Country Report Dominican Republic
Despite the Dominican Republic’s good economic performance in recent years, it has not been able to improve its weak external position. The latter is reflected by a low level of FX-reserves, a current account deficit and a large external debt stock.
Strengths (+) and weaknesses (-)
(+) Diversified economy
A relatively high degree (at least by Caribbean standards) of economic diversification, which makes the economy less vulnerable for an economic shock in a particular sector.
(-) Social issues
Social inequality, electricity shortages, illegal immigration from Haiti, insecurity, corruption,and insufficient investment in the education and health sectors are potentially destabilizing factors.
(-) Weak external position
The Dominican Republic’s external position is weak, due to a low level of FX-reserves, a current account deficit and a relatively large external debt stock.
(-) Limited access to foreign currency income and loans
Tourism, workers remittances and favourable loans from Venezuela are the only important FX sources of the Dominican Republic.
1. Economic performance
After a broad-based economic expansion of 3.9% in 2012, the economy of the Dominican Republic started to slow down at the start of 2013. In the first quarter of 2013, GDP growth fell down to 0.3% year-on-year, but growth picked up again in the two following quarters. In the first quarter, the contribution of consumption to growth was negative, as a result of pre-election spending in the year before. In the two following quarters domestic consumption started to pick up again, due to higher fiscal spending and looser monetary policy. As exports were rising, while import fell, the external sector contributed positively in all three quarters. All in all, the economy is expected to have grown by 2.9% in 2013 and to grow by around 4.3% in 2014.
2. Government finances improve
In the run up to the presidential elections of May 2012, government consumption grew considerably (figure 1 and 2), resulting in a deterioration of the budget deficit to 6.6% of GDP in 2012. After the inauguration of president Danilo Medina in August 2012, a significant tax reform was passed in Congress. The tax reform, including an extension and raise in the VAT rate, had the aim to increase government revenue by 1.6% of GDP. The raise of the value-added tax rate signals that the government is willing to bring public finances in order. In addition, more revenues were raised through a renegotiation of the terms of a contract with Pueblo Viejo Dominicana, the operator of an important gold mine. The government argued that the original contract, which was approved by congress, was too generous. Thanks to the renegotiation, the government will receive six times the amount it otherwise would have received in the next four years. However, the renegotiation of the mining contract with Pueblo Viejo Dominicana may put off future investors. What is more, the highly inefficient and costly energy sector (see paragraph below) still forms a large risk for public finances, as the government subsidizes the sector considerably. In 2012, an IMF advise to lower the subsidies to lower the fiscal burden, was disregarded by the government, as this would feed social unrest. As a result of this disagreement a standby agreement by the IMF was terminated.
3. Still poor performance of the energy sector
The energy sector is affected by several structural problems. First, as the Dominican Republic lacks domestic energy sources, the private energy producers have to import expensive foreign energy. Second, the public energy transportation network is poorly developed, which leads to frequent energy blackouts. Third, high non-payment ratio and electricity theft increase the costs for electricity producers. To keep the sector running the government subsidizes it by USD 1.5bn per year, which corresponded with 8.3% of government expenditure in 2012 (figure 2). Since it is questionable whether the government is willing to reform the sector, it may renegotiate contracts. This could have a negative impact on investment in energy production, which may worsen the energy problems, and could also have a negative impact on business confidence in general.
4. External position remains weak
Two bond issues in 2013 have improved the Dominican Republic’s FX-reserves position. A USD 1bn bond was issued in April 2013, followed by a USD 500m issue in October. However, for the medium term there are still considerable risks regarding the Dominican Republic’s external position. First, an import cover of just 2.8 months in 2013 must be considered as low. Second, despite the earlier mentioned fall of the current account deficit, the Dominican Republic is still running a sizeable current account deficit, estimated to be 3.3% of GDP in 2013 (figure 3). Third, if Venezuela changes the conditions of its favourable oil program (low interest rate loans), the Dominican external debt may become a real burden on government finances (figure 4). The latter has become more likely as macroeconomic imbalances in Venezuela are deteriorating rapidly.
After periods of dictatorship (1930-1961), civil war (1963-1965) and autocratic rule (1966-1978), the Dominican Republic became a representative democracy in 1978. The Dominican Republic’s institutions and rule of law remain fragile, but the political system has become more stable, as electoral periods have become marked by less tension between political rivals, although such frictions still exits. Current president Danilo Medina started his four year term in 2012. His party (Partido de la Liberación Dominicana (PLD) has a majority in both chambers. The fact that Medina appointed most of the ministers of his predecessor Fernández (also PLD), and that Margarita Cedeño – Fernández’s wife – is the new vice-president, underlines that Medina aimed to stick to the pro-business agenda of his predecessor. By Caribbean standards, the Dominican Republic’s economy is relatively well diversified as the economy not only relies on tourism, but also agriculture, mining and manufacturing. However, the foreign currency income structure is undiversified, as remittances and tourism are the sole major sources of foreign currency. While the country has close links with (the rest of) on Spanish-speaking Central America, which is reflected by the country’s membership of the Dominican Republic-Central America Free Trade Agreement (DR-CAFTA), the US is by far the most important trade partner. Finally, the country is vulnerable to natural disasters. Although the Dominican Republic itself escaped from the earthquake that destroyed large parts of the Haitian capital Port-au-Prince in 2010, it was indirectly affected since illegal immigration from Haiti rose strongly. The latter triggered fears of insecurity and crime.