Why is Dominican Republic improving? Is it due to political stability or a resilient economy? Interview with Euromoney Country Risk.

 

1. Why is Dominican Republic improving in your opinion? Is it due to political stability or a resilient economy?

In my view, the DR’s economic performance can be attributed to a combination of factor that includes good policy and, perhaps, good luck. Let me elaborate a little bit. The pandemic found the DR with relative strong macroeconomic fundamentals as inflation was low and economic growth high. Also the smooth political cycle change in 2020 gave the private sector the needed confidence to assume policy continuity with the new ruling political party (after 16 years under the Dominican Liberation Party, voters elected the opposition Modern Revolutionary Party headed by current president Luis Abinader).

President Abinader chose not to replace the central bank governor as his experience was perceived a needed to face the policy challenges of the pandemic, which was welcomed by the private sector, especially financial institutions and creditors.

To absorb the pandemic shock, the DR’s central bank implemented a broad set of expansionary monetary measures, including MPR reductions and liquidity provision pushing interest rates downwards. On the fiscal front, although in 2020 the government spent in many social programs to help needy households and businesses, in 2021 the fiscal policy has been noticeable conservative. In fact, the public sector has effectively controlled government expenses so fiscal policy remains less expansive than expected; and the government has ruled out implementing a fiscal reform in the short term.

Also, the fast recovery of the US economy has meant a fast recovery of sectors linked to international trade, especially free zones and tourism. Also remittances have increased substantially. 

As a result, according to official data, economic activity is expected to grow at around 10% for 2021, while improvements in the labor market continue. Recently, the DR government estimated the economy just reached the employment level prior to the pandemic.

It is important to say that, to face the challenges of the pandemic, the DR has increased its public debt substantially. Consolidated public debt would have reached 69.2% of GDP in 2020, which implies an increase of 18.7 percentage points of GDP compared to 2019.

2. How has the pandemic had an impact, how is the country coping with it, and what is the outlook for key exports and the tourism industry?

As a recent study reveals, the impact of the coronavirus meant losses in the level of production, higher levels of unemployment and depreciation of the real exchange rate. Not different as what happened in many countries. The pandemic shock not only implied a fast raising unemployment, but also falling tax revenue as the government had to spend more con face the covid-19 outbreaks. Nonetheless, the DR was quick to start vaccinating massively its population against the virus while gradually lifting mobility restrictions coupled with economic policy stimulus. It is important to mention that private sector responded as expected to the monetary policy stimulus. In fact, according to the DR’s central bank, As a result of the expansive monetary policy stance, market interest rates have fallen to historical lows and loans to private sector have grown strongly at around 10 per cent.

The external sector continues to improve, with higher tourists arrivals and sustained growth of remittances and exports. Exports are over 24% up by august 2021, while tourists arrivals grew over 90% during the same period, thus current account deficit projections for 2021 are 1.0%-1.6% of GDP, according to the Central Bank of the Dominican Republic.

Further improvements from the external sector of the Dominican economy are linked to the evolution of the pandemic both domestically and internationally. 

3. Has corruption improved as a result of the long running trial involving Odebrecht?

As the Dominican government has pledged an independent prosecution against corruption (free of political interference), public confidence in democratic institutions seems to have arisen as the public perceives less tolerance for corruption in the government.  

In fact, in one year president Luis Abinader has dismissed some high ranking government officials including ministers due questionable behavior while in duty just to signal no tolerance to corruption in his administration. 

4. Any other comments you wish to make e.g. foreign policy (Haiti), the currency, institutional risks, bank stability?

Haiti is the main national security threat to the Dominican Republic as the instability in the neighboring  country grows and migratory pressures increases. Nonetheless, the Dominican Republic government is establishing alliances with other nations, especially Panama and Costa Rica (which seems to be well seen by the US government) in order to face those challenges involving those countries’s private sector and looking to promote investments along the DR-Haiti border as well as in Central America.

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.

Better skilled labor supply and trained entrepreneurs: a challenge for the Dominican Republic

By Odalis F. Marte

Frequently, business managers complain that the universities are not producing the kind of skilled labor supply they require noting that the market needs less lawyers and more engineers. Furthermore, there is a shortage of skills in certain trades such as plumbing, mechanics, etc.  There is a mismatch between demanded skills and what the labor market offers to employers in the Dominican Republic, which is consistent with a global shortage of skills[1]. That disconnect reflects the absence of coordination between the public and private sectors and a failure to  harmonize curricula in order to meet businesses’ needs, while at the same time, the historically low investment in education in the country.

To cap the skill shortage, both private and public sectors can cooperate in order to establish training programs to better serve the real needs of businesses for specific skills. Those training programs can be both in trade schools and at the college level. In the DR, the National Institute for Technical and Professional Training (INFOTEP) exists, a trade school that has served the private sector with technicians for several years. Also, the country has numerous universities, including a public one, that pretty much offer the same types of subjects although with different levels of quality.

The DR is somehow offering financing and training programs to its entrepreneurs since management skills can boost productivity as we have seen throughout the international experience. Lots of people operating micro- and small businesses don’t have a notion of basic accounting and don’t use banks. More education in general and institutional changes to ease financial integration of small business is necessary.

Competition in the markets would tend to enhance the quality of management as well as the need for better trained labor supply, as well as institutional reforms to improve the business environment.

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[1] http://www.internationalbusinessreport.com/Press-room/2013/skills.asp. In different proportions, Latin America lacks sufficient skilled labor to supply the increasing demand for well-trained personnel.

Informal Sector in the Dominican Republic: Thinking about solutions

By Odalis F Marte 
     @ofmarte

In the context of the Dominican Republic´s (DR) economy, informality is an absolutely critical issue, reflecting both the inability of the economy to generate enough formal businesses and thus jobs because of structural constrains, and also inadequate labor market policies, especially those implemented in the last few decades. In the DR, around half of those employed works in the informal sector (http://www.bancentral.gov.do/publicaciones_economicas/otros/mercadolaboral_informalidad.pdf). According to the World Bank, “Informality can be defined along different dimensions such as operating without registration, income tax evasion, labor tax evasion, or operating outside the legal framework of an economy”. (http://www.enterprisesurveys.org/data/exploreTopics/Informality)

Policies for the labor market can be focused toward protecting jobs or protecting workers. Many developed countries (before the onset of the financial crisis in 2008) were considered operating close to full employment and as a result, labor policies tended to move from protecting jobs to systematically protecting workers. That scheme proved not to work for developing countries as the lack of opportunities in the labor market only pushed workers and businesses to the informal sector.

To reduce the informality in the DR, the government should engage in short-to-mid term microeconomic reforms to render the labor market more flexible and thus boost business and employment:

1.       Implement targeted employment programs throughout disadvantaged communities;

2.       Modify labor code to make it less costly for businesses to hire employees;

3.       Simplify tax code to make it easier for business to register and pay taxes, eliminating incentives to remain informal;

4.       Implement policies to promote more competition in the domestic market in order to expand entrepreneurship letting more people to start new businesses;

5.       Facilitate more access to financial services to small business.