Dominican Republic - Economic memorandum

o- Ls0/ Report No. 3446DO Economic Memorandum on the Dominican Republic 11 '- May 15, 1981 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.  Exchange Rate Official Rate: Dominican Peso RD$1.00 = US$1.00 Fiscal Year January 1 - December 31 Abbreviations BC = Central Bank BAGRICOLA = Agricultural Bank CAASD = Water Supply and Sewerage Corporation CDE = Dominican Electric Corporation CEA = State Sugar Council CFI = Industrial Development Corporation CONAPOFA = National Council of Population and Family CORDE = State Enterprises Corporation DNP = National Parks Directorate IAD= Agrarian Reform Institute IDECOOP Cooperative Development Institute IDSS = Dominican Social Security Institute INAPA = National Water Supply and Sewerage Institute INDRHI = National Water Resources Institute INESPRE = National Price Stabilization Institute INVI = National Institute of Housing ODC = Community Development Office ONAPLAN = National Planning Office PR = Office of the President of the Republic SB = Superintendence of Banks SEA - Secretariat of State for Agriculture SEEPAC = Secretariat of State for Education, Art and Culture SEF = Secretariat of State for Finances SEIC = Secretariat of State for Industry and Commerce SNEM = National Service for Malaria Erradication SEOPC = Secretariat of State for Public Works SESPAS = Secretariat of State for Public Health and Welfare SETI = Secretariat of State for Tourism and Information SS = Superintendence of Insurance ZOODOM = National Zoological Park FIDE = Economic Development Investment Fund GDP Gross Domestic Product  FOR OFFICIAL USE ONLY ECONOMIC MEMORANDUM ON THE DOMINICAN REPUBLIC Table of Contents Page No. MAP . ....................................................... IBRD 12711RI SUMMARY AND CONCLUSIONS ......................... I. Introduction ....... .............................1 II. Economic Activity in 1979-80 .1 A. Gross Domestic Product and Sectoral Activity 1 B. Aggregate Expenditure ...................... 4 C. The Balance of Payments and External Debt .. 4 D. Public External Indebtedness .... ........... 5 E. The Fiscal Situation . . ...................... 6 F. Money and Monetary Policy .... .............. 7 G. Prices ..................................... 8 III. Human Resources ................................. 9 IV. The Development Program ......................... 13 A. The Strategy for the Eighties .... .......... 13 B. Economic Framework for 1981-83 .... ......... 18 V, The Investment Plan and Ito Financing I I I I I I ..I.I.I.I 21 A. Public Sector Financing Requirements ....... 22 ANNREg--Tnvestment Program, 1091-83 ...................... 26-4b Economic Indicators Data Sheet .... ............... 47 Summary of Balance of Payments .......... .... ...... 48 This report is based on the work of an economic mission which visited the Dominican Republic between March 7-27, 1981, composed of Messrs. Paul Meo, Dominique Hachette and GladstQne Bonnick, This document has a restricted distribution and may be used by recipicnts only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   co a ' 2~~~~~~~~~~~~~~~~~ - dU t -, - R 0 U0 0 .''',0j =o -a r,, a, - SfD (i - o L-~- l ;; 0 E 0_; 3 v X px, ','~~~.. ..... . 0~~~~~~~~~~~0 r - J 2 _ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 <S >tAa D _N Sv t2Xr t; Q _wi_ W~~~~~Zr -Ul~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 Im 14~~~~~~~~~~~~~~~0 "~~~~~~~~~~~~~~~~~~~~~~~~ <t0v0o =000, C S _ L < =g t ( O-~~~~>a~- f -W T<E X~~~~~~~I S I ==Xt .% i J: ti:: ;i', < : . i. 1=S= = E b J f i *' _ s = 1= F CS' 0 i =2 = = v . = t = . z~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 FE t. .2ni:lll,iV8+ ow "' 1< iV!S w,~~~~~~~~~~~~~~~~~~~ 0   ECONOMIC MEMORANDUM ON THE DOMINICAN REPUBLIC SUMMARY AND CONCLUSIONS 1. The Dominican Republic's rapid recovery from the hurricane damage suffered in 1979 was hampered by a poor sugarcane crop and the shutdown of ferro-nickel production during part of 1980. Notwithstanding these setbacks, the economy, aided by substantial external assistance, a successful emergency agricultural plan and favorable export prices, achieved GDP growth of 5.4 percent in 1980, compared with 4.8 percent in 1979. With the fall in exports of sugar, ferronickel, coffee and cocoa, and with a large increase in imports reflecting in part the large increase in petroleum prices at the end of 1979, the current account of the balance of payments deteriorated substantially in 1980, more than doubling the USS341 million deficit of the preceding year. Capital inflows were inadequate to cover the enlarged deficit and net reserves fell by USS117.8 million. Although the poor performance of exports was due to temporary factors and significant improvement in earnings expected in 1981 could reduce the current account deficit substantially, it is not clear that capital inflows will be adequate to prevent a further reserve loss of about USS138 million this year, or even higher if arrangements cannot be put in place to permit the country to benefit fully from the Mexican portion of the oil credits under the San Jose agreement. 2. A significant problem in 1980 was the fiscal constraint arising from the failure of the Congress to approve tax legislation to raise resources in support of the 1980 budget. By May the budgetted expenditures had to be made subject to availability of cash from revenue collections and loans. Revenue collections in the second half of the year benefitted from the growth of the economy, higher export prices, and transfers from the Government's recently acquired Rosario Dominicana gold/silver mine. However, current expenditures had to be severely constrained and capital investments were slowed down because of inadequate counterpart financing. The fiscal problem was relieved somewhat by the decision to pass on recent oil price increases to consumers and to adJust electricity rates in respect of higher fuel costs. These efforts as a whole were successful in procuring an improvement in Central Government savings from 1.1 percent of GDP in 1979 to 2.2 percent in 1980. 3. In the face of uncertainty over Congressional approval of fiscal and other economic policies the management of the economy had to rely on monetary measures. These largely involved tightening of credit by imposing reserve requirements on deposits for purchase of foreign exchange, and the transfer of capital goods and some intermediate goods to the list of imports not eligible to be financed by foreign exchange from official sources. The operation of an export incentive scheme characterized by an exchange rate incentive and tax credit certificates in some cases is now underway but few tax credit applications have been approved. 4. The country's social situation has improved slightly. A recent survey suggests that the formerly chronic 24 percent unemployment rate in Santo Domingo may have fallen to around 20 percent. This may have been  - ii - att:4butabl h cc icoalc growth, rising construction activity and a significant increase in public sector employment since 1978. The improvements in health, education and nutrition are less well documented. The Government has been instituting new Drograms for better delivery of social services with greater emphasis on preverntive health programs, but recent labor disputes invclving education and health Dersonnel have diverted attention from the main thrust of Government's efforts and probably diluted their effectiveness. However, the crucial work of putting in place an appropriate administrative apparatus in health is well underway. In education, progress in this direction is less well marked because of frequent changes in leadership. It remains true that more emphasis is needed on improving coverage and quality of primary education; while upper secondary and technical education must become more oriented to meeting manpower requirements. 5. During 1980 the Government implemented an export incentives law, improved tax collections through better administration, carried out preparatory work in simplifying import tariffs, adjusted gasoline prices and electricity rates and introduced motorbuses in Santo Domingo. On the negative side, in addition to the non-passage of tax legislation, formal interest rate structures continue the unrealistic levels of the past except where marginal changes in lending rates have been agreed by FIDE and the Agricultural Bank in onlending funds from international institutions. The regulations o0 Law 861 to make the environment for foreign investors less ambiguous remain unpromulgated, and the regulations to remove the distortions of Law 2993 (on industrial incentives) are not yet finalized. Not surprisingly, measures requiring or likely to require Congressional approval have not fared well. The monetarv authorities have acted to neutralize the inflationary effects of fiscal policy and have not sought to throttle interest rate adjustments being made in the free market. 6. The three-year public investment program for 1981-83 has been presented within a coherent statement of development strategy for 1980--1990. Prime emphasis is on full multipurpose exploitation of water resources to produce electricity in substitution for petroleum based power and to irrigate land for agricultural purposes. With rural electrification and greatet land productivity, higher agricultural outputs are expected to provide exparded inputs for agro-industrv and higher rural incomes will expand the market for import substitution industries. The strategy is essentially inward looking, an orientation which is based on the assumption of greater protec- tionism by developed countries and continuing world inflation. The strategy does not adequately address the problem of generating jobs for the rising urban labor force nor the problem of attracting increasing amounts of capital in a situation of declining flows from developed to developing countries. Additionally, there are sDecific sectoral issues to be resolved in putting together a package of policies complementary to the investment program. 7. Fixed investment of the public sector during 1981-83 has been projected at USS2,037.2 million, of which just over US$312 million has not been identified as to project content. The investment program of identified projects amounts to U'S$1,724 million during 1981-83 with the dominant snares going to agriculture including irrigation, energy, transport and communications.  - li1. - The financing of the identified program is projected to come from the national budget (about US$785 million), external financing (nearly US$835 million), and the remaining US$104 million from unidentified internal funds. Adding nearly US$300 million for amortization of external debt to the identified program of US$1,724 million creates a public financing picture that is not outside the realm of feasibility if full use can be made of the Venezuela/ Mexico oil credits. However there are outstanding difficulties to be resolved in permitting drawdown of the Mexican credits. The projected real investment of US$2037 million plus US$300 million for amortization is likely to increase the financing gap to US$600 million since the amount of Central Government savings projected at US$1,156 million is considered optimistic and about US$350 million beyond the feasible. 8. With a recent 5.4 percent growth and outlook for growth between 5 and 6 percent in the next few years, as well as the low level of public external debt relative to GDP (some 18 percent) and low debt service burden, the Dominican Republic is creditworthy provided additional adjustment policies to reduce the increase in imports are not unduly delayed, and the risk of a rapid rise in the current account deficit in the balance of payments avoided. Also the fisc needs to be put in a position to capture more resources to meet the rising demand for higher quality government services and accommo- date more easily the growth in debt service. The root of concern is that with elections only a year away, it may be difficult to gain consensus on and prompt implementation of measures containing a strong element of restraint. In the meantime the perception abroad of Dominican creditworthiness could be enhanced by better administrative arrangements to ensure prompt payment of debt obligations.   I. INTRODUCTION l. This Economic Memorandum has been prepared for use of members of the Dominican Republic Subgroup of the Caribbean Group for Economic Develop- ment and Cooperation. Economic Memoranda, Report No. 2492-DO and Report No. 3009-DO were presented at the 1979 and 1980 meetings respectively. This report complements the Public Investment Plan: 1981-83, prepared by the Government of the Dominican Republic for presentation to the subgroup. II. ECONOMIC ACTIVITY IN 1979-80 A. Gross Domestic Product and Sectoral Activity 2. Growth in GDP has been estimated at 5.4 percent for 1980, and at 4.8 percent for 1979 according to revised figures. The expected strong recovery from the effects of the hurricanes suffered set-backs from the poor performance of sugar and ferronickel. Sugar output fell by 15 percent in 1980 due to the combined effects of rust and smut diseases, flood damage to fields and access roads during the previous year, and delayed rehabilitation of factories. Production of molasses and furfural also declined. Gross Domestic Product from sugar manufacturing fell by 13.3 percent relative to 1979, while the rest of manufacturing grew at 8.1 percent. Ferronickel production fell by one-third as the Falconbridge operations were closed during most of the second half of 1980 because of weak demand for nickel on international markets. Coupled with reductions in silver and bauxite production, the fall in ferronickel largely explains the reversal suffered by the mining sector in 1980, declining by 14.5 percent in contrast to growth of 28.2 per- cent in 1979. A 5 percent increase in gold production helped to avoid an even greater decline in 1980. Table 1: KEY ECONOMIC INDICATORS (percent) 1975 1976 1977 1978 1979 1980 a/ I981 b/ Real GDP Growth 5.2 6.7 5.0 2.2 4.8 5.4 c/ 5.5 Current Account Balance-of- payments Deficit/GDP 2.1 6.1 5.8 6.8 6.2 10.7 7.3 Central Government Savings/GDP 10.0 6.8 6.1 2.8 1.1 2.2 2.9 Central Government Surplus or Deficit/GDP 1.2 0.4 -0.3 -2.4 -6.3 -2.9 -2.5 a! Preliminary b/ Projected cI Central Bank estimate of 5.6 percent, adjusted by IBRD Mission to take account of revised estimate of fall in sugar. Source: Central Bank, ONAPLAN, and IBRD Mission estimates.  3. Services were the major contributor to GDP growtb in 1980. The group accounted for 72 percent of total GDP growth; with other services (21 percent), commerce (16 percent), and Government (15 percent) being the outstanding sources. Other services grew by 13.4 percent, partly reflecting the behavior of tourism which recovered strongly from the decline in 1979 ocasioned by the closure of hotels during the last quarter in order to repair facilities damaged by hurricanes. The growth of commerce by 5.4 percent was consistent with a resurgence in personal consumption and the increase in imports. The Govern- ment sector was again an important source of GDP growth as it grew by just under 10 percent in 1980, compared with 18 percent in 1979 when it was the most important contributor to overall CDP growth. 4. Despite the decline in the manufacture of sugar and most of its bv-products, the industrial sectors--manufacturing, construction, and elec- tricity performed well. Manufacturing grew by only 4.4 percent, but by dint of its size was nearly on par with commerce in its contribution to overall growth. Construction continued to be brisk, with growth of 7.5 percent in 1980 compared with 5.4 in 1979. The recent growth associated with significant additions to the stock of housing in Santo Domingo as well as replacement and upgrading of housing in the hurricane-devastated areas of the southwest, and public investment in roads and other infrastructure, continues the construction sector's unbroken growth trend of the seventies. Flectricity growth, measured in terms of increase in availability for sale, was over 12 percent in 1980 compared with under 2 percent in 1979, and reflects significant improvement in sectoral performance. The increase of over 15 percent in generation capacity in 1980 derived from the repair of hurricane damage to capacity in 1979 as well as from the addition of new thermal, diesel and gas units. Table 2: SFCTORAL ORIGINS OF GDP GROWTH (Percent) 1977 1978 1979 1980 Agriculture 6.0 36.3 3.9 14.2 Mining -3.0 -51.7 25.5 -14.4 Manufacturing 21.5 -5.6 19.4 15.0 Construction 12.7 10.5 7.5 9.3 Commerce 13.0 20.9 11.1 16.5 Transportation 15.8 7.6 4.5 8.3 Communications 1.5 5.2 0.6 0.9 Flectricity 6.9 6.5 0.6 3.6 Financial Institutions 4.3 5.4 1.2 2.4 Ownership of Property 10.7 13.3 7.0 7.7 Covernment 1.1 16.6 28.4 15.2 Other Services 9.5 35.0 -9.8 21.3 Total GDP 100.0 100.0 100.0 100.0 Source: Central Bank, ONAPLAN, IBPD Mission estimates.  5. The agriculture and mining sectors both rank behind services and industry in terms of contribution to growth in 1980. The growth of agriculture by 4.5 percent was a significant improvement over the 1 percent growth in 1979 and just adequate to offset the decline in the GDP from mining during 1980. The livestock sub-sector had growth in value added of 7.5 percent mainly through expansion in production of poultry and cattle in 1980, which contrasted sharply with the 3 percent increase in 1979 when African fever struck swine herds and hurricane and floods wiped out poultry flocks. Crop agriculture in 1480, notwithstanding declines in sugar-cane, coffee, cocoa, and plantains grew by 2.8 percent and more than recovered the 2 percent decline suffered in 1979. The emergency agriculture production plan put into effect shortly after the hurricanes aimed at rehabiliting fields and increasing the area under crops of short growing cycle, was successful in increasing production of vegetables, legumes and tubers. Production of rice, peanuts and fruit also increased. Production of cocoa and coffee, both seriously affected by the storms of 1979 and now subjects of a rehabilitation program, will probably require some two or three years for full recovery. Table 3: SECTORAL OROWTH RATES (Percent) Preliminary Projected 1977 1978 1979 1980 1981 Agriculture a/ 1.7 4.6 1.0 4.5 5.3 ;lining -2.5 -20.0 28.2 -14.5 10.0 Manufacturing 5.7 -0.6 5.1 4.4 5.4 Construction 10.1 3.4 5.4 7.5 8.0 Commerce 3.8 2.7 3.2 5.4 5.0 Transportation 11.5 2.2 3.0 6.2 6.5 Communications 7.5 11.2 2.8 4.7 5.2 Electricity 27.2 9.2 1.9 12.1 12.0 Financial Institutions 8.9 4.7 2.2 5.2 5.0 Ownership of Property 8.3 4.4 5.0 6.1 5.9 Government 0.7 4.8 17.8 9.5 4.5 Other Services 5.4 8.5 -5.0 13.4 1.8 Total CT)P 5.0 2.2 4.8 5.4 5.5 a/ Includes livestock, forestry and fishing. Source: Central Bank, ONAPLAN, IBRD Mission estimates.  -4- B. Aggregate Fxpenditure 6. UInlike in 1079 when real personal consumption fell by 1.4 percent, in 198O these expenditures increased by Y.3 percent according to preliminary estimates. Thus the decline in per capita real consumption over the preceding two years has been reversed. Meanwhile, Government consumption growth slowed to 6.2 percent in 1980 from the high 23 percent realised in 1979 reflecting the effect of fiscal constraints on the growth of the current budget after May 1980. Even more dramatic than the behavior of consumption was the spurt in growth in gross domestic investment estimated at 19.9 percent in 1980, nearly tripling the 7 percent growth in 1979. 1/ This was due to the behavicr of gross fixed investment associated both with post-hurricane reconstruction efforts in infrastructure and housing as well as increments in the stock of housing, factory space, plant and machinery. 7. The volume of exports of goods and non-factor services suffered a distinct reversal as a result of the decline in sugar, coffee, cocoa and ferronickel. The 25.5 percent growth in 1979 was followed by a decline of 14 percent in 1980. With the increased growth of consumption and investment and with the decline in exports reflecting a reduction in exportable output rather than a diversion to domestic uses, imports in 1980 grew by 6.6 percent compared with 13.6 percent in 1979. The slower growth of imports partly reflects a slight reduction in petroleum imports due to the shut down of ferronickel production at mid 1980, and partly the higher cost of imports due to continued inflation in source countries, as well as the decision to increase the list of imports ineligible for foreign exchange at the official rate. C. The Balance of Pavnents and External Debt 8. The decline in export volume in 1980 was more than offset by a rise in export prices such that earnings rose by over 10 percent. The major contributors to the improvement in prices came from gold with an increase of 104 percent, sugar with 86 percent and ferronickel with 14 percent. Coffee, cocoa and bauxite prices suffered declines ranging from 28 percent to 12 percent, but the impact on export earnings was limited by the smallness of their combined weight in total exports. The rise in the price level of imports was slightly less than that for exports, and there was an improve- ment of nearly 10 percent in the terms of trade. Nevertheless, the increase in prices combined with the growth in the quantity of imports gave rise to an increase of 31 percent in value of imports f.o.b. and the deficit in merchandise trade more than doubled. The increase of 41 percent in the value of petroleum imports --due mostly to higher oil prices-- accounted for 38 percent o