic Position and Prospects qrT; X & c IE of Honduras C.FIE April 29, 1974 Latin America and the Caribbean Regional Office Not for Public Use Document of the International Bank for Reconstruction and Development This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS US$1.00 = 2.00 Lempiras (L) L 1.00 = us$ o.5o GLOSSARY OF ABBREVIATIONS CABEI Central American Bank for Economic Integration CACM Central American Common Market ECLA Economic Commission for Latin America ENEE National Electric Power Company ENP National Port Authority FAO Food and Agriculture Organization FN National Railway Company IDB Interamerican Development Bank IHSS Social Security Institute INA National Agrarian Institute INVA National Housing Institute JNBS National Social Welfare Board LN National Lottery PANI National Child Welfare Institute SANAA National Water and Sewerage Service UNAH National University USAID U.S. Agency for International Development GOVERNMENT OF HONDURAS FISCAL YEAR January 1 to December 31  This report is based on the findings of an economic mission to Honduras in August 1973, composed of: Rene Vandendries Chief Guillenmo Castafieda Economivt   HONDURAS TABLE OF CONTENTS Page No. COUNTRY DATA MAP SUMMARY AND CONCLUSIONS ..... ................. i-vii I. POPULATION, EMIPLOYMENT AND INCOME DISTRIBUTION 1 II. OVERALL ECONOMIC GROWTH TRENDS .... ........... 3 III. PUBLIC SECTOR FINANCE AND INVESTMENT ......... 10 Introduction ................................. 10 Central Government Current Revenues .... ...... 13 Central Government Curr.ent Expenditures and Savings ............................... 14 Rest of the Public Sector ..... ............... 16 Public Sector Capital Expenditures .... ....... 17 IV. MONEY, CREDIT AND THE BALANCE OF PAYMENTS .... 19 Money and Credit ...... .......... .............. 19 Exports ................... ................... 21 Imports . .... 22 CACM Trade ................................... 22 Balance of Payments and External Debt ........ 23 V. DEVELOPMENT POLICIES OF THE NEW GOVERNMENT 26 Overall Economic Trends .26 Short-run Public Investment Policy. 27 Short-run Agricultural Policy .28 Short-run Industrial Policy .29 Long-run Development Policy .30 VI. THIE MEDIUM-TERM OUTLOOK (1974-80) .31 ANNEX I - THE HONDURAN NATIONAL DEVELOPMENT PLAN STATISTICAL APPENDIX Population, Employment and Income Distribution National Accounts Balance of Payments and External Trade External Debt Public Sector Finances Money and Credit Agriculture Price Indices   Page 1 of 2 COUNTRY DATA - OCUT7PRAS AR AE POPULATrON DENSITY JI --E.2u,' k2 2.7 million (mid-1'72) 23.3 per k,2 RLate of Groirth: 3.25 (from 1561 to 1972) POdEhS.CTI r CUAPAlI. P ,CT'''71' (196 -70) 1RHEALTH (1970) Crcdo Birth Rate (e- 17,7C) 49.0 Population per physician 3, 707 Cruld fIa-Th Rate (co 1.l()j 17.1 Popclation per hospital bed 582 Infant Mortality (v , 1,000 live births) 34.0 INOME Dl 5'1TR115TICN DISTIBRUTION OF LAND CONIERSUIP % of naticnal incone, lowest quintile .. % owned by top 10'P of owners highest quintile .. % owned by smallest 105 of owners A0C ,S IJ PIPF.D prsp. ACCESS TO ELECTRTCITY (1971) % of population 35 % of population 16 NU' =-TIO, (156r--63) EDUCATION (1970) Caloric intake as o of requirements 90.4 Adult literacy rate a 50 Per capita protein intake 53.6 Primary school enrollment % 83 GNP PER CAPITA in 1971:1/ US $300 GRCSS INATIONAL PRRODJCT IN 1972 ANNUAL RATE OF GPOCl1iT1` (5, conotant prices US $ MIln. % 1961-66 1966-72 1972 GNP At Market Prices 780.8 100.0 4.1 4.7 4.9 Gross Dcorestic Investmei3t 127.9 16.4 9.9 5.5 0.1 Gross National Saving / 125.6 16.1 -0.2 0.8 18.5 C rrent Ac?oun+ Balance - 2.3 0.3 ExTorts of Goods, NFS 230.6 29.5 11.5 10.1 6.2 Imports of Goods, NFS 220.9 28.3 14.3 11.7 -2.0 OUTLUT. LABOR FORCE AND PRODJCTIVITY IN 1972 Value Added Labor Force V. A. Per Worker US $ Mln. 5 Mln. ,, ___ a_ Agriculture 235 36.2 0.540 65.1 435 55.6 Industry 147 22.6 0.099 11.9 1,4G5 l69.7 Services 268 41.2 0.191 23.0 1 40 179.2 Total/Average -60 100. 0 o.83 100.0 la 100.0 GOVERNM'ECNT FINlANCE G0szneral Government Central Gover-nent TMXTX-. irn.) Fot GL D?L (a. Gi?.) _ cG? 1572 1572 1970-1 972 1_9'72 .'I 2 19o7-72 Current Receipts 222 13.9 13.9 192 12.0 12.2 Current Exoenditure 207 12.9 12.5 132 1 .4 11.1 Current Surplus 1 1.0 1 T0 10. 1.1 Ca-)ital ExoenSitures 55 3.4 4.9 4c 3.0 4.L E,ternal ASsistance (net) 24 1.5 2.3 23 1.71 2.1 ,/ The Per Capita GNP estimate is at 1971 market prices, calculated by the same conv,e.rcion techncice as the 1973 World Atlas. All other conversions to dollar-. in this tab-le are at the average exchange rate prevailing daring the pariod covered. 2 The annual growth rates are calculated on the basis of Gross National Savings as Gross National Produce minus Consumption. J Total labor force; unemployed are allocated t, sector cf their normal occupation. "Unallocated" consists nainly of unemployed workers seeking their first job. not available not applicable  Page 2 of 2 COUNTRY DATA - HIONDURAS M1EY, CREDIT AND PRICES 1965 1970 1971 1972 _ llion Lemp. outstanding end of period) YMoney and Quasi Mtoney 167 335 373 431 Bank Credit to Public Sector 18 54 70 80 a-nk Credit to Private Sector 135 347 369 414 (Percentages or Index Numbers) Money and Quasi Money as % of GDP 16.4 23.5 24.7 27.0 General Price Index (1966 = 100) ' 99.1 108.5 110.7 I14.7 Annual percentage changes in: General Price Irndex . 3.0 2.0 3.6 Bank credit to Public Sector . 13.9 30.5 14.1 Bank credit to Private Sector . 16.3 6.3 12.0 BALANCE OF PAY11NENTS MERCHANDISE EXPORTS (AVESAGE 1970-72) 1970 1971 1972 US $ Mln. % (Miillions US $)- Exports of Goods, NFS 196 216 231 Bananas 86 44.3 Imports of Goods, NFS 244 220 221 Coffee 26 13.4 Rezource Gap (deficit = -) -U -T 10 Lunber 20 10.3 Beef 13 6.7 interest Payments (net) - 3 ) ) All other commodities49 25.3 Wcokers' Remittances * ) - 23 ) - 19 Total 19 100.0 Other Factor Payments (net) - 20 TN= ransfe7s 7 7XT-IRNTAL DEBT, DEC=RE- 31. 1972 Balance on Jurrent Account - 20 -- 2 S . US $ NIn. Djrect Foreign Investment 8 7 1 Net WiLT Borrowing 34 19 15 Public Debt, ir.l. Disbursements 35 20 18 guaranteed 119 J k.m ortization 1 1 3 Non-guaranteed Private Debt Subtotal 7 17 Total outstandins & disbura.. Carital Grarts - - _ DEBT SERVICE RATIO FOR 1c72 Other Canital (net) 2 9 4 Othler items n.e.a. 6 - 9 -6 Increase in Reserres () -1 o 12 Public Debt, incl. guar'nd. 3.4> Non-guaranteed private debt Gross Reserves (end year) 24 27 40 Total outstanding & disburs. Net Reserves (end year) 9 15 27 RATE OF EXCHANGE ITRD/IDA T NDIN. Dec. 31., 1972 (Wln. US $): Through - 1971 IBR3 IDA US $ 1.00 = Leroiras 2.00 Outstanding & Disbursed 34,1 22.2 Lempiras 1.00 = US $ 0.50 Undisbursed 2L.2 2.6 Outstanding incl. Undisburoied 3 2 Since - 1971 US .$ 1.00 = Lempiras 2.00 Lempiras 1.00 = US $ 0.50 1/ Ccnsumer Price Index. j Net medium and long-term capital to private non-monetary sector and to the banking system. 3/ Debt repayable in foreign currency disbursed. I/ Ratio of Debt Service to Exports of Goods and Non-Factor Services. not available not applicable  IBRD IO OS ~~~~~~~~~~~~~~I b~~~~~~~~~~~~~~~~ 0 MS l\1 i x. 0. _ '31"A1O A.~~~~~~~~- ts ~ ~ ~ ~ , -.h,r I-I!q -A U ] ' .> X +0 0 I '1 , '' . o . , \. , ~~~~~~~~~~~~~~~- 197 ', / --I, 0 Nr W0 dX \ i~~~~~ -9T   SUMMARY AND CONCLUSIONS 1 With a per capita income of about US$300 in 19711< Honduras is the poorest country in Central America. The inajority of the population obtains a bare subsistence income. An official survey for 1967 shows an average income per capita of about $60 for the poorer 50 percent of the population. The adult literacy rate is only about 50 percent and the average national calorie and protein intake is well below minimum requirements. Progress in overcoming these deficiencies is difficult owing to the rapid population growth rate, presently estimated at 3.5 percent per year. More than 70 percent of the popu- lation reside in rural areas and a larger proportion of the lower income groups can be found there. During the last few years agricultural product per capita has declined while other sectors of the economy have grown. The relative im- poverishment of the countryside has contributed to social unrest. The increasing incidence of land invasions has been halted temporarily by an emergency land reform program instituted by the new Government, but a long-run solution to the agrarian problem must still be found. Roughly half of the farms account for only about 6 percent of the land in farms and fully two-thirds have an average size of on:ly 2.5 hectares. 2. The resource base of Honduras is limited. Known mineral deposits are not extensive; they include silver, lead and zinc, which have been exploited in small quantities, and low-grade iron ore. Land suitable for agriculture, however, is not a limiting factor. Although the population-to-lancl ratio i8 favorable, population has traditionally been concentrated in the mcuntainous south and west, the poorest areas of the country, and on the north coastal plain. As population pressure increases in the traditional areas, large invest- ments in physical infrastructure will be necessary to facilitate development of the fertile valleys further to the east. Apart from land, Honduras' other major natural resource consists of the largest unexploited pine forest in Central America. Large parts of the country are made up of rugged mountains, making transportation difficult. As a result the social and economic integration of Honduras has always been limited. Despite progress made in recent years in ex- panding the road network and improving communications, there are still substantial deficiencies to be overcome. 3. Honduras is a small, export-oriented economy, heavily dependent on the output of bananas. Although some diversification has taken place in recent years, banana exports still account for about 45 percent of the total. However, exports of products such as meat and wood are growing in importance. Real GDP rose at an average annual rate of 4.7 percent during 1965-72, but much of this expansion took place during the first three years of this period, as a conseouence of sub- stantial investment and large increases in output and exports of bananas. From 1969 through 1972 economic growth has been quite low, real per capita income growing at a yearly rate of 1.2 percent. Inflation has been limited: the consumer price index rose at an average rate of 2.1. percent per year from 1965 to 1972 The rate of price increases accelerated somewhat during the latter part of the period--prices rose at 3.6 percent during 1972--as a result of rising food prices, owing to the stagnation in agriculture, and of higher import 1/ At 1971 prices, calculated according to World Bank Atlas methodology.  - ii - prices. Several factors contributed to the slow growth of the economy during the last few years, including severe hurricane damage to banana and other crops in 1969, coinciding with the armed conflict between Honduras and El Salvador and the consequent reduction in private investment, and the withdrawal by Honduras from the free trade arrangements of the CACM, a move which adversely affected a number of export industries. These difficulties were accompanied by severe balance of payments and fiscal crises. 4e The importance of the public sector in the economy has increased noticeably during the last few years. Current revenues of the general govern- ment increased from 12.6 percent of GDP in 1965 to 13.9 percent by 1972; current expenditures grew from 10.4 percent to 12.9 percent of GDP over the same period. Public enterprises, especially the port and power agencies, also increased their relative importance. Public sector capital expenditures rose from 2.6 percent of GDP in 1965 to 8.4 percent in 1970, but then declined to l . percent in 1972. Among the major achievements were the establishment of a basic transport network connecting the main population centers, the expansion of electric power and telecommunications services, and the increase in primary school enrollment. Until 1968, there were no financial difficulties in carrying forward these schemes. 5. Public finances deteriorated sharply starting in 1969, initially because the Government had to finance the war with El Salvador at a time when domestic counterpart requirements for foreign-financed development projects increased substantially, and later because the normal growth of current ex- penditures outstripped the current revenues. Public sector savings declined from an average of 2.7 percent of GDP in 1966-68 to 1.6 percent of GDP by 1972. The overall deficit exceeded 5 percent of GDP in 1969 and 1970 and, though external financing covered a large part, excessive reliance on Central Bank financing contributed to severe balance-of-payments problems. Net inter-national reserves declined by $17 million during those two years and by December 1.970 had fallen to an amount of about two weeks of imports. Subsequently the Government emDarked upon a stabilization program. The overall deficit of the public sector was reduced and net international reserves recovered quickly to a level equal to about 6-7 weeks of imports by December 1972. However, the main element in the improved financial position of the Government was a drastic decline in public capital expenditures; this type of solution to the fiscal problem, however, impairs long-run development. At the same time current savings of the public sector continued on their downward trend. 6. The CACM was an important element in the growth of the Honduran economy during most of the sixties, providing additional markets necessary for the establishment of factories producing textiles, chemicals and metal products. Hionduras felt, however, that the benefits of integration, as reflected in its growing intraregional trade deficits, were unevenly distributed. The with- drawal of Honduras from the CACM in December 1.970 led to a drastic reduction in intra-regional trade. The industries most seriously hit by the withdrawal have for the most part been able to redirect their production to the domestic market, a step in which they were helped through increased import duty protection and their growth has been affected little. The action has, however, led to in- creased domestic prices, and risks making Honduran industry even less able to  - Aii - compete within the region than before. The economic difficulties in 1969-72, and in particular the situation in the agricultural sector, contributed signif- icantly to the circumstances which resulted in a coup in December 1972 and brought the present administration to pover. The Present Situation 7. Honduras' economic situation has improved remarkably during 1973. Led by a booming growth of export earnings, especially meat, coffee and wood, a general economic recovery appears to be taking place. Fiscal revenues have in- creased sharply and the balance of payments has been strengthened further. At the same time, the unification of the legislative and executive branches in the new administration (which took power in December 1972) had the effect of elimi- nating.certain budgetary expenditures while other current expenditures have been kept under control. Private investors are regaining confidence and private investment is on the increase. Public investment expenditures, however, continued at undesirably low levels during the year. 8. The new Government immediately took several measures to provide emer- gency solutions to some of the most pressing problems while, at the same time, it initiated the preparation of a development plan in which a long-run development strategy for the economy is to be specified. One of the Government's major concerns is the continued stagnation in public investment expenditures. Government savings have increased rapidly, indicating that the lack of investment growth does not result from a shortage of funds but rather from a lick of adequately prepared projects. As a short-run solution, the Government has added a list of small projects totalling about 15 million lempiras (US$7.5' million) to the investment program. Although all of these projects may be economically justi- fiable, it is unfortunate that these expenditures were not integrated into an overall investnment program which fixed priorities needed to achieve the Govern- ment's development objectives. 9. The stagnation of food production, the extreme poverty of the rural population and increasing agrarian unrest have led the new administration to give first priority to agricultural development. The ultimate aim is to insure an efficient utilization of the land and to improve rural living standards. As a temporary solution Decree 8, of December 26, 1972, gives the National Agrarian Institute the power to take over, by compulsory lease, unutilized or under- utilized lands to settle landless farmers. The authority to lease such lands expires after two years, by which time it is expected that a new agrarian reform bill will have become law and made provisions for permanent settlemesnt arrange-. ments. Progress has been rapid: by the end of July 1973, about 10,000 families had been settled. As a consequence of the decision to move rapidly, much of the settlement is being done on an inefficiently organized basis, however. The National Agrarian Institute is administratively still weak and will need con- siderable technical assistance to perform its task successfully. N,evertheless, many of the settlements are already producing crops with credit assistance from the National Development Bank and rural unrest appears to have diminished. 10. Some progress towards the reopening of the CACM has been made through the signing of bilateral trade agreements with Nicaragua, Guatemala and Costa Rica.  - iv - The agreements give preferential treatment to Honduras; for the commodities covered in the bilateral agreements, Honduran exports may enter the other countries free of duty while Hlonduran imports from the other three are subject to ad valorem duties ranging up to 25 percent. The prospects for a complete reestablishment of CACM are still unclear as discussions between El Salvador and Honduras to normalize relations have become bogged down in the long-standing border issue. 11. The emphasis placed by the new 7Toverninent on the preparation of a developr-ent plan is one of the most encotraging elements of the present situa- tion. The existing low level of public investments and the lack of projects result primarily from the failure of earlier administrations to define priorities and prepare programs of action. The Government has started to build the administrative base for an effective implementation of its development programs; the Direction of Rural Development, which provides extension services in agriculture, and the Direction of Forestry Resources have been reorganized and strengthened with international financial assistance; a National Institute for Professional Training was created to improve the quality of the labor force for which purpose also international financial assistance is expected. The Medium-Term Outlook 12. Honduras' growth prospects over the medium term are more promising now than one or two years ago. The development plan should, by reducing un- certainties and indicating opportunities, provide a stimulus to the private sector. A.t the same time it will lay the basis for a medium-term program for public sector development expenditures. The success of development planning, however, will depend on the timely preparation and execution of specific programs. l13 For a variety of reasons future development policy must give primary emphasis to agricultural development. About two-thirds of the labor force is employed in agriculture and the vast majority lives in conditions of extreme poverty. Food production has stagnated during the last few years and rural living standarcs have tended to decline in absolute as well as in relative ter9s. land is not scarce, but a substantial portion of the land is either un- utilized because of infrastructure shortages, or is underutilized because of the structure of the agricultural sector. Agricultural development provides the oppcrtunity to contribute not only to output growth but also to the goals of income distribution, employment creation and political stability. Success will require simultaneous efforts in a number of areas; land redistribution and resettlement, infrastructure development, farm management training, extension work, credit assistance, and market development. The speed of imple- mentation of the development plan in agriculture will depend greatly on improve- ments in the functioning of Honduran official institutions. In order to provide for coordination in the execution of the program a national-level administrative structure is being created comprising the Ministry of Agriculture, the National Agrarian Institute, the National Development Bank and the Planning Council. lh. Real GDP growth of about 6 percent (2.5 percent per capita) can be reached and sustained under the following assumptions: a substantial increase in both the level and productivity of capital investments, increases in tax  -v - revenues to finance the expanded development effort and a solution to the balance-of-payments constraint. Past road construction appears to have had limited effects on agricultural production, mainly because of such factors as the lack of complementary expenditures for extension work in agriculture or the continued inefficient distribution and use of land. New investments must be made so as to complement past investments as well as one another, and must be combined with other expenditures and policies necessary to have a maxiLmum effect on agricultural production. Likewise, the new Government will, want to increase expenditures in health, housing and other social improvements which have been neglected in the past, but care must be exercised in order to avoid a wasteful use of resources. Additional expenditures in these areas are imperative, especially in the rural areas, but they should be part of multi- sector rural development programs in order to derive maximum benefits. In the industrial sector the tendency towards high protection in order to permit production for the small national market must be avoided. Future indcustriali- zation must be based on considerations of comparative advantage--e.g., forest products, processed fruits and vegetables--and, assuming the reopenirng of the CACM, industries with a good regional market. 15. Even a relatively modest level of public sector development expendi- tures will require additional tax revenues above those generated by the existing tax system. In order to finance a program of public capital expenditures equal to about 6.5 percent of GDP--slightly above the average of the last 4 years-- and to allow for a moderate growth in current expenditures, added ta: revenues of the order of one percent of GDP in 1975 and totaling at least 3 percent of GDP by 1980 will be necessary. In view of the Honduran Government's desire to accelerate the development of the country, the above must be considered minimum objectives; larger public expenditures would require a correspondingly larger increase in revenues. A new banana export tax, planned for April 1974, should provide the Government with a very large part of the necessary resourceso Additional fiscal measures--principally increases in real estate and coffee export taxes, increases in automobile import duties and a new beef export tax-- planned as part of an anticipated general reform of the tax system indicate that the fiscal situation should create no major bottleneck for implementation of the Government's plans. 16. It should be possible for Honduras to rely upon net foreign borrowing equivalent to about 2.5 percent of GDP to finance roughly 40 percent of public sector capital expenditures. The corresponding gross inflow would amount to about 53 percent of public capital expenditures; resources of this magnitude can be mobilized, hoTwever, only if a large portion of the investment program takes the form of projects suitable for financing by external lenders. Honduras' present low debt service ratio -- 3.4 percent in 1972 -- gives the country a good margin for additional foreign borrowing. On the basis of the Bank staff's projections, the debt service ratio may reach 4.6 percent by the end of the decade, a level manageable for the economy. (These projections were made before the recent rises in actual and expected rates of world inflation. 'While the net impact of these developmerAts on the balance-of-payments is still uncertain -- see para. 19 -- there is no reason to believe that the situation will change so much as to become unmanageable; furthermore the real burden of servicing existing external debt will be reduced.) In the past, Honduras has obtained  - V2 - virtually all of its public capital inflows from official sources. It has been assumed in our projections that all new commitments will continue to be from official lending institutions. This is the pincipal reason for the modest projected debt service ratio. The underlying uncertainties combined with the country's poverty make it highly desirable that Honduras obtain its external financing on relatively favorable terms, including IDA-type terms for a part of such financing. 9ubstantial use of either supplier credits or commercial bank financing, except perhaps for projects which would directly increase export earnings in addition to generating additional savings, is undesirable. 17. The realization of the projected new commitments and capital infloms may be constrained most seriously by the lack Jf projects. Irregular and in- sufficient project preparation has contributed to large and excessive fluctua- tions in capital expenditures during the recent past. Disbursements on existing loans, including those newly committed during 1973, will insure adequate financing of projected public capital expenditures only through 1974. Develop- ment planning can only be successful if it goes beyond broad objectives and macro-econoxic projections to concrete programs and proiects; only at the latter stage, when financial, administrative and political constraints are clearer, can many specific development policy issues be resolved. Given existing deficiencies in project preparation, immediate steps are necessary to improve capacities in this area. 18. Prior to the recent increasea in commodity prices, of which petroleum offers the most dramatic but not the only example, our balance-of-payments projections showed that equilibrium could be maintained over the medium term, only under conditions of a continuing policy of import substitution and t-e development of additional export lines toward the end of the decade. Export earnings were expected to increase about as fast as GDP in current terms while expected import requirements seemed likely to grow slightly faster than GDP; consequently the resource gap would have increased to almost 3 percent of GDP by 1980. Judging by past experience, net private sector capital inflow is unlikely to grow by much more than about 10 percent per year unless a decision iE taken to go ahead with the proposed steel and forestry projects. The offici:al capital inflow is limited by absorptive capacity and the availability of fLunds on suitable terms. Commitments averaging $50 million annually in 1974-77 and $75 mi.llon annually in 1978-80 seem feasible, but would have been enough to assure balance-of-payments equilibrium only if real import growth did not exceed the projected 6 percent real GDP growth. 19. Recent developments in international prices, however, may change this outlook considerably. The oil price increases have led to a much larger import bill; import prices generally are rising because of higher actual and expected rates of world inflation. Commodity price forecasts for Honduras' major exports, however, have also been revised upwards and their effect is expected to offset the impact of higher import prices, except for oil. Most recently, Latin Americats major banana exporting countries agreed in principle to impose an ex- port tax on bananas of between 1.0 and 2.5 U.S. cents per pound. Four countries including Honduras but not yet including Ecuador (the largest exporter), subse- quently signed an agreement to 1ax banana exports at 2.5 cents a pound to become effective April 15, 1974. If the agreement is totally successful and no major drop in demand occurs, the additional export earnings will more than offset the  - vii - inc rease in petroleum import prices. The nei gain to Honduras' balance of payments, however, would gradually decline since petroleum imports are growing substantially faster than banana exports. If banana demand were to drop sub- stantially or if the export tax were to fall significantly short of 2.5 cents per pound, the added revenues would probably still be sufficient to offset the increased cost of petroleum imports in the immediate future; however, in the absence of a significant effort to develop new exports, balance-of-payments difficulties would develop towards the end of the decade0 In the urLlikely event of a total failure of the agreement, Honduras would find it extremely difficult to maintain balance-of-payments equilibrium in the short as well as medium term, except by either reducing its growth rate or mobilizing additional external resources on suitable terms. It is too early to confidently forecast the results of the producing countriest efforts to increase their earnings from banana ex- ports, so the balance-of-payments outlook is correspondingly uncertain. 20 Two major projects which have been under discussion for a number of years and to which renewed attention is being directed by the present Government, are the Agalteca Steel plant near Tegucigalpa and a large forestry products plant to be built along the north coast. Both of these projects would boost Honc,uras' export earnings during the latter part of this decade and during the 1980's. Nippon Steel Corporation of Japan has shown great interest in the development of the steel mill and a final feasibility study is planned during the first few months of 1974. If the study concludes that the projeict is feasible, Honduras should, given the need for additional exports, encourage its implementation. The plant would be designed to sell in the CACM which, even though the Common Market has not been reopened yet, seems feasible under the existing bilateral trade agreements with three of the four countries0. 21. The forestry products project would use Honduras' large pine forests in the Olancho area. Past feasibility studies have generally propotied the production of container-board for the Central American banana box market. New higher price expectations for synthetic fibers make the production cif dissolving pulp for cellulose fibers for sale in world markets a possibly more rewarding alternative. In either case Honduras cannot afford to continue to neglect the exploitation of one of its major resources. Technical studies to deitermine the appropriate development pattern for the country's forestry resources--a major national asset--are now underway. 22. Given the long lead time for the development of the Agalteca and Clancho projects, there is a clear need for the early adoption of policies which would promote the development of other exports. Several possibilities exist which would increase foreign exchange earnings in the medium term, such as exports of tropical hardwoods and of fruits and vegetables. The international fruit companies have expressed interest and could be of great assistance in the production and marketing of the latter. The smallness of the domestic market dictates that Honduras' development continue to be oriented towards exports.   I. POPULATION, E4PLOYMENT AND INCOME DISTRIBUTION 1. In 1972 Honduras' population reached close to 2.7 million. At the current rate of growth, which is of the order of 3.5 percent per year and is one of the highest in the world, population will double every twenty years. It is estimated that the birth rate has declined during thLe last decade, but the decline has been minor and no dramatic changes are! foreseen for the near future. Furthermore, the death rate has declined more rapidly than the birth rate, resulting in a slight acceleration of the population growth rate from 3.4 percent during the early sixties to the present 3.5 percent. The age structure has changed little and about 47 percent of Honduras' population is less than 15 years old. 2. The Planning Council has estimated that the Honduras-El Salvador border war in 1969 led to the emigration to El Salvador of about 73,000 pecple--El Salvadorians who had been resident in Honduras-- during late 1969 and early 1970. As a result Honduras' total population in 1970 is estimated to have grown by only 0.5 percent over 1969. Thus, even though the present rate of growth of population is 3.5 percent, the actual yearly growth over the period 1965 through 1972 was only 3.0 percent. 3. Although Honduras' GDP in real terms grew at a rate of 4.7 percent per year during 1965-72, the rapid growth of population reduced the per capita growth to 1.7 percent. With a per capita GNP of about $300 in 1971 1/, Honduras continues to be the poorest country in Central America. Furthermore, income is very unevenly distributed. Table 1: PERCENTAGE SHARE OF TIREE INCOME GROUPS IN TOTAL INCOME IN SELECTED COUNTRIES /1 Country (per capita Lowest Middle Top GNP, 1971 /2) 50 percent 45 percent 5 percent United States (5,160) 23.0 57.0 20.0 United Kingdom (2,430) 23.0 58.0 19.0 Mexico (700) 15.4 55.6 29.0 Brazil (460) 15.0 45.0 40.0 El Salvador (320) 16.0 51.1 32.9 Costa Rica (590) 20.9 56.3 22.8 Honduras (300) 14.2 56.8 29.0 /1 Estimates for early 1960's, except for Honduras (1967) and Costa Rica (1971). 12 In US$, World Bank Atlas data. Source: Honduras: Estimate based on Appendix Table 1.5 Costa Rica: World Banlk. Economic Report of Costa Rica (1973) Other Countries: ECLA. "Income Distribution in Latin America" in Economic Survey of Latin America, 1969. / 'World Bank Atlas definition.  - 2 - Inter-country comparisons of income distribution data are difficult to make. Also, there are a variety of estimates, including recent calculations for some Latin American countries produced by the Economic Commission for Latin America, which vary somewhat from those presented in Table 1. Nevertheless', some generally valid conclusions can be made. In Honduras, as in the other Latin American countries shown in the table, the lowest 50 percent of the popu- lation receives a much smaller share of total `.ncome than in industrialized countries, such as the U.S. and U.K., while the opposite i.s true for the top 5 percent. (Costa Rica's distribution, however, appears to be approaching the distribution in the developed countries.) However, Honduras' distribution, as opposed to the other Latin American countries presented, shows a compara- tively smaller proportion of income going to the very poor. This fact, added to the lower per capita national income in Honduras than in the ot}ler countries in the table, emphasizes the extreme poverty of Honduras' lower income groups. The estimate for 1967 shows an average income per capita of about $60 for the bottom 50 percent of the population. 4. The vast majority of the population--72 percent in 1972--resides in rural areas. Urban migration, mostly towards Tegucigalpa and San Pedro Sula, is taking place and urban population growth from 1965 to 1972 was .5 percent per year, considerably larger than the 3 percent growth rate for the country as a whole. However, given the relatively small size of the urban sector, the effect of urban migraticn on the rural population growth rate is small: from 1965 to 1972 rural population grew by 2." percent per year. About 31 percent of Honduras' population is classified as economically active. Cf these, close to two-thirds are engaged in agriculture, and this proportion 'as changed little over the last few years. From 1965 to 1972 total labor force is estimated to have grown, by 3o1 percent per year, versus 3 percent Der year for the agricultural labor force. Opportunities for employment in non- agricultural and urban activities have grown very slawly, with the result that the nrur.l labor force and population continue to grow rapidly despite the generally low opportunity and income levels in agriculture. 5. Sectoral growth rates of the labor force may be compared with sectoral growth rates of real product in order to obtain some information about man.i trends in the distribution of product and income in Honduras. Irdications are that the Door are becoming poorer. In 1965, product per econamically active member of the population was lowest in the agricultural sector an. eqtual to aiout two-thirds of the country average. W4hereas the latner grew by 1., percent per year during 1965-72, the product per worker in agriculture declined by about half a percent per year over this period. The more advanced subsectors in agriculture (exnort agriculture) are estimated to have outperformed the rest: this would tend to confirm the increasing poverty of Honduras' poor. (Appendix Table 1.4). Also, the urban migration of the last few years, even though it is still relatively limited, has already contributed to increasing urban poverty. Open unemployment -pre- sumab;.y mainly urban-- is estimated to have grown from 6 to 8 percent of the labor force during 1965-72.  II. OVERALL ECONOMIC GROW4TH TRENDS 6. In the small open economy of Honduras, economic growth and its fluctuations are to a large extent a reflection of developments in the export, sector. From 1965 to 1972 exports grew at slightly more than 7 percent per year both in current and in real terms and this was accompanied by real GDP growth of 4.7 percent per year. Growth was not uniform over this period, however. Mlajor fluctuations in GDP growth generally followed changes in export volumes; the most significant fluctuations in export prices, such as the decline in 1969 and the recovery in 1971 reinforced volume trends. Table 2: YEARLY GROWTH RATES OF GDP, POPIJLATION AND EXPORTS (percentages) Aver. Aver. 1965-68 1969 1970 1971 1972 1965-72 GDP /1 5.8 2.1 5.0 4.3 4.2 4.7 Population 3.4 3.4 0.5 3.5 3.5 3.0 Exports /1 12.2 -2.0 4.7 5.8 6.4 7.2 Exports 72 12.4 -5.0 5.1 9.7 7.0 7.5 /1 In real terms. 7 In current terms. Source: Appendix Tables 1.1, 2.1 and 2.2. GDP growth was highest during 1965-68, coinciding with booming export growth, principally of bananas. As a result of hurricane damage in the main agri- cultural areas, which seriously affected banana output, and of the war with El Salvador, which led to a decrease of Honduran exports to Central America, the volume of exports declined in 1969: export prices fell as well and GDP arowth was reduced to 2.1 percent. The withdrawal of Honduras from the CACM at the end of 1970 led to a further decline in its exports to Central America; banana oroduction and exports recovered in 1971 but suffered a new setback in 1972; exports of a few products, however -notably meat, coffee and wood-- increased rapidly during 1970-72; overall, exports in real terms grew moderately during the last 3 years and so did GDP. 7. In per capita terms, real GDP grew at 1.7 percent per year over the period 1965-72, but at 2.4 percent during 1965-68 versus 1.2 percent during the last 4 years. Both the decline in per capita GDP in 19I69 and the rapid increase in 1970 are somewhat misleading and result from the emigration of about 73,000 persons to El Salvador following the July 1969 border war: GDP growth was most severely affected in 1969 but the (mid-year) population estimates record the population decrease only in 1970.  8. Inflation, as measured by the consumer price index, has been very limited: prices rose by about 201 percent per year during 1965-72. An accel- eration in the rate of price increases appears to have taken place during the latter part of this period, however, with prices rising at 3.6 percent during 1972, the highest rate of increase of the whole period. Both rising food prices, resulting from the slaw growth of domestic food production, as well as higher import prices appear to be responsible for the recent acceleration in inflation. Table 3: CONSUMER PRICE INDEX, 1970-72 (1966 = 100) TOTAL FOOD 1970 108.5 110.4 1971 110.7 113.7 1972 114.7 119.1 Source: Appendix Table 9.1 and Central Bank. 9. Investment demand fluctuated widely during the last few years, reaching a peak of 21.9 percent of GDP in 1970, but declining sharply after- wards to 16 percent of GDP in 1972. The expansion of exports during 1965-68 facilitated a rapid increase in investment, both public and private, which contributed to the high GDP growth during those years. The 1969 decline in exnorts and the El Salvador border war led to a decline in private invest- ment, vet total investment increased moderately as a result of a tremendous expansion in public investment. The latter coincided with a large increase in public current expenditures associated with the war and a sharp decline in public savings. The increase in the overall resource gap was still manage- able, however, as orivate sector savings exceeded private investment by a large margin. 10. Private investment demand rose strongly in 1970. The recovery of exports contributed to a rapid increase in fixed capital formation and inventories were built up in anticipation of Honduras' withdrawal from the CACM. Public investment demand, however, continued to expand, though at a slower pace than the year before. As consumption expenditures, public as well as private, also rose fairly rapidly, the resource gap was equal to 6.7 percent of GDP. Foreign capital inflow fell far short of closing the gap and net international reserves declined by $14 million to a level equiv- alent to barely 2 weeks of imports at the 1970 rate. 11. Despite a continued recovery of exports, private investment demand declined sharply in 1971 and recuperated slowly in 1972. Reductions in inventories accounted for the strong decline in 1971; fixed capital invest- ment virtually stagnated during both years: following the withdrawal from the CACM in December 1.970, existing excess capacity was put back into utilization and new investment lagged in view of Honduras' uncertain future in the market.  -5- Table 4: DOMFSTIC EXPENDITURE, SAVINGS AND RESOURCE GA(P Aver. 1965-68 1969 1970 1971 1972 (As a percent of GEP) Public expenditure 13.1 17.5 18.3 16.3 15.7 Consumption 10.1 11.1 11.7 1156 ttW. Investment 3.0 6.4 6.6 47 3.9 Private expenditure bb.0 L54 .66.4 84.2 53.1 Consumption 73. T 7 .4 73.1 72T 71.0 Investment n 1h.2 13.0 15.3 11.8 12.1 of Which: fixed investu. (12.7) (11.9) (12.6) (12.2) (11.9) Resource gap 1.1 2.9 A 0.5 +1.2 Exports 2d =2.o 27 2 2 Imports 29.7 30.9 34.3 29.1 27.6 Domestic savings 16.1 16.5 15.2 16.0 IL.2 Public 2 /72 1.3 2.5 1.26 J T Private 13.5 15.2 12.7 13@6 15.6 (selected yearly growth rates) Public consumption 5.1 15.5 12.1 5.2 7.5 Public investment 26.0 77.2 1Q.5 -24.8 -11.5 Private consumption 7.3 2.5 7.5 5.0 4.o Private investment V 15.3 -9.3 25.5 -lb.0 7.9 of which: fixed investa. (18.1) (-10.9) (12.4) ( 3.3) ( 2.9) Total investment 17.2 8.1 20.7 -20.0 2.3 GDP deflator 2.4 1.0 1.5 1.7 1.6 Consumer price index 1.6 1.3 3.0 2.0 3.6 2/ Based on data in current prices. Yearly rates of change in the GDP deflator and in the consumer price index have been amall and are shown in the table. j Includes inventory investment. 2/ From Public Sector Accounts Source: Appendix Tables 2.2, 5.7 and 9.1.  -6- At the same time, public investment exoenditure declined sharply in both years, to some extent as a result of expenditure restraint following the start of a stabilization program in 1971, but more importantly because of the decline and termination of a few large projects, partly foreign-financed, and a lack of new projects. Private, and to a lesser extent, public consump- tion expenditures grew moderately and the resource gap became negative in 1972; by December 1972 net international reserves had recovered to the level of December 1968. 12. During the last four years public expenditure policy has operated effectively as a counter-cyclical device only in 1969 when the decline in private investment demand and the slow growth in private consumption were offset by greatlv increased public expenditures, 1/ without too much stress on the balance-cf-payments. In 1970, however, a rapid increase in public outlays was added to the strong growth in private spending, while during the next two years slow growth in private spending was accompanied by a decline in public spending, the latter because of greatly reduced public investment. While the stimulation in 1970 helped produce the highest GDP growth of the last 4 years, balance-of-payments equilibrium could not be maintained; conversely in 1971-72 the speed) improvement in the balance-of- payments was accomplished at the nrice of reduced income growth. Aggregate demand management to maintain a high income growth consistent with balance- of-payments equilibrium clearly was not satisfactory. To the extent that the low level of public investment was due to a lack of ready projects, intensified efforts in project preparation are vital to provide a much improved basis for policy making in the future. 13. Agriculture is by far the largest sector of the economy: in 1972 about one-third of CDP at factor cost originated in the agricultural sector, 65 nercent of the economically active population were employed there and more than 8O percent of all exports were agricultural products. Variations in total CGP in Hionduras are generally a reflection of developments in agriculture. The boom years of 1965-68, the recession in 1969 and the moderate recoverv since, can all be traced to the agricultural sector. 14. A major characteristic of the growth of lHonduran agricultural production is thc uneven nerformance of different subsectors. Production of several major export products --bananas, coffee, beef, wood-- has expanded considerably over the last few years, while basic grains production mainly for domestic consumption --especially corn and beans-- has stagnated or even declined. Climatic conditions, such as the prolonged drought during 1972, 1/ Although the bulk of the increase in public current expenditures was war related.  Table 5: SELECTED PRODUCTION INDICES (1966 = 100) 1965 1967 19E8 1969 1970 1971 1972 Corn 102 98 108 100 105 107 107 Beans 110 104 116 104 91 99 94 Bananas 78 109 1.19 110 113 138 126 Beef 98 116 126 123 126 140 155 Wfood 99 106 1`2 115 114 117 126 Coffee 103 95 122 102 112 121 133 Source: Appendix Table 7.1. at times have affected output negatively: yet the stagnation in production of Honduras' two most important staples --corn and beans-- has existed throughout the neriod 1965-72, and the explantion must be sought elsewhere. Nor is land as such a scarce resource in Honduras. Investigations by FAO have led to the conclusion that Honduras possesses close to 1.9 million hectares suitable for annual or permanent crops, while according to the 1966 agri- cultural census presently only about 530,000 hectares are under cultivation. Furthermore about 1.1 million hectares are presently used as pasture land, compared with a potential of 3 million hectares. Table 6: ACTUAL AND POTENTIAL USE OF LAND (in 1,000 hectares) Actual Use Potential Use Actual as percent Area Percent Area Percent of Potential Total area 2,400 100 11,200 100 21.4 Annual crops 340 14 1,000 9 3i4.0 Permanent crops 190 8 870 8 21.8 Pasture land 1,130 47 3,000 27 37.7 Other /1 740 31 6,330 56 11.7 /1 Mostly forest land. Source: Actual Use: Agricultural Census, 1965-1966, Statistical Office. Potential Use: "Uso Potencial de la Tierra, Parte V: Honduras." C.V. Plath, FAO, Rome, 1967.  15. Whereas a general shortage of roads has kept a large portion of the potential new lands inaccessible for many years, the great efforts of the Honduran Government to expand the road network during the last few years have started to eliminate that constraint. However, disregarding those land areas which because of lack of infrastructure development are still outside of the production notential, the general co;isensus of studies dealing with Honduran agriculture is that large parts of the agricultural areas are presently unutilized and that furthermore significant over- and underutiliza- tion of the land exists. Mountainous lands not fit for cropping purposes are intensely cultivated and often the more fertile lands, which could be devoted to crop production, are left idle or are used as pasture land. The low and inefficient usage of the land, presentlv incorporated into farms, can be explained largely on the basis of the land tenure system: 6 percent of the farms occupy 60 percent of the land and 47 percent of the farms occupy only 5.4 percent of the land. Fully two-thirds of all farms have an average size of only 2.5 hectares. The small size of the majority of the farms has nerpetuated poverty for these farmers and thus investments in farm improve- ments have not taken Dlace. This situation is aggravated by the lack of clear titles to the land, which is especially severe among small subsistence farmers. The development of non-export agriculture in Honduras is further hampered by a great lack of credit. Thus in 1972, of the total new banking credit for agriculture of 144.5 million lempiras (about 29 percent of all banking credit to the private sector) close to half was directed to cattle production and another 20 percent to coffee. Insignificant amounts of credit are extended for the production of such items as corn, beans, rice or poultry. 16. Unlike agriculture, manufacturing industry has grown at a relatively high rate during most of 1965-72. The high growth rates during the last two years are especially noteworthy. Table 7: REAL GROWTHl RATES OF GDP AT FACTOR COST (percentages) Aver. 1965-68 1969 1970 1971 1972 Total GDP 5.9 2.1 4.0 4.7 4.0 Agriculture 4.0 -2.7 2.4 4.0 2.0 Inanufacturing 7.3 6.3 5.8 8.1 7.4 Source: Appendix Table 2.5.  - 9 - After a slowdown in 1970 as a result of the deterioration of trade relations with the CAG!, Honduran industry received a stimulus in 1971 when the country withdrew from the CACM altogether, thereby restricting external competition for the domestic industry. 17. The manufacturing sector now accounts for about 15 percent of GDP at factor cost and employs close to 9 percent of the labor force. Traditional industries, such as flour, sugar, other simple foodstuiEfs, beverages, textiles and furniture are predoninant. Honduras' participation in the CACOl did, however, contribute to the appearance of new industries during the 1960's, such as chemical inputs for detergents and cosmetics, metal products, paper boxes and canned foods. The modern factory sector generally expanded quite rapidly during the last few years, while handi- craft production stagnated.  - 10 - III. PUBLIC SECTOR FTNANCE AND INVESTMENT Introduction 1/ 18. The importance of the Dublic sectol>-- in the Honduran economy has groun considerably over the 1965-72 period, but at a very uneven and fluctuating pace. J'xpressed as a percentage of GDP, current revenues of the general Government increased from 12.9 percent during 1965-68 to 13.9 percent by 1972; current expenditure grew from 10.8 percent to 13.0 percent over the same period. Tahle 8: PUBLIC SECTOR: INDICATORS OF SIZE (percentages of GDP} Aver. 1965-68 1969 1970 1971 1972 Public savings 2.6 1.3 2.5 2.4 1.6 t-eneral Government 2.1 0.5 1.8 1.4 0.9 (Current revenues) (12.9) (13.7) (14.3) (13.6) (13.9) (Cirrent expenditures) (10.8) (13.2) (12.5) (12.2) (13.0) Public enterprises 0.5 0.8 0.7 1.0 0.7 (Current revenues) (2.5) (2.9) (3.1) (3.3) (3.2) (Current expenditures) (2.0) (2.1) (2.4) (2.3) (2.5) Public capital exDenditures 3.6 6.7 8.4 5.5 4.2 of which, fixed capital /1 3,3 6.4 6.3 4.8 3.7 /1 There are small differences between these figures, based on the public sector accounts, and those appearing in Table 4, based on the national accounts data, but the conclusions are not affected. Source: Appendix Tables 2.2, 5.2, 5.6 and 5.7. 'A'it>ir t1ie general Government, the operations of the Central Government are hV f.r the lmost important: in 1972 the Central Government accounted for 85 percent of the consolidated current revenues of the general Government and for 30 percent of the current expenditures. Current transactions of the puhlic enterprises as well increased in relative importance over the last iew pears. Public sector capital expenditures also grew from 3.6 percent of CDP in 1965-68 to 4.2 percent by 1972. However, the peak years in public sector growth were 1069 and 1970. Current account transactions expanded most rapidly during those two years and, in terms of GDP, have varied little since. Capital expenditures more than doubled during 1969-70, reaching 8.4 percent of GDP in 1970, but declined sharply aftenrards. 1/ The public sector is defined to include the General Government (Central Government, autonomous agencies and municipalities) and public enterprises.  - 11 - Table 9: SUMMARY CONSOLIDATED PUBLIC SECTOR ACCOUNTS, 1965 and 1968-72 (In millions of current lempiras) 1965 1968 1969 1970 1971 1972 Current savings 24.8 37.5 17.7 36.2 35.6 25.8 Ceneral Government 22.1 28.3 6.6 25.4 21.2 14.5 Current revenue (128.5) (171.3) (182.6) (203.6) (205.9) (221.7) Current expenditure (106.4) (143.0) (176.0) (178.2) (184.7) (207.2) Public enterprises 2.7 9.2 11.1 10.8 14.4 11.3 Current revenue (21.0) (35.7) (38.2) (44.1) (48.9) (51.4) Current expenditure (18.3) (26.5) (27.1) (33.3) (34.5) (40.1) Capital receipts 0.9 1.2 1.9 4.5 1.0 3.0 Capital expenditure 26.0 55.3 89.4 119.7 83.7 67.0 of wihich, fixed capital (23.9) (50.3) (85.0) (89.3) (71.9). (59.4) Overall deficit -0.3 -16.6 -69.8 -79.0 -47.1 -38.2 External finanicing, net 7.5 20.3 39.2 62.9 36.9 31.5 Domestic financing, net -7.2 -3.7 30.6 16.1 10.2 6.7 Source: Appendix Tables 5.2, 5.6 and 5.7. 1"). Public finances deteriorated considerably between 1965 and 1972. Three sub-periods may be distinguished. IUntil 1968, current savings financed a substantial part of capital expenditures and the overall deficit, which averaged 0.8 percent of GDP during 1965-68, was generally financed by external sources.  - 12 - Table 10: PIUBLIC SECTOR DEFICIT AND ITS FINANCING, AVERAGE 1965-68 AND 1969-72 (As a percent of GDP) Aver. 1965-68 1969 1970 1971 1972 General Government -0.7 -3.9 -4.8 -3.2 -2.5 of which, Central Govt. (-0.8) (-3.7) (-4.6) (-3.0) (-2.4) Public enterprises -0.1 -1.3 -0.8 0.1 0.1 Total deficit -0.8 -5.2 -5.6 -3.1 -2.4 External financing, net 0.9 2.9 4.4 2.4 2.0 Domestic financing, net -0.1 2.3 1.2 0.7 0.4 Banking system, net (-0.3) (1.1) (2.2) (1.1) (0.6) other, net (0.2) (1.2) (-1.0) (-0.4) (-0.2) Source: Appendix Tables 2.2, 5.7 and 6.3. 2G. In 1969-70 the deficit exceeded 5 percent of GDP. As a result of the conflict with El Salvador current expenditures were up sharply during those two yea:-s. Capital expenditures increased even more and as revenues lagged behind current expenditures, public savings financed on the average only 25 percent of capital expenditures. External financing covered a sub- stantial nart of the deficit in both years. The remaining gap was financed in 1969 by net borroving from the private sector and by a moderate use of bank credit. Banking system financing of the deficit became excessive in 1970, however, when it contributed, together with a sharp increase in private expenditure during that year, to a strong deterioration in the balance of payments (see para. 10). 21. In 1971-72 the fiscal situation improved and the deficit was.reduced to about 2.8 percent of GDP on the average. The growth of current expenditure, however, exceeded current revenue growth and the fiscal improvement was the result of a 44 percent drop in capital expenditures during those two years. Public savings declined, yet domestic financing needs and the use of bank credit were reduced drastically which, together with developments in the private sector (para. 11), led to a rapid improvement in the balance of payments. 22. RAll of these trends in public finances between 1965 and 1072 were conerally a result of developments at the Central Government level. Only in 1969 and 1970 was the overall deficit significantly influenced by the deficit of the nublic enterprises and the latter was financed mostly by external sources.  - 13 - Central Governmnnt Current Revenues 23. International comparative studies in taxation generally show Eonduras' tax ratio to he below the average for countries at a similar level of dovelopment.l/ This characteristic appears to be common to all of Central America and in 1972 Honduras' tax ratio was about average compared with the other countries in the area.?/ Table 11: CENTRAL GOVERNMENT TAX REVENUES IN CENTRAL AMERICA, 1972 (As percent of GDP) rosta Rica 13.8 El Salvador 10.6 Honduras 10.5 Nicaragua 8.9 Guatemala 7.5 Source: Various IBRD Reports. Tax revenues, which constitute close to nine-tenths of total current revenues of the Central Government, increased from 9.6 percent of GDP in 1965 to 10.5 nercent in 1972. This implies that for every one percent increase in GDP during this period, tax revenues increased by about 1.2 percent. Several chanves took place in the tax system during this period, to a large extent offsetting one another. The buoyancy of revenues wias a consequence mainly of the fairly high prowth of direct taxes (excluding those on banana companies) resultina mostly from administrative measures to improve collections and increase the number of taxpayers. 24. The most important changes in tax legislation implemented during the last eight years were the following. Starting in 1968 an internal consumption tax replaced duties on petroleum imports. A tax on the consumption of non-essential goods and an import duty surcharge were introduced under the Protocol of San Jose in 1968: both of these yielded substantial revenues in 1969 and 1970, but were repealed by Decree 97 of December 31, 1970. Finally, the same decree ruled that a revised scale of import duties is now levied on all imports including those previously eoempt in intra-CACM trade. 1/ Chelliah, R.J. "Trends in Taxation in Developing Countries," IMF Staff Papers, July 1971; and Bahl, R.tU. "A Regression Approach to Tax Effort and Tax Patio Analysis," IMF Staff Papers, November 1971. 2/ Tax payments by the banana companies were unusually low during 1972 as a result of production losses due to weather damage. Under more "normal" conditions with regard to banana production and tax payments,, the tax ratio would have been close to 11 percent.  - 14 - 25. The decline in relative irreortance of import duties (Table 12) is a result of several factors, the most significant being exemptions granted to CAal goods and the replacement of petroleum import duties by domestic taxes.l/ Duties on fACM 7 goods were reintroduced in 1971 and revenue increased correspondinglv. Import duty revenue expressed as a percent of merchandise imports had declined continuously throughout the period until 1970 wrhen it reached a low of 8.6 percent; in 1972 this percentage returned to 13.2 percent. If the domestic tax on petroieulm products is added to the import duty revenues, their sum constituted by 1972 the sane percent of GDP as in 1965. Export tax revenue as a percentage of GDP is ouite small and varied little over the period. Revenues derived from domestic transaction taxes also were a fairly constant proportion of GDP, at least if taxes on petroleum products and the temnorary conisumption taxes are left out of the total. Direct taxes, excluding income taxes on banana companies, have grown much more rapidly than GDP and increased from 18.2 percent of all tax revenues in 1965 to 23.3 percent in 1Q72. Taxes paid by the banana companies fluctuated widely because of sub- stantial variations in output resulting from weather damage or disease; they are furthermore largely beyond the control of the Honduran %Kvernment as they are determined by the U.S. Internal Reveniue Service, following a 1950 agree- ment between the two Governments. Central Government Current Fxpenditures and Savings 26. CentralC Government current expenditures increased from 9.2 percent of GDP in 1965 to 11.4 percent in 1972, thus growing about 1.5 times faster than GDP during this period. By far the largest increase occurred in 1q69 as a result of the border war with El Salvador, yet following the termination of the conflict in 1970 current expenditures increased further. The con- tinuous growth of expenditures car, he seen more clearly if war expenditures are left out of the figoures (Table 13). 27. Social services account for about 45 percent of current expend- itures -- ahout 315 *ner capita in 1972 --- and this percentage has varied little over tine (Table 14). In 1