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Neighboring Crisis

Despite Growth In Tourism, Free-Trade Zones, And Remittances From Dominicans In The U.S., Economic Recovery For The Dominican Republic Is Nowhere In Sight, Making Next Year’s Election A Toss-Up


September 4, 2003
Copyright © 2003 CARIBBEAN BUSINESS. All Rights Reserved.

Rough future ahead for the Dominican Republic: Rampant corruption and spiraling inflation have deepened the financial crisis following the collapse of Baninter bank

SANTO DOMINGO, Dominican Republic—The recently concluded Pan-American Games, held for the first time in the Dominican Republic (D.R.), were a great test for the country.

Although the games were plagued with difficulties from the get-go, the overwhelming majority of Dominicans, regardless of political affiliation, were proud that their country was able to pull it off. Once the historic event had ended and the thousands of visitors had departed, however, Dominicans had to face the harsh realities of the dire situation in which their country finds itself.

Following a growth of 1.5% in the first quarter of 2003, the D.R. economy slumped by 2% in the second quarter, according to Minister of Finance Jose Luis Malkum. Dominicans and frequent visitors to the country didn’t have to hear the bad news; they had known it all along.

What has made the current crisis more startling for Dominicans is that they recall their economy was a showcase in Latin America. For the five years before Hipolito Mejia became president in 2000, the country registered more than 7% growth annually. A number of external factors, led by 9/11, coupled with the ongoing domestic financial crises, have plunged the D.R. into considerable gloom.

The only sectors of the economy to show any growth in the second quarter were the pivotal, hard-currency-generating ones, including tourism, exports, and the free-trade zones, said Malkum. Despite the bleak picture, Malkum maintains a bright outlook.

"Within five months, the Dominican economy should show signs of recovery and growth," he said. His words echo the forecast of the experts from the International Monetary Fund (IMF) who are monitoring the economy’s performance before approving a $1.2 billion bailout agreement for the D.R. government.

Malkum is adamant that the country is still better off than most in Latin America. "If we fulfill the agreement with the IMF and there are no other internal or foreign surprises, the economy should grow 1% to 2% next year. That is an extraordinary prediction for an economy that was shaken by a problem that cost 12% to 14% of its gross domestic product," he said, referring to the collapse of Baninter bank.

Implications for Puerto Rico promising & ominous

The four million people in Puerto Rico are well aware of the dire situation in the D.R. Almost every day, there are reports of Dominicans risking their lives in overloaded, small boats to cross the 70-mile Mona Passage and reach Puerto Rico.

Residents of towns in western Puerto Rico report growing numbers of Dominicans. In the San Juan metro area, whole neighborhoods have become home to Dominicans who make a firm imprint by opening all sorts of businesses. Immigration experts concede that only about 10% of illegal aliens are apprehended; the rest disappear into the surroundings, many with help from Dominicans who arrived earlier.

No one knows the exact number of Dominicans in Puerto Rico; some say there are as many as 300,000. The number of legal Dominican residents is estimated at 130,000. Of those, close to 40,000 are naturalized U.S. citizens, which makes them eligible to vote. Their influence on Puerto Rico politics grows as the two major parties appeal for their support. There is a Dominican-born member of the San Juan municipal council, and governors, present and past, have routinely had Dominican-born staff members.

Mejia notorious for his erratic style

President Hipolito Mejia is confronting mounting discontent among the people of the country in general and in his ruling Dominican Revolutionary Party (PRD by its Spanish acronym). The dissatisfaction started about six months after Mejia took office and has only swelled.

During a recent tour of poorer neighborhoods in Santo Domingo, Mejia was met with repeated pleas for lower food prices, fewer blackouts, reliable drinking water, and more jobs. He was fortunate that his handlers were able to move him to another sector of the capital where he heard friendly cries of "Four more [years in office]!" Mejia pledged more apartments and, anticipating victory in next year’s re-election bid, said, "There will still be a lot to do…[in] the five more years I’ll have."

Mejia’s notoriously erratic behavior has become even more pronounced as the pressure has built up. He has blamed the country’s economic crisis on the collapse of Baninter bank and on external factors such as the U.S. recession and rising oil prices. On the list of critics’ complaints are mismanagement of the government, a bloated bureaucracy, and continued excessive borrowing from abroad.

The increasing devaluation of the peso in relation to the dollar and the euro has hit the poor and middle class hard. Prices have skyrocketed—in some cases 40% to 50% from April to July—and people are fed up. Many are angry because, they say, the government refuses to share the burdens of the crisis.

Some observers warn there is a limit to what the masses will endure. They say that if the Dominican economy continues to decline, it could provoke a recession that would cause social unrest. Some note a general resignation bordering on fatalism.

Rise in authoritarian behavior

Some Dominicans say the frustration hasn’t resulted in greater protests because of how difficult life in the D.R. has become. There has been a marked increase in the presence of the military and the police, which has intimidated most. A few attempts at peacefully protesting the Pan-American Games were squelched by Mejia, who ordered the police and the military to knock heads. He sarcastically referred to a priest leading one march as "a Dominican Chairman Mao."

Some are resigned to waiting until the 2004 presidential elections for change. Polls show that if elections were held today, Mejia would lose. They also show that candidate and former President Leonel Fernandez of the Liberation Party is overwhelmingly leading in popularity.

Others who call Mejia a political fox aren’t counting the president out, noting the considerable clout of the PRD. Nevertheless, Mejia has to overcome widespread opposition from other PRD leaders looking to challenge him, including his own vice president, Milagros Ortiz Bosch. They are demanding a primary to resolve the dispute. The manner in which the stalemate is ended will undoubtedly influence the outcome of next year’s elections.

Mixed outlook for D.R. economy

The Economist Intelligence Unit (EIU) has painted a gloomy and guarded picture of the Dominican Republic’s business climate.

"President Mejia’s popularity will suffer the effects of a massive bank failure and the implementation of an International Monetary Fund [IMF] austerity plan which he agreed to as a result," said the EIU in an analysis made with Business Latin America.

"The economic costs associated with the bank failure will lead to a 1.4% contraction this year," said the EIU. While the country’s gross domestic product (GDP) grew by 4.1% in 2002, the EIU predicted it would expand by only 2.1% in 2004, led by tourism, activity in the free-trade zones, and other investment.

"[Domestic consumption] will be depressed by the erosion of incomes and a likely rise in unemployment, and industrial growth, which was 3.3% last year, will slow to 3% this year before exports and confidence boost it by 5% next year," said the organization.

Direct investment, which drives the free-trade zones and the tourism industry, has dwindled. "Foreign direct investors have lost confidence in the D.R.," said the EIU. While direct foreign investment was $961 million in 2003, it will total only $500 million each in 2003 and 2004.

If the currency stabilizes and confidence recovers. . .

"Unions have been prone to striking, so the government might want to avoid cutting public-sector jobs or salaries as was agreed per the IMF’s fiscal-austerity targets in 2003 and 2004," noted the EIU. "Currency depreciation, higher fuel prices, and fresh central-government spending will boost year-end inflation from 10.5% in 2002 to 25.2% this year." The organization projects that the rate of inflation will fall to 15.4% in 2004 if the currency stabilizes and confidence recovers.

Pointing out that bank credit will be expensive and scarce until uncertainty clears, the EIU predicts borrowers with foreign debts will suffer amid expected depreciation while interest rates, which averaged 26.1% in 2002, will rise to 29% in 2003 before falling to 27% in 2004.

"Imports are dropping amid weak domestic demand, currency depreciation, and temporary import levies, and the nation’s trade deficit will shrink from $3.7 billion in 2002 to $2.6 billion in 2003 before rising to $2.8 billion in 2004," said the EIU.

"A loss of confidence has caused steep depreciation of the peso, despite a growing current-account surplus," added the EIU. It predicted the exchange rate, which was US$1=RD$21.20 pesos at the end of 2002, would reach US$1=RD39.90 pesos by the end of this year and US$1=RD$42.80 pesos in 2004.

Bear Stearns gives D.R. upbeat review

SANTO DOMINGO, Dominican Republic—Bear Stearns, the New York risk-assessment firm, believes the banking sector of the Dominican Republic (D.R.) has the capability and determination to weather the current financial storm.

The firm recently sent a team to the D.R. to evaluate the financial situation following the collapse of Baninter bank and the country’s application for assistance from the International Monetary Fund (IMF). As a result of its findings, Bear Stearns issued new ratings for the D.R.’s bond issues of "Ba2 / B+."

In its "Update on Sovereign Bonds in Latin America" report, Bear Stearns said, "The [Dominican] government’s plan to strengthen regulations and supervision has been well received by the financial community, which itself is poised to undergo external auditing as part of the IMF agreements. Successful mergers (Bancredito-Banco Pofesional) and the liquidation of assets of some banks (like Baninter) have also been considered healthy. There is cause for optimism regarding the capability of the banking system to rise above present conditions."

Although Bear Stearns said the situation doesn’t suggest an economic breakdown, but rather a need for the country to continue to fight to stay afloat, it cautioned that the standby agreement with the IMF would entail some painful measures. As of late August, the agreement was still being fine-tuned. "The pact would allow $1.2 billion to be injected into the economy of the D.R. over the next two years and hopefully would return confidence to consumers & investors and stability to the exchange rates," said Bear Stearns.

PRD candidacy still unresolved

Regarding the 2004 presidential elections, Bear Stearns said there is good reason the ruling Dominican Revolutionary Party (PRD) is the only major party still to hold a primary to elect its candidate.

"President Hipolito Mejia has announced he will seek his party’s nomination and run for re-election, but the timing of the financial crisis has worked against his electoral aspirations," noted Bear Stearns.

"[Mejia’s announcement] not only has generated a fair amount of debate as to whether the president’s re-election bid violates PRD principles, but also has accentuated factional differences within the party," added the firm. "As a result, a primary might not occur until later in the year. Until then, the level of political noise out of the country’s largest political party is likely to intensify, not to mention the traditional public altercations between the various political organizations."

Mejia will be challenged in the primary by a number of his own party leaders, including Vice President Milagros Ortiz Bosch and Tourism Minister Rafael Subervi Bonilla.

"We view two possible outcomes for the presidential election, with the odds evenly split between the two," said Bear Stearns. "The first envisions President Mejia securing the PRD nomination but being unable to win the presidential election in the first round, thus forcing a second round against former President Leonel Fernandez [1996-2000]."

Under this scenario, the opposition Reformist Party (of the late President Joaquin Balaguer) is likely to lend its support in the runoff to Mejia, whose close relationship with Balaguer while he was alive is likely to inspire its members to align with Mejia.

Some political observers, however, note the Reformist Party in 1996 was under the leadership of Balaguer, who urged backing Fernandez in that year’s runoff. Also, with Balaguer dead, the Reformist Party has splintered into two factions, one pro-Mejia and the other anti-Mejia.

Bear Stearns’ second possible outcome envisions a discredited PRD, unable to muster the votes necessary to force a second round, effectively allowing Fernandez and his Liberation Party to secure enough votes to win the presidential election in the first round. This scenario assumes that economic recovery takes longer than expected.

"The good news is that despite the uncertainties customarily associated with any electoral period, and regardless of the outcome of the election, politics in the D.R. will sort itself out, as the ideological differences between the leading electoral contenders are minor and a sharp deviation from the current pro-market policy thrust is highly unlikely," concluded Bear Stearns.

In the latest Gallup-Omnimedia poll, Fernandez led with 51% of the vote, which would preclude a runoff. Reformist Eduardo Estrella got 12.7%, Mejia 8.7%, Ortiz Bosch 7.7%, Subervi Bonilla 5.7%, and Hatuey Decamps 2.7%.

The poll found Fernandez was most popular with women voters (55.7%) and equally popular with rich and poor. Also, the electorate is rebuffing Mejia at a high rate, with 55.6% indicating they wouldn’t vote for him. This contrasts sharply with the relatively low rejection rates for Fernandez (15.3%) and Estrella (13.7%).

D.R.’s tourism industry robust

"The D.R.’s vital tourism industry has registered a notable rebound this year," noted the Economist Intelligence Unit (EIU). "The number of foreign tourists traveling to the country during the first six months of 2003 increased 20.3% compared with the same period the year before, according to Central Bank statistics."

"The recovery is less impressive than it might appear, however, because 2002 was depressed by the aftereffects of the September 2001 terrorist attacks on the U.S., which severely damaged tourism around the world," said the EIU. Nevertheless, the organization believes D.R. tourism is poised to continue to grow and to expand its role as one of the country’s chief generators of foreign exchange and employment.

It noted that 1.4 million tourists visited the D.R. during the first half of 2003, an increase of 3.9% over the number during the same period in 2001, which preceded 9/11. "Much of the recent growth can be attributed to attractive hotel prices, a result of the sharp depreciation of the peso since last year," said the EIU.

It noted the peso lost one-third of its value in 2002 and has continued to weaken, going from US$1=RD$21.20 pesos at the beginning of 2003 to some RD$33.60 pesos today. In mid-June the exchange rate hit a record low of RD$40 pesos before rebounding slightly. The EIU attributed much of the devaluation to the government’s takeover earlier this year of the collapsed Baninter bank, which it said eroded confidence in the financial system and damaged government finances.

Acknowledges efforts to promote tourism

According to the EIU, behind the country’s tourism recovery are a reduced fear of terrorism and increased promotional work by the Ministry of Tourism, particularly with leading tour operators at major travel fairs.

The growth in tourism is reflected by Central Bank statistics. In the first six months of 2001, the D.R. received some 1.4 million visitors. The figure contracted to 1.2 million in the first half of 2002 and returned to 1.4 million in 2003.

Arrivals from the U.S. and Puerto Rico continue to rise. According to the Central Bank, 41.4% of visitors to the D.R. are from Europe, 31.6% from the U.S., and 20.6% from Canada.

While hotel operators in the D.R. welcome visitors from the world over, they are aware American visitors stay for an average of five nights, whereas Europeans average 10- to 11-night stays. Nevertheless, Americans spend about the same amount of money as Europeans in half the time. A constant challenge for the Dominican tourism industry has been raising the per-room / per-night earning, which is the lowest in the Caribbean.

Hotel occupancy was up 9.7 percentage points from 64.1% in the first six months of 2002 to 73.8% in the same period this year. The most popular destination was the Punta Cana / Bavaro area, which saw a 13% gain over 2002 and received 43% of all tourists visiting the country.

"The solid performance of tourism has contributed to a substantial surplus in the country’s current accounts this year," said the EIU. "The Central Bank reported a surplus of $307 million for the first quarter of 2003, compared with a deficit of $90 million for the year-ago period."

The EIU also noted foreign-exchange earnings were boosted "by the recovery in national free-trade zone exports and continued strong remittances from Dominicans living abroad."

Trade experts issue warnings on D.R. free-trade pact

Two trade experts are urging a cautious approach for the Dominican Republic in the fast-track negotiations between the U.S. and Central America.

"The D.R. could have a free-trade agreement [FTA] with the U.S. in place in about 200 days," said economist Federico Cuello, who was the D.R.’s representative to the World Trade Organization (WTO) under the administration of former President Leonel Fernandez (1996-2000) and held that post for the government of President Hipolito Mejia until earlier this year.

"If the D.R. had to accept the same terms as those negotiated with Chile and Central America, this would combine the two least amenable scenarios for the country," said Cuello, describing them as docking and bilateral talks. "To negotiate into the Central American Free Trade Agreement [Cafta] on equal terms, we would first have to enter the Cafta that unites Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua." According to the recent announcement by U.S. Trade Representative Robert Zoellick, those negotiations are scheduled for completion by January 2005.

D.R. Ambassador to the U.S. Hugo Guiliani Cury is known as one of the staunchest advocates of a bilateral approach, which he believes would stimulate economic development and provide security for exports and foreign investment.

"Docking to Cafta, after rushing a bilateral accord with the U.S., would have implications that haven’t yet been evaluated," said Cuello. "We have to bear in mind that the objectives of the U.S. trade representative are to eliminate all tariffs, both nontariff and government barriers, to gain full access to our apparel markets and to work jointly so the WTO subsidies to farm exports can be dismantled."

With presidential elections less than a year away and Mejia having forged an alliance with the U.S. that grows stronger, many observers of the delicate economic situation in the D.R. say there is little reason to believe the Dominican president will make many changes to his present course of action. On the other hand, leaders of the private sector, which is bearing considerable consequences from the financial collapse in the country, aren’t optimistic that their pleas for relief will be heeded.

The growing apprehension in the country’s manufacturing and agricultural industries came to a head recently when Mejia addressed a meeting of political parties of the Caribbean and Central America in Santo Domingo. Taking a swipe at developed countries, including the U.S., the Dominican leader said, "Unfair trade practices create more poverty and affect the governance of less privileged Caribbean countries."

Mejia said the nations of the Caribbean and Central America "are forced to sell their products at ever-lower prices while paying higher and higher prices for goods and services from their wealthier counterparts." He complained the policies of these developed countries are discriminatory, whether by reason of quotas or technical issues, and violate the standards of the World Trade Organization.

At the same time, the Industrial Association of the D.R. warned that the FTA with the U.S. carries certain risks due to the accelerated talks and weak conditions in Dominican industry. Lisandro Macarrulla, the association’s president, said the absence of strategies and impact studies could have weighty repercussions for the D.R.’s industrial sector. "The weak local economy and the lack of a clearly defined foreign policy represent a clear disadvantage," he said. "In a process such as this, the participation of the private sector is essential."

The Dominican pharmaceutical industry, represented by Infadom, is particularly alarmed. It has cautioned that an FTA with the U.S. puts the industry at risk. Infadom has complained that five teams from the U.S. have visited the D.R. without meeting with the organization, yet the U.S. complains the D.R. manufactures generic drugs at lower costs.

Cuello noted the U.S. doesn’t subsidize its agricultural exports. "[It grants] domestic assistance not linked to trade and thus will want to maintain those programs in place," he said. "[The matter] becomes even more complicated when other objectives of the U.S. trade representative are taken into account regarding services, government procurement, investments, and intellectual property."

16,000 jobs lost in free-trade zones

"While the docking solution was found primarily to benefit the free-trade zones in the D.R., these in the end wouldn’t be the winners," said Cuello. "The rules of origin don’t favor the D.R., and the agreement won’t recognize the WTO’s authorization to maintain fiscal incentives until 2010. The D.R. will instead have to undergo the shock of full liberalization of trade with the U.S." The news that the free-trade zones have lost 16,000 jobs this year (or 10% of their total) as a result of reduced orders from the U.S. isn’t reassuring.

"The national interest of the D.R. isn’t being considered," said Cuello, who urges the D.R. to make a counterproposal. "It is necessary to research the implications of liberalization of Dominican agricultural producers, industries, and suppliers of services. We must prepare a strategy for the opening of markets that defends our vulnerable sectors and compensates for the cost of liberalization. In 200 days, it will be too late to request technical rectifications."

Recalling the D.R. under President Mejia initially turned its back on the Caribbean Community (Caricom) and on Central America, economist Frederick Emam Zade said "the D.R. is paying a high cost now for having given up its leadership position with both the Caribbean and Central America."

Emam Zade served as assistant secretary of state for foreign affairs in the administration of former President Leonel Fernandez and was the chief D.R. negotiator in trade pacts with both Caricom and Central America. He is currently director of economic development for the Global Foundation for Democracy & Development in Santo Domingo, which is headed by Fernandez.

"The country lost its position after it stopped participating in regional meetings, indicating they weren’t of interest to the Mejia government," said Emam Zade. "The D.R. didn’t attend key meetings to set the game rules for a strategic alliance between Caricom and Central America to establish a position as a bloc prior to talks for the Free Trade Area of the Americas.

"If the D.R. had continued participating in the talks, it would have been a key player in laying down the ground rules. Instead, it now has to dock with Cafta without defending its own national interests," added Emam Zade. "One of the benefits of negotiating on our terms would have been an assurance that materials manufactured in the D.R. and used in our apparel industry would be allowed duty-free entry into the U.S. As things now stand in the negotiations, the D.R. may be forced to accept that only apparel manufactured in the D.R. with U.S.-manufactured inputs will have duty-free access."

Emam Zade said the numerous taxes imposed by the D.R. government on locally produced goods are the main reason for the reduced competitiveness of Dominican products compared with those from Central America. The economist also criticized taxes on exports imposed by the Mejia government. "Eliminating these taxes would stimulate the tourism industry to purchase more food, towels, sheets, and other goods locally instead of importing them," he said.

Analysis of Macroeconomic Data Pre- & Post-Baninter

Public Sector External Debt (US$ in millions)

Pre-Baninter: 3,177 (2001) / 4,459 (2002)

Post-Baninter: 5,475 (2003*)

Official Creditors

Pre-Baninter: 2,018 (2001) / 3,231 (2002)

Post-Baninter: 3,800 (2003*) / Assumes Baninter is partially financed by multilaterals.

Private Creditors

Pre-Baninter: 1,159 (2001) / 1,227 (2002)

Post-Baninter: 1,675 (2003*) / Incorporates part of $600 million bond issue of January 2003.

Domestic Debt

Pre-Baninter: 601 (2001) / 480 (2002)

Post-Baninter: 2,100 (2003*) / Assumes majority of Baninter financed domestically.

Nominal GDP (RD$ in millions)

Pre-Baninter: 359,560 (2001) / 413,494 (2002)

Post-Baninter: 545,306 / Assumes 50% pass-through of devaluation to inflation, boosting nominal GDP.

Exchange Rate** (average)

Pre-Baninter: 17 (2001) / 18 (2002)

Post-Baninter: 30 (2003*) / Bear, Stearns & Co. believes RD$ is undervalued, 30 average is reasonable for 2003.

Nominal GDP (US$ in millions)

Pre-Baninter: 21,390 (2001) / 22,571 (2002)

Post-Baninter: 18,177 (2003*)

Current Account Receipts (US$ in millions)

Pre-Baninter: 10,630 (2001) / 10,727 (2002)

Post-Baninter: 11,198 (2003*) / 4.4% increase in CAR in 2003, is believed conservative.

Central Government (% GDP)

Total Revenue:Pre-Baninter: 16.6 (2001) / 16.2 (2002)

Post-Baninter: 16.2 (2003*) / The revenue side of the budget is simplified by assuming revenue rises in line with nominal GDP.

Capital Revenue:Pre-Baninter: 0.1 (2001) / 0.2 (2002)

Post-Baninter: 0.2 (2003*)

Current Revenue:

Pre-Baninter: 16.6 (2001) / 16.0 (2002)

Post-Baninter: 16.0 (2003*)


Pre-Baninter: 16.4 (2001) / 16.3 (2002)

Post-Baninter: 18.7 (2003*)

Current Expenditures

Pre-Baninter: 12.1 (2001) / 11.7 (2002)

Post-Baninter: 14.1 (2003*)

Of which, Interest

Pre-Baninter: 0.8 (2001) / 1.1 (2002)

Post-Baninter: 3.5 (2003*) / Assumes average cost of new domestic debt = 25%, external = 8%.

Capital Expenditures

Pre-Baninter: 4.3 (2001) / 4.6 (2002)

Post-Baninter: 4.6 (2003*)

Overall Balance

Pre-Baninter: 0.3 (2001) / -0.1 (2002)

Post-Baninter: -2.5 (2003*)

Public Debt--GDP (%)

Pre-Baninter: 17.7 (2001) 21.9 (2002)

Post-Baninter: 41.7 (2003*) / Average for Double-B Sovereigns: 60.6

External Debt--CAR (%)

Pre-Baninter: 29.9 (2001) / 41.6 (2002)

Post-Baninter: 48.9 (2003*) / Average for Double-B Sovereigns: 110.9

Interest--Government Revenue (%)

Pre-Baninter: 5.0 (2001) / 6.5 (2002)

Post-Baninter: 21.5 (2003*) / Average for Double-B Sovereigns 18.3

* Preliminary figures

** Exchange rate: 1US$ = 27.78 RD$

Source: Bear, Stearns & Co. D.R. Update 2003

Dominican Republic At A Glance

On the eve of Baninter bank crisis

Area: 18,700 square miles

Population: 8,721,594

Population density: 431.8 per square mile

Labor force: 2.3 million to 2.6 million

Gross domestic product: $21.2 billion

Per capita income: $2,230

Sector breakdown: manufacturing, 33%; agriculture, 12.2%; services, 54.8%

Exports: $5.5 billion

Imports: $7.9 billion

Sources: Economist Intelligence Unit, Central Bank, Office for Investment Promotion

This Caribbean Business article appears courtesy of Casiano Communications.
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