Renewed reforms, Continued growth

Five years of very strong growth have brought the Dominican Republic plenty of plaudits. But according to Andrés Dauhajre, executive director of the unit in charge of the government’s medium-term external financing program, the roots of that performance lie in structural reforms pushed through a decade ago, when the country was struggling out of an economic mess.

The lesson is clear for the Mejía administration: it should not neglect any further reforms needed to preserve that hard-won macroeconomic stability, especially at a moment when that strong economic growth is slowing sharply. So far during more than a year since he took office – helped by the political support in Congress that his predecessor Leonel Fernández did not enjoy – President Mejía has already been able to chalk up a string of successes.

Francisco Guerrero Prats, governor of the Central Bank, says the new authorities began implementing a series of measures “to correct the distortions the economy was showing.” Government deficits had widened, in large measure due to higher oil prices and pre-election spending.

Although observers say more could still be done to cut tax evasion and improve collection, tax reforms, including a new fuel tax, have brought a brighter fiscal outlook. The top tariff rate has been cut from 35% to 20%, and the overall tariff structure simplified. Electricity companies are relieved by the approval of a new regulatory law for that troubled sector. Private pensions are to be introduced, potentially opening up an important new source of domestic savings.

Dauhajre says the most important reform in the pipeline is the new ‘monetary and financial code’, which will grant autonomy to the central bank, prevent it from lending to the public sector, and will unify the two existing foreign exchange markets. Some analysts also believe it could pave the way for the banking system to be strengthened through more foreign participation. Currently only two foreign banks operate, holding no more than 7.5% of the system’s assets between them. The law, which Guerrero Prats says is in accordance with international standards, should be presented to congress by the end of the year.

“The renewed reform effort could, after a brief period of adjustment in 2001, help the country return to high levels of growth thanks to improved efficiencies and output from productivity gains,” said Standard&Poors, the credit rating agency, in September.

Monetary reforms include efforts to cut interest rates, increase liquidity, raise international reserves – which Guerrero Prats says are at their highest level in the central bank’s history – and modernise open market operations. The central bank is gradually reducing reserve requirements and redeeming the instruments known as ‘certificates of participation’ that it had used to restrict monetary policy.

“This is to create better conditions for growth in the productive sectors, which have been hit by the world economic slowdown and this year’s fiscal reforms,” says Guerrero Prats. He hopes deposit interest rates, which have fallen from around 18% at the start of the year, will remain around 11% at year-end.

Inflation, which according to government targets should end the year at 6%, had reached just under 4% in the first nine months of the year. “If you exclude the impact on prices of fiscal measures in January, accumulated inflation would be only 1.8%,” says Guerrero Prats. Value-added tax rose from 8% to 12% and luxury taxes rose sharply. The aim of the tax package was to increase tax revenues by almost 2% of GDP this year.

The government hopes to reduce the overall public sector deficit in 2001 to 0.7% of GDP from 2.2% of GDP last year. Growth in GDP is forecast to be slightly above 3% this year, a slowdown that the government attributes to the US economic downturn and the effects of its own fiscal and fuel price adjustments. Lower global oil prices are a relief to the Dominican Republic, which has no reserves of its own. According to Dauhajre, if oil prices remain at around the $21 level for the rest of this year it will mean a $400 million year-on-year saving for the country. That will contribute to the government’s efforts to narrow the current account deficit, which it hopes will be cut from 5.2% last year to below 3%. Dauhajre also hopes a further lowering of fuel costs will increase consumer spending power and boost growth.

The challenge remains of spreading growth around the country’s poorest sectors. A study of the Dominican Republic by the Inter-American Development Bank acknowledged the impressive economic performance of the 1990s, but says growth did not produce sufficient new jobs. “Nine years of steady growth merely returned income distribution indices to the levels that had existed in the 1980s, before the crisis of 1990,” found the ‘country paper’ report issued in July 2001.

The I-ADB welcomed the Mejía administration’s desire to improve social conditions, but issued too a stark warning that now was the time to act. “The new government team is also aware that if the current challenges are not met they could destabilise the economy, and this would not only compromise further growth [. . .] but would in effect close the current window of opportunity for completing the pending institutional reforms in what is a relatively favorable climate, without the adverse social and political conditions that an economic decline would inevitably bring with it,” said the I-ADB, adding that harsh adjustment during a downturn would be a tough task. “The authorities realise that they must therefore exercise maximum caution on the macroeconomic front in order to preserve stability and growth while accelerating reforms,” the multilateral bank said. “As the new century begins, the administration has an opportunity, such as few other countries enjoy, to press ahead with the necessary reforms while the political and social costs are still relatively low.”