Consultative Group for the Reconstruction and Transformation of Central America

"reconstruction must not be at the expense of transformation"

Honduras Recent Economic Developments
Tegucigalpa, Honduras  7-8 February, 2000

Summary

Human and material losses caused by Hurricane Mitch were extensively reported and discussed at the Stockholm meeting last May. In summary, it can be recalled that the human toll has been set at 5,657 deaths, 8,058 missing, 12,272 injured and a total of 1.5 million people affected. United Nations’ ECLAC estimates material losses at around US$3.6 billion, of which US$2.05 billion affected productive sectors while the rest represents damage to social infrastructure (US$ 1.02 billion) and economic infrastructure (US$ 0.51 billion).

As expected in the wake of Hurricane Mitch, 1999 was the year that felt the full impact of destruction over productive capacity and exports. It was also the year when major effort to reconstruct and transform the Honduran economy was launched, with the cooperation of the international community of donors and development financial agencies. Fortunately, the negative impact of the disaster on the economic activity was not as severe as originally predicted, in good measure due to timely efforts to restore some degree of normalcy to economic flows, as well as to reconstruction endeavors carried out with the support of external resources. Also important were the economic policy management efforts executed under an ESAF program guidelines.

The latest estimates indicate that for 1999 the decline in GDP will be around 2.5 per cent instead of 3+ percent predicted earlier in the year. The balance of payments show a significant increase in the overall trade deficit, as non-maquila exports fell by 22 percent and merchandise imports grew by 17 percent. Yet, that trade deficit was virtually covered by the high levels of net transfers and net capital account inflows. Both fiscal and monetary performances were found to be well within target, according to the ESAF program subscribed with the IMF. As a consequence, the inflation rate was close to 10 percent during the second half of the year, while the average rate for the whole year was 11.6 percent, down from 13.7 percent in 1998. As further indication of improved macroeconomic performance, gross international reserves continued to accumulate by well over 30 percent and the nominal exchange rose by 6 percent, for a real appreciation of the Lempira of about 2 percent.

In addition to six loans for US$ 197.4 million approved the year of the Hurricane, in 1999 the Bank approved four loans for US$85.2 millions, including financing for housing post Mitch, a Program for Transition and Social Protection, and one for water and sewage and roads reconstruction. The program agreed upon with the Government for 2000-2002, continue to emphasize reconstruction. The new loan program will include loans for community development; reactivation of the rural economy; and roads rehabilitation. In addition, projects under preparation include legislative reform; education, sustainable management of water basins, preinvestment, reform of the Honduras Family Institute, and Social Programs.

Country Analysis

Recent Economic Situation
During 1999 the Honduran economy entered in a recessionary period caused by the destruction of various crops and economic infrastructure in the aftermath of Hurricane Mitch late in the previous year. The rate of decline of real GDP however, estimated recently at 2.5 per cent, is far less than anticipated shortly after the disaster when prospects for GDP reduction in 1999 were put at 3.0 to 3.5 per cent. No doubt, the significant reconstruction efforts led by the Special Cabinet for Reconstruction and actively supported by the international community of donors did contribute to slow down the retrenchment of the economy.

Incomplete data on production illustrate the significant damage caused by Mitch in Agriculture. By mid year banana shipments were 82.4 per cent lower than the level reached over the same period, one year earlier. Likewise, by June the volume of coffee exports was down 34 per cent, while overall agricultural production for all of 1999 is expected to decline by around 15 per cent over the previous year levels. When all the numbers are in, significant drops in production are expected in related industries such as sugar, milk, flour, beer, spirits and cigarettes. On the other hand, due in part to early efforts to restore operational capability in transportation and communication systems, some activities were able to show remarkable recovery. According to balance of payments estimates, the assembly industry (maquiladora) will increase hard currency earnings by 32.6 per cent over 1998, indicating that this activity’s domestic component is growing in a similar fashion. Shrimp farming, after suffering heavy production losses during Mitch was back to normal levels of production by the second half of 1999. In other manufacturing, textiles and some construction materials will probably post a strong growth for 1999. Reconstruction efforts, both public and private, are resulting in construction activity growth that is likely to exceed the 20 per cent mark over last year.

The Government reconstruction efforts, strongly supported by the international community, are concentrated in social infrastructure, transportation infrastructure and support to private sector recovery. By the third quarter of 1999 it has been estimated that GOH has build 747 schoolrooms and 131 education centers. Reconstruction and rehabilitation works have benefited 15 hospitals, 100 health units and two emergency clinics, while house construction exceeded the 38000 mark and funding for water and sewage projects nationwide has been set, so far, at approximately US$ 107 million.

In transportation, roads reconstruction projects are under execution or earlier stages of preparation at a cost of US$ 197 million, including the reconstruction of 64 bridges. Investments in seaports and airports are estimated at US$ 12 million, while flood protection works in river basins have been made at a cost of US$ 35 million.

To promote private sector recovery and growth after Mitch, GOH has made available through FONAPROVI credit resources of some US$ 53 million for the agricultural sector, in particular to producers of basic grains, sugar cane, shrimp and independent banana producers, as well as for middle class housing rehabilitation.

The balance of payments, as expected in the year following a major disaster, reflected both the loss in export earnings as well as a sizable increase in imports for reconstruction, financed through international aid and other related inflows. Full year estimates show that non-maquila exports contracted by 22.5 per cent, due to the collapse of banana and coffee exports, compounded by the deterioration in international price of the latter commodity. But given the strong growth of maquila and the receipt of insurance indemnification, the overall exports of goods and services fell only by six per cent. On the import side, the bill for merchandise did go up significantly, 17.2 per cent, while imports of non-financial services remained in line with recent trends. Despite a reduction in interest due on external debt of 10 per cent, total imports grew by 13.7 per cent, which led to a doubling of the overall trade deficit, to US$ 1,146 million. This deficit was virtually covered with net transfers including family remittances (US$465 million), and net capital inflows (US$ 626 million).

Total external debt at year end is estimated at US$ 3,645 million, some 6.5 per cent below the level recorded a year earlier. Honduras has benefited from significant debt forgiveness from a number of bilateral creditors, particularly the Paris Club membership. Furthermore, some donor countries continue to contribute to the World Bank Emergency Trust Fund earmarked for servicing Honduras’ and Nicaragua’s multilateral debt as payments become due (and resources are available). This, while not affecting significantly total debt burden, it does provide balance of payment and budgetary relief to Honduras until an alternative for multilateral debt relief becomes available. Honduras was declared eligible for HIPC benefits last December; as soon as the Decision Point is reached later in the year 2000, the country is expected to start experiencing reductions in multilateral debt over the next several years. It is important to note that both GOH and the multilateral lenders agree on the need to limit new lending to concessionary financing, particularly during the reconstruction years.

In the Consultative Group for the Reconstruction and Transformation of Central America held in Stockholm last May, pledges of help to Honduras amounted to US$ 2,763 million, including new financing of reconstruction projects, emergency relief, reprogramming of previously approved financing and debt relief. A significant amount of pledges remain to be committed, as in some cases projects need to be refined and prioritized and conditions for approval and disbursement need to be worked out between the government and donors. One important element is implementing agreed procedures for improving efficiency and transparency in the use of resources.

Management of the monetary situation continued to improve in 1999. Data through October of that year show that money and quasi-monetary liabilities of the financial system grew by 11 per cent over the 10 month period, while the previous year expansion was close to 20 per cent. Following the pattern of the previous two years, practically all of the expansion was due to the increase in international reserves in the system. In fact, growth in credit to the private sector was more than offset in absolute value by a net increase of public sector deposits (i.e., a net reduction in credit to the public sector). In general, the restrained pace of expansion of credit to the private sector (15 per cent through Oct.) is considered at this stage to be adequate for sustaining the recovery in economic activity while effecting a gradual reduction of the rate of inflation. Prudent fiscal and monetary management, along with mild recessionary conditions in demand go a long way in explaining the inflation rate, as measured by the consumer price index, hovering around 10 per cent in the last seven months of 1999. Despite the fact that some adjustments are unavoidable in this first year of reconstruction, the average rate of inflation for 1999 ended at 11.6 per cent, down from 13.7 and 20.2 per cent in 1998 and 1997 respectively.

Overall fiscal performance for the year was found to be better than expected, according to a recent review by the IMF. Nonfinancial public sector current revenues remained at nearly 30 per cent of GDP, despite the expected effect of reduced economic activity on tax revenues, due to improvements in tax administration and a broadening of the tax base. Current expenditure at 23.1 per cent of GDP is slightly above target as a government salary hike took effect and transfers to rural development and poverty programs were increased. Capital expenditures, programmed to rise by 4.6 percentage points of GDP over the preceding year’s level are expected to exceed that target somewhat by year end; real investment is below its target, but lending to the private sector is more than compensating that shortcoming. As a result, nonfinancial public sector deficit for 1999 is estimated at 6.2 per cent of GDP, i.e., two percentage points below the target set in the current ESAF program. Further, actual external financing exceeded that deficit, causing the public sector to accumulate deposit balances in the Central Bank.

Economic policy has been conducted within the framework of two major guidelines¾ the Master Plan for Reconstruction and Transformation and the ESAF program agreed with the IMF. While no major changes were effected in policy instruments, the emphasis in policy has been, on one side, to carry out the institutional measures and the technical work necessary for accelerating the implementation of the reconstruction plan. On the other side, the aim has been to pursue fiscal and monetary policies in a manner consistent with the objective of fulfilling the relevant targets of the ESAF program. As indicated earlier, to promote private sector recovery, GOH has made available through FONAPROVI credit resources of some US$ 53 million for the agricultural sector, in particular to producers of basic grains, sugar cane, shrimp and independent banana producers, as well as for middle class housing rehabilitation.

Outlook
Honduras has been able to manage the transition from a major disaster to an increasing level of reconstruction while keeping macroeconomic performance in a satisfactory fashion. In general, the level of economic activity contracted less than expected and is showing early signs of recovery. Good tax management is being reflected in government revenues and the ability to finance the increased budget without undue recourse to domestic borrowing. Central Bank is showing a steady hand at monetary management. Damaged export industries are recovering as expected, or even better, just as international resources for reconstruction are being increasingly mobilized. As GOH presses on with its initiatives for reform and institutional strengthening, the opportunities for private sector participation in a modernized economy with private investment can be expected to play a growing role.

Since none of these positive conditions are expected to reverse themselves over the medium term, prospects are that the Honduran economy will attain a moderate growth in 2000 (perhaps 3-to-4 percent). Thereafter, it could reach growth in the 5 to 6 percent range over the next 3 to 4 years. If the monetary and fiscal situations are kept under control in this environment, the prospects are good for gradual reduction of inflation to levels well under 10 percent per year over the medium term. The balance of payments has the potential for moderating trends in its current account, making it quite possible to finance a significant portion of the expected deficit with the high levels of external financing projected, plus other resources such as foreign direct investment and privatization proceeds. This scenario implies that both GOH and the international community of donors must work hard at procedures that allow an acceleration of the reconstruction and transformation plans and make available the financing required in a timely basis.

Activities of the Bank

The Bank program of support to Honduras follows the guidelines of the Master Plan for Reconstruction and Transformation. This plan seek to rekindle economic activity and productive employment, while safeguarding macroeconomic stability; fighting poverty and promoting human development; fostering the sustainable use of natural resources and protecting the environment; strengthening democratic institutions at the national and local levels; and instituting adequate prevention and mitigation measures against natural hazards.

In 1998 the Bank approved loans to Honduras for US$197.4 million. Funding was concentrated in social and poverty objectives, with particular emphasis on emergency and reconstruction activities after Mitch. Financed programs included the reorganization of the Health System, a second phase for the Honduran Program for Family Assistance (PRAF) and phase 3 for the Social Investment Fund (FHIS). In addition, programs were approved for the Urban Development and Reconstruction of Tegucigalpa and San Pedro Sula as well as the Strengthening of the Tax Administration (Directorate of Revenue).

In addition, the Bank approved loans to Honduras in 1999 for US$85.2 millions. Of the loans approved in 1999, the concentration was in the social sectors through programs for housing post Mitch, the Honduran Program for Transition and Social Protection, and potable water and sewage and roads. 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 community development; reactivation of rural economy; and roads. Additionally, there are projects under preparation in the sector of legislative reform; education, sustainable management of water basins, preinvestment and reform of the Honduras Family Institute, and Social Programs.

The IDB Group also provides support for private sector development through specialized unit 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.

 

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

Inter-American Development Bank