An attempt to analyze the Dominican Republic’s economy in a few words

By Odalis F. Marte

Despite not being a fully financially integrated developing economy, the Dominican Republic (DR) is considered to be an emerging market because the country has the ability to issue foreign debt that is traded in the international bond market. As such, it is subject to the effects of international capital flows, the monetary positions assumed by the developed economies, along with international financial conditions, especially those deriving from the United States’ macroeconomic policies.

As a small country from the Caribbean, the DR’s major trading partner is the US, which not only accounts for more than 40 percent of international commerce, but is also the main source of capital inflows. This way, the Dominican peso is predominantly pegged to the US dollar.

It is important to mention that the European Union, especially the Eurozone countries of Spain, Italy, France, and the Netherlands, are important trading partners, accounting altogether for close to 10% of the DR’s trade and also being a source of capital for the country. Finally, trade with Haiti is also significant, especially due to the high surplus maintained by the DR as a result of its exports to that market.

How is the DR doing in recent years?

According to official figures from the DR’s Central Bank (BCRD), the economic growth rate has been remarkable -- even by Latin American standards -- throughout the last several years: an average of 5.8 percent, during 1996-2002;  7.0 percent, 2004-2008. In 2003, the country experienced a calamitous bank collapse and the financial crisis that ensued was equivalent to about 20 percent of gross domestic product (GDP). During that time, the economy contracted by 0.3 percent, but rapidly recuperated, thanks to capital expenditures and consumption, made possible in part by an IMF Stand-by agreement, and an expansionary international business cycle.

The economic growth rate during 2008-2012 averaged 4.9 percent reflecting lagged effects of the international economic crisis, despite fiscal and monetary stimuli equivalent to more than 4 percent of GDP. It is important to note that the foreign exchange rate regime is, in practice, a crawling peg, so the major source for stimulating the economy comes from government expenditures. Although the DR has been subject to different external shocks in recent years (i.e., commodity prices, especially food and oil beginning in 2008, coupled with foreign credit restraints in 2009-2010), the exchange rate has not reflected this due to the central bank’s foreign reserve drainage and an increase in government debt (held in both  foreign and domestic currencies).

Graph 1 shows the consolidated public debt as a percentage of GDP, including the central bank’s debt. Since 2008, the country has been consistently increasing its borrowing, especially to finance public works in order to stimulate economic growth and keep the exchange rate (USD/DOP) relatively stable, with a depreciation rate between 2 percent and 4 percent from 2005 to 2012.

                                                           Source: Ministry of Finance and the Central Bank of the Dominican Republic.

It is important to note that in 2012 the consolidated public sector deficit, which includes the central bank’s losses, closed at 7.9 percent of GDP. This is explained by an excess of public spending -- higher than budgeted -- and including the quasi-fiscal deficit, which is roughly equivalent to 1.1 percent of GDP. At the end of 2012, a tax reform package was approved that combined an increase in taxes with a reduction in spending, which is expected to lead to a consolidation of 4% of GDP for 2013.

Graph 2 shows the external debt service as a percentage of tax revenues between 2004 and 2012. The effort the Dominican government makes to service its debt is an increasing burden on public finances. Efforts to normalize that ratio should embrace a long-term fiscal consolidation process, which would include a combination of increasing fiscal revenue and implementing measures to reduce less productive expenditures, coupled with a privatization process of certain government-own assets.

                                           Source: Ministry of Finance and the Central Bank of the Dominican Republic.

Graph 3 shows the external debt service as a percentage of exports. As the DR has been increasing its debt more than its exports between 2000 and 2009, the debt service has been accounting for an increasingly larger share of exports. This ratio has improved since exports have experienced some recuperation in recent years, but is still almost twice the level of 2000. 

 Source: Ministry of Finance and the Central Bank of the Dominican Republic.

A glimpse at the current account balance

The current account balance (surplus or deficit) as a percent of GDP can provide an indication of the level of international competitiveness of a country. Typically, countries recording a strong current account surplus have an economy heavily dependent on export revenues, with relatively high savings ratings, but probably weak domestic demand. On the other hand, countries recording a current account deficit have strong imports, a low saving rates and usually high personal consumption rates as a percentage of disposable incomes.

Emerging economies, which experienced growth rates that exceed the capacity of its domestic savings, tend to have some level of a current account deficit due to the use of foreign savings. The Asian experience of the 90s taught us that, among other reasons, a high level of spending and overconfidence by investors can lead to unsustainable deficits, which in the long-run could be corrected but only after unleashing a crisis. Crises like these show the importance of prudent management of the current account by the policy makers.

In the case of the Dominican Republic, it recorded a current account deficit of 7.2 percent of GDP in 2012, down from around 8 percent in 2011. It is important to note that the DR’s current account deficit to GDP averaged 3.13 percent from 1993 until 2012, registering a historic surplus of 5.10 percent of GDP in December of 2003 and a record deficit of 9.90 percent of GDP in December of 2008.