Consultative Group for the Reconstruction and Transformation of Central America

"reconstruction must not be at the expense of transformation"

Central America After Hurricane Mitch
The Challenge of Turning a Disaster into an Opportunity

Honduras

A. Summary

For Honduras, Hurricane Mitch constituted an unprecedented catastrophe due to the devastation caused, the human and social toll and the losses and damages to its infrastructure and productive system. Nearly one third of the highway network was affected, with the consequent isolation of cities and productive zones; thousands of dwellings were destroyed leaving thousands of families homeless, many of them unemployed and with no source of income; there was likewise a negative impact on future production and exports, economic growth, employment and revenues. According to the National Emergency Cabinet, the hurricane caused the death of 5,657 people (without counting the 8,058 missing), injuring another 12, 272 and initially affecting 1.5 million people (of the 6.2 million total population), but with the mitigation of the emergency, this last figure was reduced to 700,000, of which 285,000 remained in provisional shelters until the end of November. The preceding clearly portrays the human and social tragedy that Hurricane Mitch represented for Honduras. With respect to material losses, ECLAC estimated them at around US$3.8 billion, of which US$2.0 billion affected the social and productive capital of the country and the remaining US$1.8 billion on production.

The economic program of the Government in 1998 had been largely successfull despite the effect on food supplies from the El Niño during the first half of the year. Growth of the GDP was registering (until October) a rate similar to that of the preceding year; inflation, despite the increase in the sales tax and El Niño, maintained a steady rate below 15% annually; fiscal accounts and the balance of payments were performing satisfactorily, the latter resulting in continued strengthening of international reserves. At the moment of the disaster, the macroeconomic results and outlook were so auspicious that the government and the IMF were close to signing an ESAF program. Preliminary estimates indicate that GDP growth for all of 1998 was only 3%, compared to the 5.1% recorded in 1997 and the 5% that had been estimated before Hurricane Mitch. The prolongation of the hurricane effects on production, particularly agriculture, is expected to result in a 2% decrease in GDP for 1999.

The Administration is likely to collect extraordinary revenues from the privatization of Hondutel and should be able to release resources as the programs for debt relief are carried out. This could allow the Administration to finance the expenditures and extraordinary investment that the reconstruction effort will require, while maintaining the fiscal equilibrium that is crucial for macroeconomic stability. The first estimates point towards a financing gap of the current account of the balance of payments at more than US$400 million and a drop in GDP of 2%, added to the decrease in fiscal revenues and investment expenditures increases, all of which are expected to generate a fiscal deficit of 8.4% of GDP.

With significant damage to the economic and social infrastructure, a multiannual reconstruction program that will prioritize over time the investment needs will require the approval of reconstruction programs and projects in amounts that can only be achieved through a decisive commitment from the international community of donors and multilateral development agencies.

The program agreed with the Government of Honduras for future loans from IDB emphasizes on reconstruction and transformation. A loan program is actively prepared which, in addition to the already approved Emergency for Water and Highway Infrastructure operation, includes one for Water and Sanitation, another for the Housing Sector, and one for Protection of Social Expenditures. Other projects under consideration include Highway Rehabilitation, and Legislative and Judicial Powers modernization.

B. Country Analysis

B.1 Recent economic situation
During 1998, the GDP of Honduras grew by 3%, as compared to 5.1% recorded in 1997 and 5% forecasted before Hurricane Mitch hit Honduras at the end of October. ECLAC estimated that the hurricane produced direct and indirect losses of US$3.8 billion and that its effect on the economy will be felt with greater intensity in 1999. / Agricultural production, measured at constant prices, fell by 7%, while the sectors that showed the most dynamism were those of construction, which grew by 17%, and financial services whose rate of growth was at 10%. The maquiladora industry continued to support the growth of the economy, generating more than US$400 million in value added and increasing employment with the creation of 9,200 new jobs.


Graph 1

The international price of coffee led to an increase in the value of its exports turning this commodity into the main export, displacing bananas. Nevertheless, the dynamism shown by other productive sectors was unable to compensate for the strong drop in agricultural activity, whose participation in production continues to be the most important in Honduras.

During 1998, direct foreign investment reached US$100 million, a level lower than that of the preceding year. As a result of the damage produced by Hurricane Mitch, levels of unemployment have risen, primarily in labor intense agricultural activities such as banana and melon. It is expected that the reconstruction programs initiated in 1999 will contribute to a reduction in unemployment during the time it takes for economic activity to recover to historical levels.

Foreign trade in 1998 shows total exports growth of 11% while total imports grew at 12%, growth rates similar to those recorded the preceding year. The balance on current account presents a deficit of 3% of GDP, compensated for by net inflows of capital of US$312 million, including foreign debt relief received during the year of about US$80 million. These results allowed for an increase in international reserves of US$234 million, bringing the total amount to US$650 million. The rate of debt service to exports reached 17%.


Graph 2

Banking credit to the private sector continued to grow strongly in real terms in 1998 and increased by 32% (versus the 21% recorded the preceding year), taking private credit up to a 28% level of GDP at current 1998 prices. Of the total credit granted, credits in convertible currency represented 27%.

Deposits in the commercial banking system grew by 25%. Of the total deposits, 27% represent accounts in foreign currency, the growth of which in 1998 was 18%, less than the 37% growth observed in 1997, suggesting a slowdown of the dollarization of deposits. The restrictive monetary policy was unsuccessful in reducing the annual inflation index, which in December reached 15.7%, reflecting the impact of three singular events: the extraordinary drought that caused a scarcity of food in the second quarter, the increase in sales taxes from 7 to 12% in July, and the impact of Hurricane Mitch on the expectations of the economic agents during the last months of the year.

As a result of Hurricane Mitch, the Administration confronted a deterioration of the fiscal situation in 1998. The growth of current revenues of 33% was extraordinarily high during the first 10 months of 1998, while in that same period total expenditure had barely grown 15%. Under those circumstances less than a 1% deficit was anticipated for the central government. With Hurricane Mitch and the need for extraordinary expenditures to rehabilitate the principal means of communication and to provide emergency relief to displaced persons, as well as a decrease of US$30 million in current revenues of the central government, the deficit of the central government rose to 3% of GDP. During 1998, the Government of Honduras introduced important changes in economic policy. In fiscal matters, the sales tax rate was raised from 7 to 12% while the income tax rate at the highest income bracket was reduced from 35 to 30%. In 1999, this income tax rate will drop further to 25%.


Graph 3

The National Congress approved the law required for the privatization of HONDUTEL, the public telephone company. In addition, laws for the concessioned operation of public infrastructure, especially ports and airports, were approved; a new code of mining in accordance with international requirements, and a framework of incentives for tourism, an activity whose promotion is expected to produce an important increase in foreign investment and generate new jobs, were also approved. In addition, new measures to protect land ownership in rural areas were approved as well measures to support productive and social sectors .

In matters of monetary policy, the Central Bank maintained open market operations as its principal instrument for regulating the level of liquidity. Obligatory investments of the banks were reduced to a level of 13% in 1998, which, added to the 12% on reserve, makes a total of 25% of total deposits in financial institutions.

Immediately after Hurricane Mitch, the Secretary of Finance transferred US$30 million to the National Fund for Production and Housing (FONAPROVI) in order to grant credits to financial intermediaries, for the production of basic grains as well as for medium and long term projects.

Given the need for funds in the medium and long term to finance the process of productive rehabilitation, the Central Bank also transferred 3 percent of the obligatory investments of the banks to FONAPROVI in the month of December, a value that amounts to US$37 million, that will serve to support the refinancing of damaged credit with possibilities of recovery.

In addition, FONAPROVI created a mechanism to treat private bank losses that allows them to channel credit classified as lost due to the effect of Hurricane Mitch through titles without interest issued by FONAPROVI, and which grants them up to 10 years to amortize them against annual profits. According to an initial estimate made by the Honduran Association of Banking Institutions, the amount of the credit affected is equal to 4% of the total portfolio.

In the area of banking supervision, 1998 was also a year of progress. Legislation was passed on several pending matters, such as related credits by administration or property to the financial institutions, capital requirements, the use of norms to prevent the laundering of money, the standardization of rules for accounting and the publication of information among others. The National Commission for Banking and Securities received technical assistance from the IDB and the IMF for improving the quality of supervision.


Graph 4

B.2 Damages caused by Hurricane Mitch
For Honduras, Hurricane Mitch constituted an unprecedented catastrophe due to the devastation caused, the human and social toll and the losses and damages to its infrastructure and productive system. Nearly one third of the highway network was affected, with the consequent isolation of cities and productive zones; thousands of dwellings were destroyed leaving thousands of families homeless, many of them unemployed and with no source of income; there was likewise a negative impact on future production and exports, economic growth, employment and revenues.

According to ECLAC, Hurricane Mitch is one of the most violent weather phenomena to have hit Central America this century. This is due to the force that it attained as it touched down on the region's coasts, its diameter, the amount of precipitation and the unpredictable trajectory it maintained for several days. According to the National Emergency Commission, the hurricane caused the death of 5,657 people (without counting the 8,058 missing), another 12, 272 injured and initially affecting 1.5 million people (of the 6.2 million total population). With the mitigation of the emergency, this last figure was reduced to 700,000, of which 285,000 remained in provisional shelters until the end of November. The preceding clearly portrays the human and social tragedy that Hurricane Mitch represented for Honduras.

With respect to material losses, ECLAC estimated them at around US$3.8 billion, of which US$2.0 billion affected the social and productive capital of the country while the remaining US$1.8 billion represents production losses. Both direct and indirect effects have been taken into account in the calculation of these figures (for example, the loss of industrial production due to the interruption of raw material delivery). From the sectoral point of view, the greatest losses were found in the productive system (over US$2.6 billion, or 69% of the total), damages to the economic infrastructure (US$665 million), social infrastructure (US$440 million) and the rest are losses and damages to the environment and the irrigation and drainage systems (over US$70 million).

The agricultural sector sustained severe damages and a significant portion of several of the major crops which are cultivated for domestic consumption were lost. These losses included: 58% of the expected corn output, 24% of sorghum, 14% of rice and 6% of the bean crop. In addition several of the important export crops were affected, such as bananas, which sustained a crop loss of 85%, sugar cane, 60%, melons, 29%, African palms 28% and Coffee, 18%. Total damages were estimated at more than US$1.7 billion. For example, the high water levels of the Choluteca River which ravaged Tegucigalpa also wreaked havoc over the croplands, cattle, installations, machinery and tools in its path towards the Pacific Ocean. The hurricane coincided with the harvesting and planting of certain crops. The high river levels and the floods kept some crops under water for an extended period, damaging not only the current harvest but also future harvests. In all, more than 80,000 hectares or 29% of the country’s arable land was affected.

Bovine herds for meat and milk production decreased by 50,000 heads due to the death of those that were grazing on lowlands. 60% of the fowl population was lost in addition to the damages caused to chicken coops and dairies. Significant damage also struck the fishing industry, where the production of farmed shrimp had become a lucrative industry. Their installations were affected and a large portion of the harvest was lost. Losses in the forests were much less significant. The total estimated damages in livestock, fisheries, and forestry equal US$300 million.

Damages in industry and commerce are estimated at almost US$600 million--85% as direct damages— and consist of losses in infrastructure, machinery and production, as they were affected by the rains, floods, landslides and absenteeism during the weeks immediately after the disaster. The maquila industry, which produces goods for foreign markets, was affected, as were the national industries, producing goods for the domestic and Central American markets. Included in these losses are the minor losses to the tourist industry as well as the severe damages to the city of Tegucigalpa, where a large portion of national commerce is based.

Of the estimated damages to the economic infrastructure, the transportation and communications networks were the most affected (US$579 million), followed by drinking water and sanitation (US$58 million) and the energy sector (US$28 million). Highways and roads suffered the full impact of the rising river levels which left enormous deposits of debris and detritus on the slopes of the North Coast Mountains. Riverbeds overflowed and destroyed the roads and buildings in their paths. In other hilly and mountainous areas of the country, the debris left by the rivers--rocks, sand and the remains of trees--blocked passage and drainage and caused heavy erosion of the slopes and vegetation. In many sections of the national highway network up to 70% of certain highways must be rebuilt.

Landslides and floods adversely affected the supply of drinking water and disposal of wastes in urban and rural areas. In Tegucigalpa and Comayaguela, which has the country’s most important aqueduct, primary waterlines were destroyed and carried away by the river at 15 different cross-sections. Similar events took place in mid-sized cities, such as San Pedro Sula, Choluteca and La Ceiba. Numerous small and mid-sized cities saw their aqueducts seriously damaged (Comayagua, Puerto Cortés, Catacamas, Trujillo, Tocoa, Islas de la Bahía). In rural areas, 1,600 systems have been identified with serious problems (flooded, or with excavated wells for drinking water blocked or obstructed). Landslides and floods also affected the electric system, particularly the distribution grid and the generating plants.

The social infrastructure suffered estimated damages of almost US$440 million, principally in housing (US$334 million) health services (US$62 million) and education (US$33 million). According to the Social Fund for Housing (FOSOVI), about 35,000 dwellings were destroyed and another 50,000 partially affected; the losses were catastrophic in Isla de Guanaja and in the departments of Colón and Atlántida. The overflow of the Cangrejal River damaged buildings on its banks; the intense waves destroyed not only housing but also hotels on the Atlantic side; the rising level of the Aguán River violently impacted the majority of the communities in the valley; the flooding of the Chamalecón had a great impact on the city of La Lima and submerged neighborhoods of San Pedro Sula under mud. A total of 123 health installations were damaged (of the 1,091 in existence); the Honduras Social Security Institute Hospital incurred enormous losses to its building and equipment. The educational subsector also received the impact of the hurricane; a total of 4,835 classrooms were destroyed, damaged or affected, of the total 20,942 public school classrooms in the country.

B.3 Medium range perspectives
The Government’s 1998 economic program was being successfully implemented, despite the shortage of food supplies due to the El Niño effect, which began during the first half of the year. Growth of GDP until October was at a rate slightly higher than that of the preceding year. The inflation rate was held below 15% annually despite the increase in the sales tax and El Niño. In addition, fiscal accounts and the balance of payments were performing in a satisfactory manner, as a result of the continued strengthening of international reserves. At the time of the Hurricane, the macroeconomic situation and outlook in Honduras were such that the government and the IMF were on the verge of signing an ESAF program. The Hurricane delayed the process, and the ESAF was approved later in 1999.

Preliminary estimates indicate that GDP growth for all of 1998 was only 3%. The prolonged effects of the hurricane on production, particularly agriculture, will result in a 2% decrease in GDP for 1999. The Government’s fiscal shortage has been exacerbated by the decrease in tax revenue and the increase in emergency expenditures. Nevertheless, the macroeconomic impact of this will depend on how the budgetary support provided by external assistance is used. With regards to the Balance of Payments, it is anticipated that there will be a large increase in the trade deficit, which will bring the current account deficit to above $400 million. This would require strong flows of external net capital and possibly some dilution of international reserves.

At the end of 1998, external debt was US$ 3.9 billion. About 59% of that was with multilateral institutions. External debt service represented about 11% of GDP, more than 22% of exports and comprised nearly one third of total public expenditure.

Hurricane Mitch has created a great challenge to the new government, whose commitment to macroeconomic stabilization and the reduction of poverty was threatened by the nature of the damages caused by the hurricane.

The immediate assistance provided by the international community after the emergency helped maintain a climate of confidence, which is very important for investment and avoiding capital flight The activities of the Central Bank after the crisis have been oriented to reducing expectations of accelerated devaluation and lack of confidence in the local currency. Nevertheless, the breach projected in the current account of the balance of payments for 1999 might impose restrictions on economic growth and produce a temporary slowdown in the fight against poverty.

The government’s budget is being revised in order to include the extraordinary expenditures and investments that Hurricane Mitch demands. While the budget for 1999 is being discussed in Congress, the preceding year’s budget will remain in force. Taking into account that the income tax rate has been lowered and that the slowdown in economic activity should reduce expected sales tax collection, the Secretary of Finance is revising all sections of the budget of every ministry to eliminate non-essential expenditures. During the next twelve months, it is anticipated that distribution of electric energy will be privatized. Advances have already been made towards this goal; as in January the commercialization of ENEE was turned over to a local private consortium. This year, substantial improvements in the administration of tax collections will also be introduced and the Executive Directorate of Revenues (DEI) will be further empowered so that it can play a very important role in providing the revenues needed by the Administration.

In terms of structural reforms, the Government of Honduras has proposed to continue those reforms that will insure the viability of growth in the medium term. Thus, in 1999, the Securities Law will be reformed, the Law of Capital Markets will be approved, and insurance to protect the interests of small deposits will be created. The Administration has kept its commitment to macroeconomic stability in spite of the crisis produced by Hurricane Mitch. This will provide the conditions for enhanced private sector participation in economic growth.

C.  Activities of the Bank

The Bank approved loans to Honduras in 1998 for US$197.4 million. Of the loans approved in 1998, the concentration was in the social sectors; through programs for Reorganization of the Health System, the Honduran Program for Family Assistance and the Honduran Fund for Social Investment. These were in addition to programs for the strengthening of the municipalities of Tegucigalpa and San Pedro Sula as well as a program to strengthen the Directorate of Revenue. Most of these loans were approved after Hurricane Mitch and their structure took into account the needs created by the disaster.

The program agreed upon with the Government for future loans, puts emphasis on rebuilding given the necessities created by Hurricane Mitch. The new loan program will include loans for Water and Sanitation, Housing Sector Investment, and Social Programs.

The IDB Group also provides support for private sector development through specialized units such as the Multilateral Investment Fund (MIF) and the Inter-American Investment Corporation. These units are considering the possibility of financing private investment, giving support to the strengthening of the financial system supervisory bodies and providing technical support to small and medium-sized businesses.

Honduras
Table of Basic Data

Macroeconomic indicators 1990-1993 1994 1995 1996 1997 1998
GDP (growth rate) 3.8 -1.3 4.1 3.7 5.1 3.0
Inflation (december-december) 13.6 28.9 26.8 25.3 12.8 15.7
Public Sector Deficit (% of GDP) 5.5 6.0 3.0 3.4 1.5 2.0
Current Account Deficit (% of GDP) 6.6 9.1 4.6 3.2 0.8 3.2
International Reserves (month of imports) 1.3 1.5 2.1 1.8 3.6 2.9

 

Social indicators Honduras Central America Latin America
Population (rate of growth) 2.7 2.4 1.7
Infant mortality (per 1000 born) 45.4 39.2 36.5
Illiteracy (% population over 15 years old) 27.3 32.1 14.0

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Nicaragua, May 2000   -   Honduras, February 2000   -   Stockholm, May 1999

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