THE DOMINICAN REPUBLIC is enjoying a growth spurt at the moment. Just look at its GDP figures. After four consecutive quarters of negative growth, the economy slowly started growing again in the second quarter of 2004. Since then, each quarter has outperformed the previous one, with the second quarter of 2005 showing year-on-year growth of 7.2%. And the growth isn’t just in export industries: private consumption grew 12.6% in the first half of 2005. Finally, it seems, the Dominican economy is recovering from the crisis of 2003.
“All expectations are being exceeded at the moment,” says Franco Uccelli, a sovereign analyst at Bear Stearns. “Even the government and the central bank are expressing surprise at the rate the economy is growing.”
Credit for the stellar figures can be placed squarely with the newly elected administration of Leonel Fernández, who took control of the presidency for the second time in August 2004. Fernández turned the Dominican Republic into the fastest-growing economy in Latin America during his first term in office, between 1996 and 2000, so he does seem to have something of a magic touch.
In contrast, the administration of Fernández’s predecessor, Hipólito Mejía, proved to be disastrous for the country. After a banking crisis and an overly generous government bailout of the financial system, the Dominican Republic’s economy was left in tatters, with the exchange rate devalued by 105%, inflation running at more than 80%, poverty rates increasing and the total external debt doubling from $3.6 billion to $7.2 billion.
The Mejía administration “used external financing extensively for a very big expansion of public expenditure,” says Julio Ortega-Tous, chairman of the Dominican Republic’s council of economic advisers. Specifically, he says, after 14 years out of power, Mejía’s PRD party had a lot of political bills to pay, and the government payroll grew to the point where it vastly exceeded capital expenditure.
When Fernández took control again in 2004, debt service was consuming 40% of the budget, and two successive IMF agreements had collapsed. The country was in default to its commercial creditors, was $200 million in arrears to the Paris Club of official creditors, and the 30-day grace period on one bond coupon payment was about to expire.
After paying the bond coupon, the Fernández administration embarked on a comprehensive financial overhaul. The centrepiece was a complete debt restructuring, starting with existing Paris Club paper and then moving on to the republic’s bondholders.
The bond exchange was a huge success. There was no haircut: maturities were simply pushed out by five years. Once the market realized that the exchange was going to work and that default was no longer imminent, the yield on Dominican Republic debt fell to levels lower than the coupons on its bonds. In turn, that meant that pretty well every bondholder wanted to take part in the exchange – which is what happened in the end.
Meanwhile, tough fiscal decisions started being made. Taxes were increased, energy subsidies cut and value-added tax was increased to 16% from 12%.
The non-financial public deficit of 3.2% of GDP in 2004 fell to just 0.7% in 2005, and is forecast to become a surplus of 1% in 2006.
Overnight success
Almost overnight, key economic indicators started improving dramatically. Inflation was running at 65% in August 2004; it dropped to 47% by the end of 2004 and was actually negative by June 2005. Net foreign reserves trebled in a matter of months. And the benchmark central bank interest rate has come down to 13% from about 60% a year ago.
An ecstatic IMF agreed to a new stand-by arrangement in January 2005 worth $665 million. The Paris Club, in turn, is certain to agree to a second rescheduling of sovereign debt.
But all is not rosy in the Dominican Republic. On the economic front, the banking system remains weak, and the central bank’s ability to control and strengthen it is so far unproven.
And behind the macroeconomic figures lies a political reality. On the ground, the country’s citizens are not feeling the economic growth. The fastest-growing sector is telecommunications, which employs a tiny number of people. Meanwhile, agriculture, which is politically and geographically central to the economy, is shrinking. “The figures in the national accounts don’t correspond to perceptions,” says Ortega-Tous, quoting a Gallup poll that says that 61% of the population thinks the economic situation in the country is either bad or very bad.
To make matters worse, the Central American–Dominican Republic Free Trade Agreement, or Cafta-DR, is about to come into effect after being passed in the US legislature in August by the slimmest of margins. “Agricultural production in the US has much higher productivity than ours, and they have subsidies we don’t have,” says Ortega-Tous. “The social and political impact of the agricultural sector, as well as its employment impact, is very important.” Somehow, within a very tight fiscal framework, the Dominican government will have to compensate farmers in the most politically sensitive areas, such as rice, beans, coffee, sugar and cattle.
Yet Cafta-DR is probably good for the Dominican Republic in the long term, even if it causes short-term losses in agriculture. But, more important, it is absolutely crucial for the textiles industry, which presently employs about 100,000 Dominicans exporting to the US under the terms of the Caribbean Basin Initiative. The CBI has fewer than three years left to run, so Cafta-DR is a necessary replacement.
It is inevitable then that the Dominican economy is simply going to have to move away from agriculture over the longer term. “We need to make more efforts to develop tourism and light-industrial production for export to the US markets,” says Ortega-Tous. As for the sugarcane fields, which have 500 years of history behind them, moves are already afoot to convert them into production facilities for ethanol, biodiesel and synthetic fuels.
The Dominican Republic certainly has its fair share of commercial advantages. It is very close to the US, which means it can turn around light-manufacturing jobs in as little as 24 hours. A large part of its population is bilingual in Spanish and English. And there are somewhere between 1.5 million and 2 million Dominicans living and working in the US, who help to raise the country’s profile as well as sending back remittances.
Tourism alone can easily be imagined as a source of rapid growth. “Tourism is our most important producer of foreign currency, but the number of jobs in the industry is very limited,” says Ortega-Tous. The growth potential comes largely from the fact that most tourists in the Dominican Republic come from western Europe – for some reason Americans tend to avoid the island. But if American tourists can be persuaded to come, they spend more than their European counterparts. And there’s certainly space for them: the country’s 2,000km of coastline could accommodate 20 million to 30 million tourists a year, compared with just over 3 million at present.
But the visitors the Dominican Republic really wants are bond investors. The country is now trading at about 322 basis points over treasuries. It’s a vast improvement over where it was only a few months ago: bonds that were trading at a price of 70 before the May debt exchange are now worth around 107. And yet analysts remain bullish. “The strong first-half performance is proving that the recovery of the Dominican economy has been more vigorous than just about all predictions,” wrote JPMorgan analyst Ben Ramsey in a recent report. “While fiscal reform remains a key hurdle, the robust macroeconomic results continue to support our overweight recommendation on external debt.”
Upgrade
The ratings agencies are doing their bit, too. Fitch and Standard & Poor’s both took the country off their default ratings after the bond exchange, and gave it a single-B credit rating. In S&P’s case, the move from default to B with a positive outlook was the largest single upgrade in its history.
So if and when the Dominican Republic concludes its next round of negotiations with the Paris Club, it probably won’t be long before it starts tapping the international capital markets again. Investors are desperate for diversity and potential capital gains, while the country would surely love to be able to lock in funding at present very low levels – just as Uruguay has been able to do.
Once again, a country coming out of a distressed debt exchange is likely to be welcomed by the markets with open arms. Investors happily lent to the Mejía government and they will happily lend to this one, too – at even lower interest rates. No-one expects another default or restructuring, of course, but then again no-one seems to have learnt many lessons from the last one, either.
