A Caribbean Competitor

The Dominican Republic has undergone a remarkable transformation in the last decade. Ten years ago, the country hid behind trade barriers but now has one of the most open economies in the region. It has grown without interruption for nine years. Although the rate of expansion has slowed, the government still expects GDP to grow by an impressive 6% in 2002.

Confidence in pro-market economic reforms is waning across Latin America, yet the Dominican Republic is clinging firmly to the policies that delivered a decade of strong growth and is pressing ahead with structural reforms. President Hipólito Mejía recently warned Dominicans that while the unfavorable world environment threatened Latin America with another lost decade, it presents the Dominican Republic with fresh opportunities. “We need to be cautious and take opportune decisions,” he said. “We have taken decisions from the beginning of this administration that allow us to be better prepared to face the threats of an adverse international environment.”

Pursuing a free trade agreement with the US is the most important challenge for the Dominican Republic. It has signed free trade agreements with other Caribbean countries and it is included in the Caribbean Basin Initiative, but the US sidelined the Dominican Republic earlier this year when it agreed to initiate talks with Central American countries on a free trade agreement. “The most important issue for the Dominican Republic today in diplomacy is trade,” says Hugo Guiliani Cury, the Dominican Republic’s ambassador in Washington, and until this September, secretary of industry and commerce. Mejía met with President George W. Bush in Washington in July to push for a bilateral free trade agreement.

If the US were to grant Central America a preferential trade pact first, it would be a blow to the Dominican Republic, which competes directly with Central America in several industries. Guiliani claims the Dominican Republic risks losing US foreign direct investment, but investment by local companies could also dwindle. Investors in the country’s free trade zones would be tempted to move their operations to less costly countries in Central America. Losing out to the Central Americans could damage the country’s efforts to move away from textiles and light manufacturing toward more value-added goods such as electronics and medical equipment.

However, there are few Central American countries with a record of economic reform, growth and political stability to match that of the Dominican Republic. Most companies considering investing in the country are attracted by these achievements, as opposed to a plentiful supply of cheap labor. The country needs to continue attracting investment both to sustain growth and create jobs, and to broaden its industrial base. The government’s “Competitive Plan” identifies more than 60 farm products that the Dominican Republic could produce for export to the North American and European markets.

Developing agriculture could boost hard currency earnings and continue to reduce the country’s reliance on imported food. Mejía, an agronomist by training, stated in August, “The best demonstration of the success of the agriculture policy that we have executed is the reduction in imports, which was $150 million a year under the last government and has been reduced to less than $100 million a year in the last two years.” Supporting farmers could also help reduce the country’s poverty rates. The World Bank estimates that 22% of households in the Dominican Republic live below the poverty line. Mejía announced at the outset of his presidency that tackling poverty and improving education standards were to be his principal policy objectives.

Since taking office in August 2000, Mejía has brought a steady stream of reform legislation to Congress, passing some of it by presidential decree when necessary. Mejía has pushed 11 major reform packages through Congress since last year, including a reorganization of the social security system, revamping healthcare, amending intellectual property laws and boosting tourism development. The draft Financial and Monetary Code, which envisages making the Central Bank independent and making the banking system more transparent, is awaiting passage in Congress and should be signed into law in November. “The best and most complete indication of the stabilization of the financial sector is the independence of the Central Bank,” says Francisco Guerrero Prats, governor of the Central Bank.

Progress on Power
In September, Mejía outlined his strategy for tackling the electricity crisis that has dogged the country for years by promising to eliminate debts previous governments had accumulated with the private sector distribution companies. Insufficient investment in generating capacity and an overburdened transmission and distribution system have led to frequent blackouts. Privatization of part of the power industry in 1999 has increased capacity and reliability of electricity supplies, although outages are still common. Mejía’s policies have drawn criticism from the opposition Partido de La Liberación Dominicana (PLD), which accuses him of overpaying foreign companies in his haste to end the electricity crisis.

The opposition and the media also criticized the government after it successfully floated its first international sovereign bond last September in the wake of the terrorist attacks in the US. Politicians denounced the $500 million, five-year bond as irresponsible and challenged the government’s decision to spend the proceeds from the bond on infrastructure projects. Andrés Dauhajre, executive director of the unit in charge of the government’s external financing program, says bond investors clearly have confidence in the country’s economic management since the bond’s bid price hovers between 105 and 107 on the secondary market. Nevertheless, while infrastructure projects may increase the efficiency of the country’s economy, they do not generate hard currency revenues needed to pay service charges on the bond.

The government wants the rating agencies to upgrade the country in recognition of the reforms it has made since the agencies awarded the country a Ba2 and BB- long-term foreign currency rating in September 2001. “We made a compromise with Standard&Poor’s and we have to honor that compromise,” Dauhajre says. “The compromise was that we would not go back to them for additional revisions before the approval of the Monetary and Financial Code. We have to wait for its approval before we call our friends at S&P to start discussions again.” Officials say the country deserves a ratings upgrade because it was able to deal successively with severe external stresses in 2001 and 2002.

Despite the country’s accomplishments, Mejía recognizes that not all is well. “It is obvious that economic growth in 2002 was stimulated by a rise in internal demand that is not recommendable,” he said. “We consider it healthier to increase internal savings and cut expenditure. We must be responsible, and not play around with the economy.” Part of this rise in domestic demand has come from government spending on infrastructure projects. Since Mejía took office, the government has built or resurfaced over 1,000 kilometers of highways. Guiliani says sound management of the economy is sacrosanct and that is why the president will not disburse, at least for now, the $1.2 billion in loans originally promised various ministries for spending on public projects.

Boosting Investment
Instead, the government wants to attract private-sector investment to infrastructure projects. Governments past and present have rolled back the role of the state, leaving the Dominican Republic with one of Latin America’s smallest public sectors. The public sector accounted for less than 7% of GDP last year. However, a small government requires considerable commitment from the private sector to invest in public services, particularly utilities, and in the future, in managing a fully-funded pension scheme. The country depends heavily on increasing inward investment to sustain its growth rates. A drop in capital inflows would dent growth, undermine its export effort and make it harder to diversify the economy. The government has offered companies generous investment incentives. For instance, it offers a 10-year income tax holiday to local or foreign companies developing new tourism infrastructure such as marinas, ports and recreational resorts. It has successfully attracted foreign investment to some sectors that have languished for years, such as the mining industry.

Free trade zones also are an important part of the Dominican Republic’s development plans and it has defended them fiercely. In the World Trade Organization negotiations in Doha, Qatar, the Dominicans succeeded in extending the tax exemption laws for all developing countries with free trade zones for two years until 2009.