WASHINGTON, USA -- On February 19, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Dominican Republic, and considered and endorsed the staff appraisal without a meeting on a lapse-of-time basis.
The Dominican economy has continued its vibrant performance. Growth averaged over 7 percent during 2014–15, fueled mainly by domestic demand. Employment recovery and the decline in oil prices boosted disposable income, while the consumption-led recovery in the US provided tailwinds through linkages with tourism and remittance flows. Strong growth in private investment dovetailed the expansion in consumption.
Despite strong growth, lower oil prices kept inflation low and strengthened the external position. While inflation expectations remained within the central bank’s target of 4±1 percent, actual inflation was below the target range throughout 2015, picking up to over 2 percent by end-year as the oil price effect waned and food prices spiked following a mid-year drought.
The external position strengthened on the back of lower oil prices and robust remittance and tourism inflows. The current account deficit is estimated at about 2 percent of GDP by end-2015 and reserves recovered to a level equivalent to over three and a half months of imports, excluding free-trade zones. The current account deficit and the real exchange rate are broadly in line with the economy’s fundamentals.
The monetary policy stance remained broadly neutral during 2015. Softening core inflation prompted several rounds of interest rate cuts by the central bank in early 2015, to 5 percent, which offset an earlier policy tightening. The banking system continues to show healthy capitalization, profitability and asset quality.
Fiscal policies continued to safeguard the gains from the recent fiscal consolidation. The fiscal adjustment during 2013–14, to a consolidated public sector deficit of about 4.5 percent of GDP, has been critical in restoring confidence. Excluding one-off receipts, the deficit in 2015 is estimated to have been maintained at broadly similar levels as the previous year.
This, together with the face value reduction in public debt (by 3.1 percent of GDP) due to the restructuring of the Petrocaribe liabilities, moderated the increase in consolidated public sector debt (including the debt of the electricity sector and the central bank) to 48.5 percent of GDP estimated by staff for 2015.
Going forward, the growth momentum will soften as the economy returns to its potential growth. Staff projects growth to slow to 5.4 percent in 2016 and to its longer-term potential rate of 4.5–5 percent by 2017. The positive output gap and the incipient pressures on real wages are projected to return inflation to the target range in 2016.
Risks to the staff’s macroeconomic outlook are moderate and somewhat tilted to the downside, largely owing to potential negative spillovers from weaker growth in advanced economies.
Executive Board Assessment
In concluding the 2015 Article IV consultation with the Dominican Republic, executive directors endorsed the staff’s appraisal as follows:
Economic activity maintains a strong momentum, aided by a favorable external environment and a strengthened policy framework. Domestic demand has been the main growth engine, supported by an expansion in employment, robust credit growth, lower oil prices, and the recovery in the US. Inflation remained low, the current account deficit contracted, and key social indicators improved.
The implementation of sound policies has underpinned the strong economic performance. The inflation targeting framework has been successful at maintaining inflation expectations around the official target range in the face of positive supply shocks, and notable fiscal consolidation efforts over the past three years have slowed further increases in public debt.
Going forward, as some of the external tailwinds dissipate, the economy is expected to slow to its potential growth of 4.5–5 percent. The challenge for macroeconomic policies will be to sustain high growth rates and address remaining poverty and inequality challenges, further strengthening the fiscal position, limiting risks of negative international spillovers and tackling long-term legacies in the electricity sector.
Fiscal sustainability and social spending pressures require renewed attention to strengthening the fiscal position. Over the medium-term, public debt is set to rise due to large consolidated deficits, and additional pressures are building from the need to sustain adequate infrastructure and social spending.
The authorities’ continued commitment to fiscal discipline is welcome, and the favorable cyclical position provides a good opportunity to undertake the adjustment to put debt on a downward path. A major effort is needed to expand the narrow tax base, eroded by tax exemptions and incentives, and to tackle inefficient spending, including on generalized electricity subsidies.
The strides achieved over the past decade in building up institutions are notable, but there is merit in further strengthening the fiscal framework by anchoring annual policy decision-making to sustainability objectives and improving the quality of spending. The risk profile of public debt would benefit from reduced reliance on foreign currency borrowing, which necessitates further development of the domestic bond market in coordination with the central bank, a major issuer in the market.
The monetary policy stance is appropriate in guiding inflation back to target range, but a strengthened framework could further improve policy effectiveness and outcomes. The strong economic outlook, waning supply shocks, and tightening labor markets are reducing the scope for further interest rate cuts. The tightening bias is therefore appropriate in guarding against upside risks to inflation.
Transition towards more exchange rate flexibility and the continued buildup of reserves will increase resilience against external spillovers and shocks. The challenges of managing monetary policy and legacy quasi-fiscal debts should be tackled through increased coordination with the fiscal authorities in avoiding overlap between two issuers to develop the local bond markets and in firming up the recapitalization arrangements.
The resilience of the financial system has been strengthened over the past years in tandem with improved bank supervision. The regulatory reform agenda for the banking system needs to be further advanced towards best international practice, and pockets of rapid credit growth warrant monitoring. At the same time, the supervision of non-bank financial intermediaries remains weak and -- although these are not systemic -- vigilance is needed against inherent risks, especially those related to potential AML/CFT activities.
Sustaining strong economic growth and making it more inclusive will require concerted reform efforts. The authorities’ reforms in education, strengthening social safety nets, and in promoting financial inclusion should help boost growth and improve social outcomes.
Addressing long-standing problems in the electricity sector remains key to improving growth prospects. Needed measures include significant upgrades to the public distribution networks, a move towards cost recovery pricing and reducing regulatory uncertainty. The latter would also foster a stronger investment climate needed to narrow infrastructure gaps, while increased product market competition and labour market flexibility would strengthen the economy’s competitiveness.