Honduras - Economic position and prospects

Report No. 1165-HO FILE COPY Economic Position and Prospects of Honduras August 23, 1976 Latin America and the Caribbean Regional Office FOR OFFICIAL USE ONLY Document of the World Bank 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.  CURRENCY EQUIVALENTS US$1.00 = 2.00 Lempiras (L) L 1.00 = US$0.50 GLOSSARY OF ABBREVIATIONS BANASUPRO National Development Bank Food Marketing Agency BNF National Development Bank CABEI Central American Bank for Economic Integration CACM Central American Common Market CIDA Canadian International Development Association COHBANA Honduran Banana Corporation COHDEFOR National Forestry Corporation CONADI National Investment Corporation CONSUPLAN National Planning Council ECLA Economic Commission for Latin America ENEE National Electric Power Company ENP National Port Authority FAO Food and Agriculture Organization FNH National Railway Company IDB Interamerican Development Bank IHSS Social Security Institute INA National Agrarian Institute INFOP Professional Development Institute INVA National Housing Institute JNBS National Social Welfare Board LNB 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  FOR OFFICIAL USE ONLY This report is based on the findings of an economic mission to Honduras in October/November 1975 composed of: Ren6 Vandendries Mission Chief Mary Ellen Weber Deputy Mission Chief Stephen Weissman Investment Analyst Lorne Sonley Agriculture Luis Liberman Industry Helmut Wieseman Power Kye Woo Lee Education Jaime Biderman Social Sectors, Power Manuel Benedito Economic Statistics Susana Rodriguez Secretary 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.   HONDURAS TABLE OF CONTENTS Page No. COUNTRY DATA MAP SUMMARY AND CONCLUSIONS ............. .. ................ i-viii . BACKGROUND AND MAJOR ISSUES ............. ..1............ SECTORAL ISSUES AND POLICIES ..... ............. 4 A. Agriculture ...................................... 4 Background ................................ 4 Agricultural Potential ..... ........... 7 Constraints to Agricultural Development ..... 8 Recent Developments ..... ............ 9 Major Issues and Prospects ................. . 11 Conclusion ...... ............ ................ 14 B. Forestry ......................................... 15 Resources and Their Use ......... .. .......... 15 The Forest Law of 1974 ......... .. ........... 17 Major Issues and Prospects ........ .. ........ 17 C. Manufacturing Industry ........................... 22 Growth and Structure ........... .. ........... 22 Major Issues and Prospects ......... ......... 25 D. Social Problems and Policies .... ................. 27 Introduction ............... .. ............... 27 Health and Nutrition ........... .. ........... 28 Housing ........ ............................. 30 Water Supply and Sewerage .... ............... 31 Education ................................... 32  TABLE OF CONTENTS (Continued) Page No. III. PUBLIC INVESTMENT ..................................... 36 Developments Prior to 1972 ....................... 36 Recent Trends .................................... 37 Investment by Sector ............................. 39 Highways ....................................... 39 Ports .......................................... 40 Other Transport Facilities .................... 40 Power .......................................... 40 Communications ................................. 41 Education ...................................... 41 Health ......................................... 41 Water and Sewerage ............................. 41 Housing ........................................ 42 Urban Development .............................. 42 Agriculture .................................... 42 Forestry ....................................... 42 Tourism ........................................ 43 Investment Priorities and Constraints .... ........ 43 IV. PUBLIC FINANCE ........................................ 47 Background ....................................... 47 Structure and Trends: 1960-1975 .... ............. 48 Central Government ............................. 48 Autonomous Institutions ........................ 52 Public Enterprises ............................. 52 Financing Development: 1976-1981 .... ............ 52 Central Government ............................. 52 Rest of the Public Sector ...................... 53 Conclusion ....................................... 58 V. BALANCE OF PAYMENTS ................................... 59 Introduction ..................................... 59 Outlook and Creditworthiness ..................... 60 STATISTICAL APPENDIX  Page 1 of 2 pages COUNTRY DATA - HONDURAS AREA 2 POPULATION DENSITY 112,100 km 2.9 million (mid-1975) 26.0 per km2 Rate of Growth: 2.7/1 (from 1961to 1974) .. per km2 of arable land POPULATION CHARACTERISTICS (1970-75) HEALTH (1974) Crude Birth Rate (per 1,000) 49.3 Population per physician 3,710.0 Crude Death Rate (per 1,000) 14.6 Population per hospital bed 800.0 Infant Mortality (per 1,000 live births) 117.6 INCOME DISTRIBUTION (1967-68) DISTRIBUTION OF LAND OWNERSHIP % of national income, higtest quintile 60.6 7 owned by top 10% of owners lowest quintile 2.5 % owned by smallest 10% of owners ACCESS TO PIPED WATER (1974) ACCESS TO ELECTRICITY (1974) % of population - urban 89.o % of population 27.0 - rural 15.0 NUTRITION (1969-71) EDUCATION (1974) Calorie intake as % of requirements 94.o Adult literacy rate % 52.0 Per capita protein intake 56.o Primary school enrollment % 81.0 2/ GNP PER CAPITA in 1975 : US $ 350 GROSS NATIONAL PRODUCT IN 1974 ANNUAL RATE OF GROWTH (%. constant prices) US $ Mln. % 1963-68 1968-74 1974 GNP at Market Prices 954.9 100.0 5.8 3.3 2.4 Gross Domestic Investment 251.1 26.3 9.9 6.5 31.3 Gross National Saving 109.7 11.5 10.8 5.4 10.3 Current Account Balance 3/ -108.9 -11.4 Exports of Goods, NFS 327.5 34.3 16.0 0.7 -3-3 Imports of Goods, NFS 455.5 47.7 13.4 3.4 17.2 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1974 4/ Value Added Labor Force- V. A. Per Worker US $ Mln. % Mln. % US $ % Agriculture 282 32.3 0.566 64.3 498 50.2 Industry 221 25.3 0.104 11.8 2,125 214.0 Services 371 42.4 0.210 23.9 1,767 177.9 Unallocated ------___ Total/Average 874 100.O o.880 100.0 993 100.-0 GOVERNMENT FINANCE General Government Central Government (US$ Mln.) % of GDP ( US$ Mln.) % of GDP 1974 1974 1972-74 1974 1974 1972-4 Current Receipts 153.4 15.8 15.0 126.1 13.0 12.6 Current Expenditure 130.3 3 L 1 103,2 11.1 J1.L Current Surplus 23.1 2.3 1.7 18.9 1.9 1.5 Capital Expenditures 49.4 5.1 4.1 46.8 4.8 3.8 External Assistance (net) 11.4 1.2 1.2 9.3 1.0 1.1 1/ Population growth rate is lower than the rate of natural increase, largely because of emigration since 1969 of El Salvadoreans resident in Honduras. 2/ GNP per capita estimate at market prices, calculated by same conversion method as World Bank Atlas (1973-75 basis). 3/ Includes transfers. i Total labor force; unemployed are allocated to sector of their normal occupation. "Unallocated" consists mainly of unemployed workers seeking their first job. not available not applicable  Page 2 of 2 pages COUNTRY DATA - HONDURAS MONEY, CREDIT and PRICES 1969 1970 1971 1972 1973 1974 (Million US$ outstanding end period) Money and Quasi Money 147.0 164.4 182.2 207.8 253.8 265.9 Bank Credit to Public Sector 11.5 26.9 35.1 40.1 43.8 42.9 Bank Credit to Private Sector 149.4 173.7 184.5 206.7 253.8 290.6 (Percentages or Index Numbers) Money and Quasi Money as % of GDP 22.0 23.0 24.0 25.4 28.2 27.5 Consumer Price Index (1966 = l1o) 105.3 109.1 111.6 115.4 120.7 136.2 Annual percentage changes in: Consumer Price Index 1.3 3.6 2.3 3.4 4.6 12.8 Bank credit to Public Sector 172.6 133.9 30.5 14.2 9.2 -2.1 Bank credit to Private Sector 23.1 16.3 6.2 12.0 22.8 14.5 BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1972-74) 1972 1973 1974 US $ Mln % (Millions US $) Exports of Goods, NFS 236.4 294.5 327.5 Bananas 87.1 33.5 Imports of Goods, NFS 228.0 303.7 455.5 Coffee 39.9 15.4 Resource Gap (deficit = -) -84 -9.2 -128.0 Wood 35 2.7 Beef 18.2 7.0 Interest Payments (net) -5.6 -8.1 -14.0 All other commodities 78.9 30.4 Workers' Remittances .. .. .. Total 259.7 lOQ. o Other Factor Payments (net) -21.9 -25.1 o.6 Net Transfers 6.6 7.0 32.5 EXTERNAL DEBT, DECEMBER 31. 1974 Balance on Current Account -12.5 -35.4 -108.9 US $ Mln Direct Foreign Investment 3.1 6(. 5 -1. 2 Net MLT Borrowing 16.3 1:1.3 22.0 Public Debt, incl. guaranteed 1/ 154.0 Disbursements (20.2) (16.9) (28.0) Non-Guaranteed Private Debt Amortization (3 o,) 5.6) 6.0) Total outstanding & Disbursed Subtotal 19.4 17.8 20.8 2/ Capital Grants .. .. .. DEBT SERVICE RATIO for 1974- Other Capital (net) 1.9 1,'.6 91.3 % Other items n.i.e. ..2 .2L9 6. Increase in Reserves (+) 12.0 -_4.1 9.5 Public Debt. incl. guaranteed 3.7 Non-Guaranteed Private Debt Gross Reserves (end year) 35.2 41.8 44.4 Total outstanding & Disbursed Net Reserves (end year) 26.6 22.5 32.0 RATE OF EXCHANGE IBRD/IDA LENDING, January 31, 1976 (Million US$) Through - 1971 IBRD IDA US $ 1.00 = L 2.00 L 1.00 = US $0.50 Outstanding & Disbursed 57.1 28.7 Undisbursed 55.4 6.9 Since - 1971 Outstanding incl. Undisbursed 112.5 35.6 US $ 1.00 = L 2.00 L 1.00 = US $0.50 1/ Repayable in foreign currency. 2/ Ratio of Debt Service to Exports of Goods and Non-Factor Services. not available not applicable  PUERTO CORTES,..- ~~~~~~~~~~~~~~~~PUERTO CASTILLA9 k DE LA ~CRUZ ~ LCIA ARMENIA zLA-qE I BA ~~~~~~~~COROC ITO OANCHITO -AV MA Y 0 R 0 I ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~B -10395 ROATA. ISLAND PY~~~~~~~~~~100~(R lE IL.C,E, pJQMBRE /El. PAR ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~DE CUL~MI S A N J O S E S EA~~~~~~_ 0 L EN t t IE MANTO ~ AN FRANCISC t ovr, cooo E L PAZ ~ V Oa 5- TA nERITIO LALP0ERT-IAST ALANAM A/ATACANA DE 0 T ~ ~ ~ DI SRE -. Co~~~~~~~~~~~~~~~~~~~~~~~~~~~~~O toSNA AI .--5 ol TA LA 3I U~2--' \A PSOAAREVER~1 II-~IIR WR GUAT T UATE6~~~~~~~~~~~~~~~~~~~~~~~~~~TXIUT ~JUE- Ctot noTaoo fltn O G RIFTIA RI AT Po JETLa 0-O RXWA ~ ~ ~ ~ ~ ~ ~~~~~~~~~~~~ACLANGUA 4-OM A .FabR O odEtinnn nitrn J AE R ) ( ~ ~ ~ ~ ~ ~ L)~ od onocro tocgl. TO0 CA LA SAA. SATAM RIRIA l FONSEA (-~~'-~~ KIOMETES -- -- STERtoE 00 09 EM ~ ~ ~ ~ ~ ~ ~ ~ .-~~~~-r5j. - ROt -~~~~0 --1.- - T AY 97 kt T I 8 U AGALT ITA PARM i W~~~~~~~~~~~~~~~~~~~~~So   SUMMARY AND CONCLUSIONS Background i. With a per capita income of about $350 in 1975, Honduras is one of the poorest countries in the Western Hemisphere and continues to be pre- dominantly a land of small farmers obtaining a meager living by primitive methods. The adult literacy rate is only about 50 percent and the caloric and protein intake of most of the population is well below minimum require- ments. These deficiencies are especially severe in rural areas, which still account for about two-thirds of the population and for a larger proportion of the lower income groups. An official survey for 1967-68 shows the per capita income for the poorest (mostly rural) 40 percent of the population at about one-fifth of the national average. ii. The natural resource base is limited and often poorly utilized. The best agricultural soils include the northern coastal plain, where banana production for export has been developed by foreign companies since the late nineteenth century, the southern coastal plain and some major inland river valleys. Apart from these, the predominance of steep rugged terrain seriously limits the agricultural potential. Most rural areas are fragmented into isolated valleys. Thus, road construction is a most difficult and costly task, and significant road development started only in the middle 1950's. Nevertheless, there are ample opportunities to improve land use by bringing areas of good potential more fully into the agricultural economy and by shifting land already in use to higher value crops. The country's other major natural asset consists of the largest pine forests in Central America: thus far, their exploitation has been limited and they are being wasted owing to uncontrolled forest fires and lack of conservation. Known mineral deposits are small: they include silver, lead and zinc, which have been exploited in limited quantities, and low-grade iron ore. iii. Variations in banana output have been the main determinant of economic growth in the past. Between 1925 and 1950 real per capita income grew by only about 10 percent (0.4 percent per year). Bananas accounted for about 90 percent of exports during that period and, apart from the banana enclave development along the north coast, little changed during those years in the economy. Government attempts to stimulate the economic development of the country were first initiated in 1950. A program of highway planning and improvement was begun, a Central Bank and a National Development Bank were created, the income tax was introduced and a significant effort was started to broaden education services. Difficulties in the banana industry coupled with several years of political instability caused delays in the preparation and execution of development programs until about 1960. Some progress has been made since that time. A basic transport network connecting the main population centers was established, electric power service was expanded considerably and a significant increase in primary school enrollment took place. Lack of internal integration has limited the size of the domestic market and hampered industrial development. The creation of the Central American Common Market (CACM) in the early 1960's was an attempt to enlarge  - ii - the market for industry and was responsible in large measure for the develop- ment of some new industries, including detergents, cosmetics, metal products, canned foods and plastics. Progress was halted by the conflict with El Salvador in 1969. Even while the common market was fully operational, Honduras did not reap all of the expected benefits as, owing largely to deficient infrastructure, it was at a competitive disadvantage vis-a-vis its neighbors in attracting new investments or developing new industries. On the whole, economic growth remained low: from 1950 to 1975, real per capita income grew by 19 percent or about 0.7 percent per year. iv. Several factors help explain the continued sluggish performance of the economy. Even though the share of bananas in exports declined from 75 percent in 1950 to 40 percent in the early 1970's, with the introduction of coffee, lumber and beef exports, economic growth still depends heavily on bananas, a product with a sluggish market and poor prospects. Much of the economic expansion in the last 25 years occurred during 1963-1968 when banana exports boomed. On the other hand, the dependence on bananas and thus on the vagaries of the weather was dramatically illustrated during 1974-75 when destruction in the banana plantations resulting from hurricane Fifi caused a 5 percent drop in per capita income. Deficient credit, technical services and development programs for agriculture are other major reasons for the slow devel- opment of the economy. Roughly half of the farms account for only about 6 per- cent of the land in farms and fully two-thirds have an average size of only 2.5 hectares. In addition, about one-third of rural families are landless. Until recently, major public sector involvement in agriculture was primarily limited to credit programs. Rural incomes stagnated in recent years as value added in non-banana agriculture grew at about the rate of growth of rural popu- lation. Another major explanation for the sluggish economic growth is the continued shortage of basic infrastructure and of a well-trained labor force, despite significant efforts in these areas. Finally, and perhaps most impor- tant, economic development has been held back by the absence of a dynamic domestic entrepreneurial class. Economic entrepreneurship has been dominated by foreign investment, mainly in banana plantations, mining, banking and forestry. Domestic entrepreneurship centered on agriculture and livestock. The commercial sector was largely in the hands of first or second-generation immigrants. The lack of transport infrastructure, the isolation of the capital from the banana plantations/San Pedro Sula economic center in the north, and the dominant role of foreign enterprise may be mutually related. Because government was physically isolated from business, and because business was largely foreign, the Honduran elite may have kept longer to the tradi- tional occupations--political, military, religious--than has been the case in some other Latin American countries, where more and more of the elite went into business. The low rate of economic growth has continued in spite of a substantial investment effort. The only dynamic segment of the economy, the industrial center in the north, was isolated from the rest of the country and heavily protected, leading to over-investment in import-substitution indus- tries, hence to low capacity utilization and a high incremental capital-output ratio. Apart from this, the subsistence farming and government sectors are predominant in the economy. Government investment has been largely in slow yielding basic infrastructure investment which the country lacks and which is a precondition for growth.  A Development Strategy v. The Government which took power at the end of 1972 brought with it major changes in public development policy-making. A period of active devel- opment planning has been initiated and several measures have been taken to lay the basis for a considerably improved economic outlook over the longer term. Ongoing public investment in infrastructure is at an all-time high. Under pressure by militant peasant organizations, temporary land reform measures introduced in December 1972 were replaced in January 1975 by a comprehensive Agrarian Reform Law which aims at a much improved utilization of land and increases in incomes of the poorest peasants, through the trans- fer of unutilized or poorly utilized land from large land-owners to landless rural families. In January 1974 a forestry law was issued establishing the boundaries for private sector participation in forestry development and creat- ing a state forestry corporation (COHDEFOR). COHDEFOR was put in charge of all basic forestry and forest industry policies and activities in order to begin to exploit the country's large forest resources more rationally and to increase exports. vi. The central issue is whether the Honduran economy with its rela- tively limited productive resource base can be lifted out of its long stag- nation. The development strategy during the next few years calls for large public investments in infrastructure, in the area of export diversification through forestry development and tourism, and in agriculture to implement the land reform program. On the whole the public investment program is designed to alleviate the most significant bottlenecks to the country's long-term development process. At the same time, the size of the program will be constrained by the macro-economic and fiscal limitations discussed below and priorities will have to be set. Accelerated economic growth will require a strategy emphasizing productive investments especially in projects with good export potential. Investment in infrastructure will have to be kept within limits and social improvements will have to come more from increased efficiency than from larger allocations. The necessary large outlays for basic infrastructure investment during the next few years imply a continued high incremental capital - output ratio. Macro-economic Limitations vii. On the basis of current trends and if expansion programs, espe- cially in lumber and sugar production, are carried out as planned, exports of goods and non-factor services can be expected to grow by about 7.6 percent per year in real terms between 1975 and 1981. A considerable part of this growth reflects recovery of banana exports following the destruc- tion caused by hurricane Fifi in 1974. Under normal conditions, real export growth through 1981 would be only about 5 percent per year. Based on these export developments and feasible investment levels (around 22 percent of GDP) GDP could be expected to grow at about 4.6 percent per year, or 1.6 percent  - iv - per capita, during 1976-81. Investment will be constrained by low domestic savings, limits on the expected availability of foreign capital and by the growing burden of external debt service after 1980. The economic stagnation in 1974-75, resulting mainly from the hurricane and aggravated by a 20 per- cent deterioration in the terms of trade (which is expected to be reversed by only about 8 percent by 1981) has seriously reduced the country's savings capacity. The policy mix needed for an improved savings performance will have to include such measures as additional taxes (beyond the new tax measures already introduced in 1975), credit curtailment to non-productive activities (such as consumer loans) and higher interest rates which together with a sound investment climate could help mobilize substantial private savings. A gradual recovery of the savings ratio by the early 1980's to the level reached in pre- hurricane years will require that real consumption growth be limited to about 3.6 percent per year. viii. Capital goods imports are expected to remain large in function of the projected high investment levels, but restrained consumption growth and successful agricultural and industrial development policies should help keep the import elasticity with respect to GDP at about 1.1. Under these conditions, economic growth could be accompanied by a resource gap declining gradually from 11.7 percent of GDP in 1975 to less than 7 percent by 1981. The financing of these resource gaps will require substantial capital inflows, the bulk of which will have to be met through public borrowing. About two- thirds of the public investment expenditures proposed in this report would have to be covered by gross disbursements on foreign loans, or roughly $600 million during 1976-81. An additional $110.0 million would have to be dis- bursed during this period as credit lines for development programs and $90.0 million might become available under the Venezuelan Economic Cooperation Agree- ment. Even if Honduras obtains over 80 percent of the $800.0 million from the main international lending institutions and governments on relatively favor- able terms and the remainder from suppliers, these projected capital flows are not expected to be sufficient to fill the balance of payments gap. Additional annual capital inflows (the bulk from commercial sources) of about $45.0 million during 1976-79 and larger amounts thereafter would be needed to achieve the projected modest GDP growth and associated import levels. The public debt service ratio would rise from 5 percent in 1975 to 16 percent in 1981 and 24 percent in 1985, an undesirably high level in view of the demonstrated vulnerability of export earnings. The 4.6 percent growth target will probably require commercial bank borrowing during the next 3 to 4 years of the orders of magnitude suggested above. If during these years policy makers and entrepreneurs are very selective in their investment priorities and place emphasis on quick yielding investments, especially in projects with good export potential, economic growth can be maintained and the resource gap reduced further towards the end of the decade to keep the debt service ratio at about 15 percent of exports and maintain creditworthi- ness in the longer term.  Public Investment ix. Ongoing investment projects of the public sector, mainly in infra- structure, are expected to bring public fixed investment to about 10 percent of GDP during 1976-77 compared with 6.4 percent in 1973-75. The Government's proposed investment program, including a $400.0 million hydro-electric project at El Cajon, would raise this ratio to close to 12 percent during 1977-80. Even a public investment program which does not exceed some 10 percent of GDP as proposed in this report will probably imply a reduction in private invest- ment from about 15-16 percent of GDP in recent years to about 12 percent through 1981. It is doubtful that the economy can expand even at 4.6 percent per year if private investment falls short of that level. x. Furthermore, a public investment program of close to 12 percent of GDP would require a public savings effort implying an unrealistic increase in taxes or a reduction in essential current expenditures. Major problems facing the public sector are limited administrative capacity, owing partly to low salaries, a tendency for current spending to be kept below levels needed to complement capital spending and provide for operating and maintenance costs, and a fairly inelastic revenue structure. Even so, between 1972 and 1975 the central government tax ratio rose from 10.3 percent of GDP of 12.1 percent, owing to improvements in tax administration as well as additional taxes. New tax measures adopted during 1975 should bring the tax ratio to about 13.5 percent of GDP during 1976-78. The correction of past spending deficiencies combined with the necessary financing and complementary current spending requirements of the public investment program proposed in this report (about '0 percent of GDP) will require an increase in central government current spending of at least 6 percent per year in real terms during 1976-81 and therefore additional tax measures by 1978-79 to bring the tax ratio to a high 15 percent of GDP by 1981. xi. The outstanding feature of the proposed public investment program is the considerably increased emphasis, as compared with the past, on invest- ment in the productive sectors, which is projected to rise from 4.6 percent of the total in 1970-75 to 21 percent in 1976-81. At the same time, infra- structure investment will continue to absorb more than 50 percent of the total, while investment in the social sectors, though not growing between 1976 and 1981, is expected to be at several times its past levels in absolute terms. The main issue is the amount to be invested in power. The suggested investment program includes close to $200 million for power, an amount equal to about one-half the cost of the El Cajon hydro project (which would substi- tute for existing power from diesels as well as produce surplus energy through the 1980's). The choice open to the Government is between the $400 million El Cajon project on the one hand or a smaller investment in power (possibly on the same site as El Cajon) combined with a number of projects in areas such as feeder roads, agriculture, forestry or tourism on the other hand. The requirements of agricultural development and the need to improve the balance of payments position argue strongly for investments in the latter areas. The feasibility of alternative power investments is currently being explored by the power company in conjunction with the updating of the El Cajon feasibility study and it is expected that sufficient information for a decision will be available by the end of 1976.  - vi - Sectoral Prospects xii. A decisive effort has been started to improve agriculture's perform- ance. The technical possibilities for production increases are substantial. Government policy for agriculture has two broad objectives: (a) the improve- ment of agricultural incomes for lower income groups, and (b) the acceleration of agricultural output and export growth. Progress towards these objectives is being made. An alleviation of rural poverty will depend on continued implementation of land reform. Its success will be contingent in part on adequate financing and access to trained technicians: it is the Government's intention to concentrate its resources on the land reform., Over time the agrarian reform (now mainly for the landless) can lead to a more intensive land use and help increase production. Because growth and exports are essen- tial, and land reform can be expected to contribute only modestly to these objectives in the short term, it is important that a sound investment climate be maintained. Whereas the Government cannot provide much finance and tech- nical assistance to commercial farmers directly, it must continue to promote the provision of these services (for instance through an expansion of the existing Trust Fund in the Central Bank, with the commercial banks as opera- tives) if commercial agriculture is to grow. xiii. Forestry development prospect are encouraging. Given the country's resources, lumber and lumber products exports could become a major source of growth. The focus of attention today is the implementation of the development plan for Olancho, the largest remaining reserve of pine in Central America. In designing the strategy for Olancho, the Government had two major options: (a) to proceed immediately with a pulp and paper plant and associated solid wood product industries; (b) to expand the solid wood product industries gradually and to follow up at a later stage with a pulp and paper plant. Given the size of the investment required and the desirability of spreading the expenditures over several years and because of inexperience with large scale highly complex activities, and the need to proceed gradually in opening up the area to ensure the development of forest management and protection practices, the Government in May 1976 selected option (b). At the same time, the Government may want to consider exploiting the pine resources in the rest of the country at the maximum possible rate in order to generate the foreign exchange needed to lift the country out of its long stagnation. For this to happen and given COHDEFOR's limited administrative and technical capacity, an active involvement by the local and foreign private sector, within the confines of the forest law, would be required. xiv. Past manufacturing industry growth has been modest, in large measure because of the small size and sluggish growth of the domestic market, the in- ability to take much advantage of the CACM, and limited government promotional efforts. Several of the constraints to more rapid and efficient growth could be overcome though a new draft Treaty (1976) proposing a restructuring of the CACM (giving preferential treatment to Honduras) and a revision of fiscal incentives schemes and through the recently created National Investment Corpor- ation (CONADI) to promote and directly participate in industrial enterprises.  - vii - The expansion of industry will further require efforts to mobilize private savings. If, in addition, a major drive to promote exports to regional as well as extraregional markets is initiated, the growth potential of the industrial sector is substantial. xv. Whereas substantial improvements in living conditions in Honduras will be conditioned by an accelerated rate of economic growth, the severity of the current situation requires a minimum improvement in social services to help increase labor productivity. Increased spending in the social sectors will be constrained by the demands for public funds from other sectors and much emphasis will have to be placed on more efficient spending by making the contents and standards of services offered more appropriate to the needs of target groups. At the same time, the requirements of agricul- tural and forestry development, especially, call for a substantial expansion of training programs in those sectors. In addition, a reorientation of many social sector programs towards the rural areas is desirable to complement other government development programs. Conclusion xvi. Honduras' rate of economic growth has been low in spite of a substantial investment effort. The country is still in a stage of devel- opment where large public investments in infrastructure are required. These ate preconditions--necessary but not sufficient--for further efficient output- generating investments. The overall return on capital investment has been low, not only because of the need to make substantial outlays for slow yield- ing basic infrastructure, but also because some productive investments have either not taken place or have had low yields. The adoption of new methods of production in sectors such as agriculture or forestry which could yield high returns on investment did not materialize for a number of reasons, including government policies and the lack of skilled labor and a strong entrepreneurial class. On the other hand, government policies subsidizing investment in industry did stimulate substantial capital outlays but led to idle capacity and hence low returns. Because current government policies have become much more development-oriented and because the supply of skilled labor and entrepreneurs is increasing, future investment should yield better returns than in the past and the country's growth performance should gradually improve. However, the continued need for large infrastructure outlays during the next few years is expected to keep the return on the economy's overall investment low. Moreover, as absorptive capacity improves, the mobilization of domestic and foreign savings is likely to become a much more important condition for growth than in the past. xvii. The Government of Honduras is trying to lay the basis for the long-overdue acceleration of economic growth. The public investment and expenditures program proposed in this report and based on government plans is consistent with the resources which the public sector can realistically mobilize. Within these limits, the growth objective requires that priority be given to productive investments. A major illustration is provided by the issue of the amount to be invested in power. The construction of the  - viii - large $400 million El Cajon hydro-electric project would involve cutting some of the major programs the country is counting on to carry out the agrarian reform or to improve the balance-of-payments outlook and stimulate growth. The success of the public investment program will depend largely on whether tax revenues can be increased and the public sector administration improved, and on the pace of the agrarian reform program. A major effort will be required to improve the efficiency of public spending in education to upgrade the quality of the labor force without substantially increased expenditure. Finally, these efforts are unlikely to succeed unless new exports besides forestry products are generated. If, in addition to public investment in export-oriented activities, a major effort is made to direct and stimulate private investment in foreign exchange earning projects, economic growth might be accelerated and the country be expected to remain creditworthy over the longer term.  CHAPTER I: BACKGROUND AND MAJOR ISSUES 1. In the 150 years since independence from Spain, Honduras has made slow economic progress, with per capita income reaching only $350 by 1975. It is one of the poorest countries in the Western Hemisphere and cointinues to be predominantly a land of small farmers obtaining a meager living by primitive methods. The adult literacy rate is only about 50 percent and the average national caloric and protein intake of most of the population is well below minimum requirements. 2. The natural resource base is limited and often poorly utilized. The best agricultural soils include the northern coastal plain, where banana production for export has been developed by foreign companies since the late nineteenth century, the southern coastal plain and some major inland river valleys. Apart from these, the predominance of steep rugged terrain seri- ously limits the agricultural potential and makes transportation difficult and costly. Nevertheless, there are ample opportunities to improve land use by bringing areas of good potential more fully into the agricultural economy and by shifting land already in use to higher value crops. The country's other major natural asset consists of the largest pine forests in Central America: thus far, their exploitation has been limited and they are being wasted owing to uncontrolled forest fires and lack of conservation. Known mineral deposits are small: they include silver, lead and zinc, which have been exploited in limited quantities, and low-grade iron ore. 3. Until around 1900, when commercial exploitation of bananas began, the principal export was silver mined in the vicinity of Tegucigalpa, the capital city. Since then, bananas have become the leading export. From 1925 until World War II bananas accounted for about 90 percent 'of exports. Apart from the banana enclave development along the north coast which led to the growth of San Pedro Sula, the country's main industrial and commercial city, little changed during those years in the economy. Estimates of GDP and population growth suggest that real per capita income only grew by 10 percent, or about 0.4 percent per year between 1925 and 1950. Honduran governments did little to stimulate the economic development of the country. The moun- tainous terrain and the consequent relative isolation of population pockets contributed to the growth of regional rivalries: political instability was the rule and governments were more concerned with political and military problems than with the economy. 1/ Thus, for example, in the mid-fifties Honduras had only 24 miles of paved roads and public electric energy pro- duction per capita was only one-third the level in Nicaragua and Guatemala, one-fifth of El Salvador's and one-twentieth of Costa Rica's. 1/ From 1932 to 1949, General Tiburcio Carias Andino did bring relative political stability to the country but, as a strong defender of the status quo, failed to generate any significant material progress.  - 2 - 4. The first serious government attempts to activate the economy were initiated in 1950. A program of highway planning and improvement was begun, a Central Bank and a National Development Bank were created, the income tax was introduced and a significant effort was started to broaden education services. At the same time, demands for social change were growing, culminating in the banana workers' strike in 1954 which centered on the United Fruit Company. Though the company had long enjoyed the support of the ruling classes, the Government refused to break the strike, which lasted for more than three months. Only after the company had lost some $20.0 million was an agreement reached including substantial concessions to the workers in the form of wage boosts, housing programs and medical facili- ties. This strike, with results unequaled in Central America, not only gave labor the right to organize but also marked the beginning of socio-economic reform and contributed to the emergence of peasant organizations which most recently (see paragraph 8) led to the initiation of a comprehensive agrarian reform program. 1/ 5. The difficulties in the banana industry coupled with several years of political instability caused delays in the preparation and execution of development programs until about 1960. Some progress has been made since that time. Major trunk roads now link the western valleys, the north coast, Tegucigalpa, the south and neighboring countries. The mountainous topography of the country has made expansion of the road network slow and costly and substantial deficiencies remain to be overcome, especially in secondary and feeder roads, before the economy is integrated. The modernization of Puerto Cortes, the country's main port, was another major achievement in transport. Apart from transport, the bulk of public fixed investment, thus far, has been in power, where significant improvements were made: the National Power Company's installed generating capacity more than tripled since 1965. Lack of internal integration has limited the size of the domestic market and hampered industrial development. The creation of the Central American Common Market (CACM) in the early 1960's was an attempt to enlarge the market for industry and was responsible in large measure for the development of some new industries, including detergents, cosmetics, metal products, canned foods and plastics. Progress was halted by the conflict with El Salvador in 1969. Even while the common market was fully operational, Honduras did not reap all of the expected benefits as, owing largely to deficient infrastructure, it was at a competitive disadvantage vis-a-vis its neighbors in attracting new investments or developing new industries. The Government has spent substan- tial and increasing amounts on education but with limited results, as the low productivity of the labor force remains a major obstacle to growth; the adult literacy rate, which rose from 35 percent in 1950 to 47 percent in 1961 has changed little during the past fifteen years. 1/ The Villeda Morales administration (1958-1963) provided the first attempts at socio-economic reform in Honduras. In 1961, an agrarian reform law was passed and an Agrarian Reform Institute was created, but the program was deemphasized during the subsequent administration.  - 3 - 6. From 1950 to 1975 real GDP per capita grew by 19 percent or about 0.7 percent per year. The continued lack of basic infrastructure and the low efficiency of educational efforts explain in part the sluggish perform- ance of the Honduran economy during this period. Other major reasons in- clude deficient credit, technical services and development programs for agriculture and the neglect of forest development. Even though the share of bananas in exports has declined from 75 percent in 1950 to 40 percent in the early 1970's, as the structure of production and exports has become more diversified, 1/ economic growth has continued to depend heavily on bananas. Between 1950 and 1963 when strikes, the Panama disease and wind damage led to long-run stagnation in banana output, real GDP growth per capita was barely 0.2 percent per year. The introduction in the mid-sixties of bananas less subject to wind damage and resistant to the Panama disease restored the comparative advantage lost earlier to Ecuador: the volume of banana exports rose by about 150 percent between 1963 and 1968 and real per capita GDP grew by 3.5 percent annually. Since 1968, banana production and exports have stagnated again (declining sharply in 1974 and especially in 1975 as a result of hurricane Fifi); real per capita GDP grew by 0.2 percent per year between 1968 and 1974, and declined by 3.3 percent in 1975. 7. The continued low level of economic development, insufficient infrastructure, deficiencies in labor productivity and in public administ- ration, and modest prospects for traditional exports put severe limits on the degree to which economic growth can be accelerated. On the other hand, several developments in public policy-making during the last three years offer grounds for optimism. Since December 1972, economic development policies have been much more dynamic than in the past. 8. A period of active development planning has been initiated and several measures have been taken to lessen the major obstacles to economic growth. Much emphasis is being placed on further infrastructure development. Most important, a start has been made to improve the exploitation of the country's major resources, land and forests. Under pressure by militant peasant organizations temporary land reform measures introduced in December 1972 were replaced in January 1975 by a comprehensive Agrarian Reform Law which aims at a much improved utilization of land. At the same time the law seeks to increase the incomes of the poorest peasants, mainly through the transfer of unutilized or poorly utilized land from large land-owners to landless rural families. A state forest corporation (COHDEFOR) was created in January 1974 and was put in charge of all basic forestry and forest industry policies and activities in order to begin to exploit the country's large forest resources more rationally and to increase exports. Finally, a preliminary medium-term development plan calls for substantial public expenditures in infrastructure, agriculture and forestry. While the country faces some difficult years ahead, these efforts could lead to the long overdue acceleration of economic growth. This report analyzes the conditions under which these efforts are most likely to succeed. 1/ Coffee and lumber became important export items shortly after World War II; beef exports have grown rapidly since 1970.  CHAPTER II: SECTORAL ISSUES AND POLICIES A. Agriculture 1/ Background 9. Honduras has remained predominantly an agricultural economy. Agri- culture (including forestry) still accounted for a third of value added during the early seventies--more than manufacturing, construction and commerce com- bined--and for nearly two-thirds of employment: agricultural products made up about 80 percent of exports. The slow development of the economy has been a reflection of slow agricultural growth, the major exception being the period 1963-68 when agricultural value added grew at 8.2 percent per year in real terms (see paragraph 6 above) and the economy grew at 6.3 percent. Crops account for some 65 percent of value added in agriculture; livestock and poultry for 23 percent; forestry for 11 percent; and fisheries for the remainder. In 1970, major crops included bananas (27 percent of value added in agriculture), coffee (11 percent), corn (10 percent) and beans (4 percent). Since 1950 the production of bananas and coffee has grown considerably faster than that of corn, beans and sorghum, the staple food of the rural population. Corn and beans production did expand at a satisfactory rate through the late sixties, when Honduras was able to sell surplus production to El Salvador, but has declined since. Periodic droughts, floods and hurricanes have led to large fluctuations in agricultural output. The substantial hurricane damage to the banana plantations in September 1974, for instance, reduced banana export volumes in 1975 to about half the level of previous years. Then, an emergency basic grains program designed to offset the consequences of the hurricane had only limited success because of a drought. 10. Rural incomes stagnated in recent years: value added in total crops production grew by 5.3 percent per year between the early 1960's and the early 1970's; value added in banana production grew by 11.6 percent per year, but other crops, mainly staple food, grew only by 1.8 percent per year, about the rate of growth of the rural population. 11. Crop yields are generally low. Improved seed is not widely used, fertilization is minimal, and pests and diseases take a heavy toll. The major exception is bananas: produced in the Sula and Aguan Valleys in the northern region, about 20,000 hectares are under cultivation. Some 65 percent of bananas are produced by two foreign companies. Corn is the small farmer's basic crop: used mainly for food, corn is grown in most parts of the country and far exceeds other crops in acreage. Beans, a major source of protein for lower income persons, are often interplanted or rotated with corn. Coffee is 1/ The IBRD/IDB/AID Agricultural/Rural Sector Survey of Honduras (Yellow Cover Draft completed in December 1975, hereinafter referred to as Sector Survey Report) may be consulted as a supplement to the following section.  - 5 - Table 1: OUTPUT OF SELECT AGRICULTURAL PRODUCTS (Annual averages for crop years, in 1000 metric tons) Export Crops Basic Grains Year Bananas Coffee Corn Beans Sorghum 1951-53 520 15 188 22 48 1961-63 650 25 269 44 49 1967-69 1316 36 344 60 45 1970-72 1494 39 278 37 41 1973-75 1274 5