Market Call - February 2009

MARKET ENVIRONMENT

Overview

The Dominican economy has had some good news during the month of January, which has been tempered by the sobering reality of the global recession. The most important news was the second cut in the overnight rate and the rate at which the CB lends to other banks. More importantly, the banking system ended the year with a solid performance, with solvency and profits reaching record highs. It is also expected that inflation (though not yet reported for the month) will tend to be negative this month as well, as the government has reached agreements with importers to reduce the price of certain goods, even though gasoline prices have not decreased noticeably this month. Unfortunately, the global recession, and the concomitant decrease in local demand, has impacted several of the main sources of government revenue, including remittances, taxes on fuel and goods, as well as import duties. This has meant a decrease in government revenues, which has been met by increased internal financing. Equally worrisome is the fact that lay-offs in free zones and mining have totaled 126,000 by September of 2008, with more expected to be reported in the last quarter of 2008. Overall, it appears that caution is warranted in the 2009 outlook for the DR economy, substantiating predictions by the IMF that, for example, the growth in GDP predicted for 2009 will be 1.8%.

International Impacts

The US stock market continues to vary considerably from week to week: the last week of the month of January, stocks enjoyed gains throughout the first three trading days, only to experience major selloffs Thursday and Friday. Early in the week, investors helped pull the markets up as they scooped up bargains from last week’s declines. Much of this was based on reports that December existing home sales rose by 6.5% from the previous month, topping forecasts, and that the index of leading economic indicators rose 0.3% in December, also inspiring confidence. This was coupled with news of the stimulus package and President Obama’s “bad bank” plan, which gave a much needed boost to financial stocks. As has been the case, bad news chased the good, as dismal corporate earnings reports and news of large layoffs across the country were also reported. To this was added to a report that new housing sales reached a record low and that new initial unemployment claims reached record highs. A Commerce Department report on the last Friday of the month showed that the economy contracted at its fastest pace in almost 27 years in the fourth quarter. The only silver lining on the horizon is the stimulus package currently under discussion in the Senate. Also on the bright side, oil remains at around US$ 42 per barrel.

As commented last month, the weaker US economy impacts the DR economy directly, hurting exports and curtailing access to financing for tourism projects and other types of direct investment. The lower price of oil gives some relief to external accounts, but it might not be enough to offset reduced exports. Already, some effects are being felt: as a result of the economic contraction caused by the global economic crisis, the year has begun with less money entering the national coffers. According to official figures, as of 19 January 2009, collections have fallen by RD$9.43 billion after reaching RD$12.4 billion during the same period in 2008. The greatest reduction came in customs collections, which went down from RD$2.952 billion to just RD$1.70 billion for the period. This was influenced by two elements: the crisis and the lowering of tariffs according to international agreements. In the case of the Tax Department, collections fell from RD$7.97 billion to RD$6.215 billion. At the same time, Treasury receipts also went down from RD$1.4 billion to RD$1.35 billion. These figures do not include foreign or local loans. According to newspaper sources, one element that stands out is the fact that income from the selective tax on fuels fell from RD$862 million to RD$331 million. Collections for this tax represented 38.4% of what was collected in the former period and 52.9% of what was budgeted. This could provide an explanation for the very controversial increase in the price of fuels in January, despite the fact that world oil prices have maintained low.

Inflation

Inflation for the month of January has not yet been reported. The expectation is that it will tend to be negative, especially since the government finally convinced importers to reduce prices by 15%, the amount that the government estimated is above what prices should be at considering reductions in the price of oil and the reduction in the international price of food and other commodities.

Despite the fact that the price of oil has dropped by more than 70% over the last six months, the cost of many basic consumer goods in the Dominican Republic remains very high. According to newspaper sources, on the New York Stock Exchange, a barrel of West Texas Intermediate cost US$147 on 11 July 2008, and as of late January 2009 the price was around US$42.00, a decrease in over US$100 dollars. But there are still many products that have gone up considerably, and are still the same or even priced higher than what they were when the price of crude oil was at its highest. The National Food Retailers Federation (Fenacodep) says that this is because many industrialists and importers need to reduce their inventories before they can reduce prices. If this is the case, the adjustment should be felt in January, or February at the latest.

Government sector

The IMF expressed its support for economic policies implemented by the Dominican government to help protect the economy from the effects of the economic financial crisis that began last September, including the DR’s ability to maintain exchange rate stability. In its review of the DR’s post Stand-by Arrangement monitoring program, the IMF says that proper fiscal planning in 2009 will help ease external pressures and create a margin for monetary flexibility. The report says that the IMF is satisfied with the government’s macroeconomic policies, which seek to rebalance fiscal and monetary policies, aiming to place the DR in a position to effectively deal with international financial concerns. The report highlights the capitalization of the nation’s banks, their liquidity and their profitably and the fact that recent stresses have proved they can handle shocks to the markets, but warns that if external pressures continue the DR must be ready to apply even more flexible exchange rate policies. However, according to IMF projections, the DR’s GDP growth will only total 1.8% due to external economic pressures. This is visibly lower than the 3% projection by Dominican authorities, and lower than the 4.8% and 8.5% economic growth registered in 2008 and 2007. The Economist Intelligence Unit forecasts a contraction of 0.8%.

The government is trying to meet its obligations, particularly to energy generators. The government will undertake payment of some of the debt it has with electricity generators through a bond issue for US$250 million. The total debt comes to more than US$700 million. The generators, nonetheless, have conditioned their acceptance of the payment because they have not been told when the bonds come due or the condition of the rest of the debt. Pedro Pena Rubio, Coordinator of the CDEEE Distribution Committee says that authorization from the Ministry of the Hacienda is pending, and this will determine the conditions and the interest rate that will be paid.

On the negative side, financial analyst Alejandro Fernandez Whipple mentions that pension plan savings by Dominicans are being increasingly invested in government securities. “Money belonging to Dominican workers is being invested to sustain government deficits, contributing very little to the creation of value in the Dominican economy,” he points out. Though this is legal, the argument is that the government is lending money to itself, via the decentralized but state-controlled Banco de Reservas, thus helping to finance its own deficit. Fernandez suggests that the government instead needs to reduce its spending.

However, instead of reducing spending, the Tax Department (DGII) is finding ways of increasing collections for taxes already on the books. To this end DGII has updated the way assessors value a property with the intention of increasing collections on taxes on real estate properties (IPI) or taxes on homes or plots considered in the luxury residence category (IVSS) for the 2009 fiscal year. According to newspaper sources, once the adjustments are made by the DGII a house that was valued at RD$4 million in 2005 could now be valued at RD$6 million, and will have to pay 1% of its value in taxes. The government also raised the departure fee for all passengers leaving from the Dominican Republic, from US$10 to US$15, parts of which will be directly used to fund various government initiatives. Other initiatives are currently being discussed in order to raise money for the increases in the salaries to doctors, which include taxing capital gains and increasing the tax on bank payments or transfers.

Dollar-Generating Industries

Freddy Ortiz, president of the Dominican Association of Remittances Companies (ADEREDI) said yesterday that 2009 could see a steep decline in remittance levels as a result of the recession that hit the US in late 2008, as reported in El Caribe. It has been expected that the DR would follow the present regional trend of reduced remittances. Ortiz added that since August 2008 there has been a downward trend in remittances to the Dominican Republic compared to previous years. He explains that from January to September 2008, remittances were RD$2.33 billion, which was US$109.9 million more than last year, for a low 5% increase so far. He says there has been a significant decline in remittances as of August, reflecting the number of Dominicans losing their jobs in the US and Europe. Ortiz says the outlook for 2009 is bleak and that recent news reports coming in from the US and Europe focus on the downturn.

Thus far, we maintain our predictions of last month that FDI flows will also be affected. A positive note is the recent call by Fernando Gonzalez Nicolas, president of the Commonwealth Round Table in the Dominican Republic, encouraging Dominicans to seek new business, investment and trade partners in the 53 countries that make up the Commonwealth. “The current global crisis means that public and private sectors should redouble efforts in place to diversify Dominican trade,” and that they should reach out to non-traditional partners. Gonzalez feels the DR could develop more business, investment and trade with India, Australia, New Zealand, South Africa, Singapore, Malaysia, Canada and Great Britain, among others. He sees new markets for Dominican rum, cigars, bananas and a selection of industrial free zone products.

In recent declarations, the top executives of the nation’s free zone companies hope that the 53 industrial free zones and their 530 companies and 130,000 employees will get the needed boost for the sector that exported US$4.5 billion last year. Lower demand has slowed down their activity significantly.

Domestic Demand

The Association of Vehicle Producer Concessionaires has announced that new car sales dipped by 29% in 2008 and forecasts a similar trend for 2009. Acofave indicates that vendors will sell 12,000 new vehicles, at most. Acofave director Enrique Fernandez said the situation could be similar to the one in 2003, which was the worst year for car sales in recent history. Fernandez said that an increase in bank interest rates have adversely affected car sales. Fernandez is calling for lower interest rates, a review of vehicle importation laws and a review of transport taxes paid for the right to drive a vehicle.

Dominican banks finished 2008 with assets totaling RD$596.5 billion, for an increase of RD$60 billion over 2007. Bank Superintendent Rafael Camilo also announced that banks made RD$12 billion in earnings, RD$2.6 billion more than in 2007. He said banks paid RD$3 billion in taxes in 2008. He also explained that credit increased by 17.2%. Bank solvency rate also registered an increase of 1.4%, reaching 14.5 in 2008.

Exchange rate

There was a clear upward trend in rates in the month of January. Not surprisingly, the EIU forecasts a real depreciation of around 8% in 2009 (to a rate of around 41 pesos to one USD) followed by a more moderate depreciation in 2010. This is mainly due to a reduction in fiscal income and a worsening international environment. The Central Bank has been able to intervene to prevent a sharper deceleration in 2008, but it is not clear if it will do so in 2009, especially given the warning by the IMF regarding this type of intervention.

Fixed Income Market and RatesThe Central Bank has again cut the interest rates it is paying on deposits. Overnight deposits are now at 7%, down from 8.5%, and Lombarda deposits at 12.5%, down from 14%. It also reduced 2% from interest rates on all certificates of deposit. This is the second cut in less than a month.

It is expected that the Central Bank will continue reducing rates in 2009 to help arrest the decline in internal demand, but it also needs to keep an eye on the exchange rate. According to the EIU, further rate cuts will also be complicated by the need to manage the large stock of Central Bank certificates issued in the wake of the 2003 banking collapse, which amount to the equivalent of 18% of GDP, and impose a quasi-fiscal servicing cost of an estimated 1.3% of GDP. Too sharp a reduction in interest rates could fuel capital flight.

Weighted average commercial lending rates remain around 24%. Annual private-sector credit growth slowed sharply in 2008 to just 8.4% (down from 31% in 2007). The main monetary aggregates have been shrinking since June 2008, with the decline deepening sharply in October-December 2008.

A positive note has been the recent reduction in the rates of letters with maturity between one month and one year. Though the rates ended higher for the last week of January, the average for the month was a decline in comparison to December.