A Regional Standout

Over the past few years, as most Latin American countries struggled to keep growing, the Dominican Republic has defied the odds. The country has sustained a remarkable stretch of GDP growth, with the highest rates in Latin America and among the highest in the world. Low inflation and interest rates, a healthy banking system and far-reaching reforms have fueled an average annual growth rate of 6% since 1994.

External factors such as rising oil prices and the risk of a double-dip recession in the United States could yet spoil the Dominican Republic’s fairy tale prosperity. But under the administration of President Hipólito Mejía the country has deftly positioned itself for continued, if more modest growth. Francisco Guerrero Prats, governor of the Central Bank of the Dominican Republic, says, “We are proud of the fact that the [Dominican Republic] obtained the highest growth rate in Latin America for eight consecutive years and we are expecting to have the highest growth [in the region] for the ninth year.”

The country’s low external debt-to-GDP ratio of 19.3% in 2001 was among the lowest in Latin America. Brazil, for example, has a debt-to-GDP ratio exceeding 60%. The Dominican Republic’s current account deficit declined to 2.9% of GDP in 2001 from 5.2% a year earlier thanks to a 6.6% growth in money sent home by Dominicans living abroad, mostly in the United States. Remittances accounted for $2.1 billion or 10% of GDP in 2001. Remittances represent the country’s second-largest foreign capital earner, ahead of even exports and foreign direct investment. But the Dominican Republic’s ability to attract handsome levels of foreign direct investment, which rose 25% last year, kept its current account coverage ratio at 1.4 times in 2001.

The telecommunications sector attracted the most foreign direct investment followed by the tourism and electricity sectors. “The country’s fundamentals are very stable, among the most stable in the region,” says Carl Ross, director of emerging markets sovereign research at Bear Stearns. “It has been able to achieve high growth rates with relatively low inflation, a near balanced budget and a moderate current account deficit – that’s a country that looks like a country that has its macroeconomic house in order.” The country’s solid fundamentals helped it survive last year’s steep drop in tourism-related hard currency revenues, which accounted for a fifth of GDP.

Political stability and a Congress in which Mejía’s Dominican Revolutionary Party (PRD) now controls both houses mean that the succession of successful structural reforms that have so far characterized his two-year presidency should continue. “The most important characteristic of the Dominican Republic is the high degree of governability, which is crucial for foreign direct investment,” says Andrés Dauhajre, executive director of the Economic Development Foundation, who is also charged with the government’s external financing program. Dauhajre says a stable government, with its control of the legislature, allows the country to react quickly in the face of crisis. “We can pass measures within 24 hours to deal with shocks and [because of that] we will continue to outperform in terms of growth and macroeconomic stability,” he claims. Ignacio Jasminoy, Citibank’s corporate business head, says, “The president cut $1.2 billion in expenditure and Congress accepted with almost no noise. It is good to have a strong and unified economic team working in the same direction these days.”

In his two years in office, Mejía has focused on boosting tax revenues and supporting growth and low inflation. The government has based its approach on increased access to foreign markets, balanced public sector finances and free market economic policies. He has also increased investment and output in the country’s free trade zones. The new tax reform measures have proven effective since, on an annualized basis, tax collections during the first four months of 2002 rose to 17.4% of GDP from 15.9%. Continued success would help the government stay on track for an overall fiscal deficit of 1.5% of GDP, according to forecasts by Morgan Stanley.

Helping Farmers
Agriculture is the next target of the administration’s modernization efforts and it has promised to invest $280 million in technology and infrastructure targeted mainly at small-scale farmers to help them reduce costs and become more efficient. Indiana Jones, head of treasury at public commercial bank Banco de Reservas, says developing an exporting agriculture sector is important to alleviate poverty in the rural areas and distribute wealth more evenly. Residents of Santo Domingo complain about migration to the city, but it is easy to understand why people are leaving the countryside. In a rural area bordering the country’s new port development near Boca Chica, tin shacks sit on crudely plotted farmland where farmers still use hoes and hack undergrowth with cutlasses.

But the country has made considerable progress. Not long ago, it was primarily an exporter of raw materials but is transforming itself into a service economy. Tourism is by far its most important service industry. Guerrero Prats says tourism has recovered from a decline of 27.7% last November to growth of 6.4% in September, “but it is still a very volatile recovery,” he says. But manufacturing, especially in free trade zones where companies are exempt from import duties and income tax, has been a key contributor to growth. Between 1996 and 2000, export revenues from free trade zones grew about 24% a year. “Foreign direct investment is crucial for us to cover the fiscal deficit,” says Dauhajre. In 2001, the Dominican Republic attracted $1.1billion, and in the first half of 2002, $441.7 million in foreign direct investment poured in, an 8% increase over in the first half of last year. Bear Stearns estimates there is $5 billion of foreign direct investment in the pipeline, with $1.5 billion earmarked for 2002.

The country’s net international reserves, which had risen to $962 million at the end of 2001, lost considerable ground earlier this year when the central bank intervened in the currency markets to stabilize the peso’s rapid deceleration. The bank spent $260 million to defend the currency, which has since hovered around 18 per dollar. The current account has also been weakened by an economy that is increasingly being driven by domestic demand, rather than global demand.

Improving Trade Flows
The country wants to develop local exporting industries to help improve the imbalance in the trade flows. President Mejía is working towards this targeting key sectors in a competitiveness plan that outlines the next stage of the country’s economic development. Some companies are already breaking into new markets, such as the rum distiller Brugal. But developing a more organized approach would greatly advance the fortunes of the economy.

While the Dominican Republic’s economic fundamentals are strong, the country remains vulnerable to forces beyond its control – namely the risk of rising oil prices were the US to invade Iraq and a double-dip recession in the US. Another risk factor is the banking system. Throughout the country’s years of headlong growth, the country’s banks have increased their assets aggressively. In 1997, the Dominican banking system had $5.1 billion in assets, which by the end of 2001 had doubled to $10.1 billion. As Bear Stearn’s Ross points out, growing assets is fairly easy to do when the economy is expanding at 7%. But in a low-growth scenario or recession, asset quality becomes much more vulnerable. Says Ross, “It’s not a ticking time bomb, but it’s something to watch.”