WASHINGTON, USA -- On January 25, 2013, the executive board of the International Monetary Fund (IMF) concluded the 2012 Article IV consultation with the Dominican Republic.
Over the past two years, economic activity has decelerated and macroeconomic imbalances have increased. Economic growth declined from 7.8 percent in 2010 to 4.5 percent in 2011 and to a projected 4 percent in 2012. A large increase in government spending in 2012 was partly offset by declining private sector demand. As the impact of earlier world price shocks dissipated, headline inflation declined below 3 percent, well below the central bank’s target range of 4.5–6.5 percent. The large fiscal expansion combined with the easing of monetary policy, and limited exchange rate flexibility increased public sector debt, kept the external current account deficit high, and fueled losses in international reserves.
The fiscal deficit in 2012 rose to an estimated 8.5 percent of GDP. This reflected a combination of weak revenue performance (excluding temporary factors), and an increase of about 40 percent in primary expenditure. As fiscal deficits widened, the stock of public debt reached nearly 45 percent of GDP, compared with 35 percent of GDP in 2007–08.
Monetary policy was eased. In December 2011 the central bank formally adopted an inflation-targeting framework and set a target for inflation of 5½ percent (+/- 1 percent) for 2012 and 4 percent by 2015. As inflation eased during the year, the central bank lowered its overnight deposit rate during May–August by a total of 175 basis points (to 5 percent). Following the easing of monetary conditions, private sector credit growth picked up in recent months.
The external position weakened. The external current account deficit in 2012 was about 7 percent of GDP, somewhat lower than in 2011, but still above the 1994–2011 average of about 3 percent of GDP. However, net capital inflows were also lower than in 2011 and gross international reserves declined to about US$3.6 billion (about two months of imports), about US$500 million lower than at end-2011.
According to official data, the financial sector is well capitalized. At end-October, average capital adequacy ratios of commercial banks were 15 percent of assets, although non-performing loan ratios rose to 3½ percent. The share of claims on the government in the asset portfolio of some banks increased significantly. The government is planning to develop special financing facilities to support small- and medium-size enterprises and microfinance. The recapitalization of the central bank continues broadly as envisaged.
There are risks in the near-term. The fiscal tightening contemplated by the authorities would keep growth subdued while inflation is expected to rise to 5 percent (within the central bank’s target). Confidence and the external environment will be critical for a strong recovery in private sector activity. Lower-than-projected growth in the United States and Europe could worsen the outlook for tourism and remittances. Unexpected increases in oil prices and lower availability of external financing would also carry risks.
Executive Board Assessment
Executive Directors observed that economic growth in the Dominican Republic has slowed significantly since 2010, while inflation also declined sharply in 2012. Directors saw downside risks to the outlook stemming from continuing global uncertainties and domestic and external vulnerabilities. They urged decisive implementation of strong macroeconomic policies and structural reforms to address fiscal and external imbalances, build policy space, and boost growth.
Directors welcomed the fiscal package put forward by the new government to enhance revenue collection and contain total spending, while increasing spending on education. Going forward, Directors saw a need for additional fiscal adjustment, especially on the revenue side by further reducing tax exemptions, to lower the public debt relative to GDP and ensure fiscal sustainability. They encouraged timely specification of additional consolidation measures, and steps to enhance fiscal transparency and public accountability.
Directors stressed the importance of boosting international reserves over the medium term. In this regard, they welcomed the central bank’s intention to allow more exchange rate flexibility, which is important to absorb external shocks and will facilitate the transition to full-fledged inflation targeting. They encouraged the authorities to improve the monetary management and foreign exchange intervention policy.
Directors commended the solid performance of the financial sector, noting its high capitalization and strong prudential indicators. They encouraged close monitoring of the rapid increase in banks’ holdings of government debt and risks associated with special financing facilities, and welcomed the authorities’ efforts to strengthen the financial regulatory and supervisory framework. Directors also stressed the importance of recapitalizing the central bank to underpin monetary policy credibility.
Directors welcomed the authorities’ renewed commitment to structural reform. They commended the recent measures to eliminate administrative barriers to the creation of new firms and the priority being given to improving the quality of education. Directors urged the authorities to put in place quickly a comprehensive reform program for the electricity sector, which remains a major fiscal and structural vulnerability. This should include a mechanism to adjust tariffs in line with energy costs and measures to enhance the efficiency and reliability of the electricity supply, improve the financial viability of the electricity distribution enterprises, stimulate investment in the sector, and better target subsidies to the poor.