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Dominican Republic: Poised for Growth
LatinFinance / March 2006

By Larry Luxner

Despite vague rumblings about another banking collapse barely three years after fraud and mismanagement nearly destroyed the country's financial system, the Dominican economy seems headed for another year of prosperity.

Observers say the Dominican Republic will enjoy GDP growth of at least 5% in 2006, following last year's impressive 9.3% showing, according to the Central Bank.

"The economy's doing very well," said Frederic Emam-Zade, director-general of the Fundación Global Democracia y Desarrollo - a think tank created by President Leonel Fernández, who returned to office in August 2004 following a four-year hiatus. "I don't look so much at the rate of growth, but rather at how many sectors of the economy are growing. Two years ago, all 15 sectors were going down, and now 10 out of the 15 are up. As usual, the fastest-growing sectors are free zones, tourism, telecommunications and construction."

The UN's Economic Commission for Latin America and the Caribbean (CEPAL) also predicts 5% growth in 2006, noting in a recent report that "fiscal and monetary discipline permitted the rapid stabilization of the Dominican economy." CEPAL foresees inflation running at 6% to 8%, and unemployment hovering around 18%.

This is in sharp contrast to 2003, when GDP fell to $16.8 billion from $21.7 billion the year before, following the collapse and government bailout of Banco Intercontinental S.A. (Baninter), then the country's third-largest bank.

In May 2003, following the discovery by investigators that Baninter had altered its books to cover up massive bad loans, the Central Bank - under former President Hipólito Mejía - paid $2.2 billion to assuage the bank's largely wealthy depositors. To cover its losses, the government began printing money, sparking a massive devaluation of the Dominican peso, which fell from 26 to the dollar to 57. Two other banks - Bancredito and Banco Mercantil - also collapsed.

Emam-Zade places the blame for the banking crisis squarely on the Mejía administration.

"The government was spending way too much money and they had to borrow internally and externally. But internally, the funds are very limited. The country ran into a very strong deficit, and had to go not only to foreign borrowing, but also to the local credit market. This dried up the market and crowded out everybody else, causing a recession. Interest rates almost tripled, inflation took off and there was capital flight; close to $3.5 billion left the country. All they needed was a little panic and it happened. There was a run on the banks, and the most vulnerable bank was Baninter."

All told, the crisis cost the Dominican Republic about 15% of its GDP and sent an estimated 1.6 million people into extreme poverty. Before Baninter blew up, about 4.6 million Dominicans were living on $2 a day or less. That number has since risen to 5.8 million, or 62% of the population, according to Emam-Zade.

"People lost more than half their income in a one-year period," he said. "This crisis will take us six, seven, eight years to get out of."

In December, Bear Stearns lowered its recommendation on Dominican Republic debt to marketperform from outperform, in part because of an investigation that the Dominican government launched into Banco del Progreso earlier that same month. "When there's noise related to a bank, it's going to bring back bad memories," explains Franco Uccelli, the fixed-income analyst with Bear Stearns who called for the downgrade. "If the bank is not entirely forthcoming, it raises some concerns."

Dominican authorities are questioning the bank's parent company, Grupo Progeso SA, about a commercial paper deal it issued worth RD$9 billion ($250 million). Shortly after the debt was issued, rumors of fraud began to circulate, and the bank's board fired Banco del Progreso president Pedro Castillo. Key shareholders then assumed the chairmanship of both the bank and its holding company, and pumped in $280 million to liquidate all the financial group's liabilities.

"The expectation is that things will indeed blow over, and that systemic risk is unlikely because of Banco del Progreso's troubles," says Uccelli. "It's just that we wish we had more clarity on the issue, and there's been a general hesitation on the bank's part to say much."

On February 9, Banco del Progreso's existing shareholders announced they would inject RD$14 billion ($400 million) to cover losses and supply the bank with fresh capital, without requesting public funds. Before the crisis, the bank's total capital was no more than RD$2.3 billion ($67 million). They are also suing former Castillo in a Miami federal court and in the Dominican Republic, alleging fraud, money laundering and other crimes.

In spite of the controversy, Uccelli says he remains bullish on the Dominican Republic's short-term macroeconomic prospects. He also highlights some obstacles ahead, such as a slow-moving legislative process that has stalled the implementation or even passage of much-needed reforms. "Deliberations have, at times, been painfully long and legislative outcomes somewhat insufficient."

Eddy Martínez, the country's minister for exports and investment, admits that the country still has "a rather cumbersome process for approving investment projects - not so much for free-zone manufacturing but certainly for infrastructure projects. The approval process is lengthy."

At present, the Dominican Republic has 58 industrial parks, 30 of them privately owned and the rest state entities. Within those free zones, there are 540 companies employing around 170,000 people, more than half of whom are women. In 2004, the zones exported a combined $4.4 billion worth of garments, high-fashion apparel, cigars, electronics and medical devices, mostly to the United States.

José Manuel Torres, executive director of the Dominican Association of Free Zones Inc., said competition from China cost the Dominican Republic more than 32,000 apparel manufacturing jobs last year, though ratification of DR-CAFTA offers the country an excellent chance of regaining some of that lost competitiveness.

Torres said that in addition to improved U.S. market access for specific products like footwear and jewelry, DR-CAFTA - which will likely come into effect July 1 - offers investors certainty.

"Instead of just renting space to manufacture, you can buy it and invest with a more long-term scenario," he explained. "That will definitely be a big attraction for potential investors to come to the Dominican Republic and establish a business, with the objective of exporting goods or services to the U.S. market."

While allegations of mismanagement at Banco del Progreso - which had also previously backed out of a deal to take over Baninter - continue to cloud the country's prospects, most observers agree that poor educational standards and continuing problems in the energy sector represent a much more serious threat to the nation's long-term economic future.

Financial analyst Alejandro Fernández, who helped the Superintendency of Banking restructure the system following the last collapse, said he's confident the Banco del Progreso scandal won't lead to another crisis.

"It's kind of disappointing that we had this crisis two years ago, cost us 20% of our GDP and supposedly safeguards were put in. You would figure this wouldn't come to pass, but it did," said Fernández, director of the BetaMetrix SA consultancy. "The key issue is the way the authorities have dealt with it. There's been no use of public funds and the shareholders have the discipline and responsibility to do what they have to do - in this case, bring in money, which is different from what happened before."

Emam-Zade calls the Banco del Progreso episode "a storm in a glass of water" because he sees the magnitude of the problem as nowhere near that of Baninter or other financial fiascos. "It's a relatively small bank, whose shareholders are some of the oldest and wealthiest families in the country. Any one of them could face up to the problems of Banco del Progreso. They have the money, and more importantly, they have the will."

Kevin Manning, president of the American Chamber of Commerce of the Dominican Republic, also discounts the possibility of another banking collapse. "I think the owners of Banco del Progreso have taken adequate steps to keep the bank out of a distress mode. It's operating, there's been no run on the bank, and in the meantime, the investigation is going on. This will not result in any major economic impact."

President Fernández, referring to the banking crisis during a recent speech to U.S. telemarketing executives in Santo Domingo, said "our first goal has been to regain investors' confidence and make a turnaround, harmonizing monetary and fiscal policies. Because of that, we have been able to attract $1 billion in tourism infrastucture, and major investments in free trade zones."

Manning notes that in the last 20 years, the Dominican economy grew an average 5.5% a year - the best performance of any Latin American country including Chile. "This country has had tremendous success, and the present government has been very instrumental in bringing the country back up after the Baninter failure," he said. "Economic stability has returned, growth is back up there and inflation is in the single digits again."

Foreign investment is returning as well, spurred on by the country's recent ratification of the DR-CAFTA agreement. Last October, the $113.5 million Cementos Dominicanos cement factory - built by Italian and Dominican investors - was inaugurated in San Cristobal province. The plant is the largest and most modern Portland cement and clinker plant in the Caribbean, and is expected to produce one million metric tons of cement and 850,000 tons of clinker per year.

In addition, Canada's Placer Dome is spending $1.5 billion to develop the Pueblo Viejo gold mine. The project is expected to produce 12 million ounces of gold at an average cost of $200 to $210 per ounce over a 20-year period.

Telecommunications giant Verizon is now the largest single foreign investor there, thanks to a telecom explosion that has seen more than 860,000 wireless lines added during the first nine months of 2005. As of Sept. 30, according to regulatory agency Indotel, there were just over 3.4 million cellular lines in the country, up 23% from a year earlier. In fact, so many people have signed up for mobile phone service that the Dominican Republic has just secured a second area code, 829, to stave off a looming number shortage.

Likewise, the Santo Domingo CyberPark has received an infusion of $250 million in investment projects by foreign firms in the fields of telecom, IT, robotics and microelectronics. These include Caribbean Custom Mold, Brightstar, Interdom, Quick Cash Inc., UVColor, Super Clik and Tansource PBO Solutions.

The Cyberpark - located five minutes from Santo Domingo's Las Américas International Airport - is also at the epicenter of the Dominican Republic's growing role in telemarketing and outsourcing. According to President Fernández, no less than 12,000 Dominicans are now working in 35 call-center companies, lured to the country by low wages and large numbers of people who are fluent in both English and Spanish.

"We must transform our economy from a low-end assembly center to a knowledge-based center of excellence," he said. "I see the digital economy as the best opportunity we in the Dominican Republic have ever had of leapfrogging to a new level of economic development. For the first time in our history, we have a chance to eradicate poverty and increase our standard of living to an unprecedented level."

Yet Manning criticizes this and previous administrations for not placing a higher priority on education - especially in rural areas - in a country with a 15% adult illiteracy rate and notoriously bad public schools.

"We can't see the Dominican Republic maintaining its economic growth under the intensifying competition in global markets," he warned, "unless the government begins to improve the overall education of its citizens."

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