Dominican Republic W/TPR/S/11 Page 1

I. THE ECONOMIC AND TRADE ENVIRONMENT

(1) Major Features of the Economy1

1. The Dominican Republic is located in the eastern half of the Caribbean island of Hispaniola (with Haiti on the western half). It has an area of 48,442 km2. In 1993, the population was around 7.5 million; population growth has declined to around 2 per cent in the 1990s from 2.7 per cent in the early 1970s. The urban population is increasing, amounting to 63 per cent of the total in 1993 (Table I.1). The Dominican Republic is endowed with different types of soil suitable for agriculture and is rich in minerals; its traditional production structure has been in agricultural goods such as sugar, coffee, cocoa, and tobacco and in the exploitation of minerals such as nickel, doré (a gold and silver alloy) and bauxite. The abundance of labour and the proximity to the United States have been important elements in the rapid growth of exports, mainly of clothing, from free zones (Chapter V(4)); furthermore, a buoyant tourist industry has developed around the many attractive beaches (Chapters V(5)).

Table I.1 Major features of the Dominican Republic economy (1987 prices) 1970 1975 1980 1985 1990 1991 1992 1993 Population (thousands) 4,423 5,049 5,697 6,376 7,110 7,247 7,387 7,543 urban population (per cent) 40.0 45.3 50.5 55.7 60.4 61.2 62.1 62.9 Current GNP per capita (US$) 340 720 1160 760 890 1010 1170 1230 Labor force (thousands) 1,157 1,340 1,571 1,862 2,187 2,251 2,317 2,384 Female participation (per cent) 11.0 11.7 12.4 13.7 15.0 15.3 15.6 15.9

GDP at constant market prices GDP (US$ million) 2,184 3,345 4,240 4,588 5,493 5,545 5,975 6,151

Share in GDP Agriculture 27.6 20.9 20.0 20.3 16.0 16.5 16.2 15.8 Industry 23.7 29.2 28.4 26.2 24.6 23.5 24.6 24.2 Manufacturing 15.4 15.7 15.3 13.7 12.5 12.3 12.9 12.6 Services 48.6 49.9 51.6 53.5 59.4 60.1 59.2 60.0

School enrollment ratio Primary 100 104 118 126 ...... Secondary 21 36 42 51 ......

... Not available

Note: Education ratios may exceed 100 per cent where children outside the normal school age are attending school.

Source: World Tables 1994/95; and IMF, IFS.

2. The Dominican Republic is a middle-income developing country; in 1993, the current per capita GNP was US$1,230. Throughout the 1980s (and particularly after 1985), real GDP movements became

1The principal data referred to in this Chapter correspond to the tables and charts which are based mainly on World Bank, IMF and UNSTAT data. Other data were provided by the Government of the Dominican Republic. W/TPR/S/11 Trade Policy Review Mechanism Page 2 increasingly erratic, reflecting macroeconomic instability (Chart I.1). After a downturn in 1990, real GDP growth recovered during 1991 and 1992. In 1993, the growth rate decreased but it has remained positive; according to more recent data provided by the Dominican authorities, GDP growth stood at 4.3 per cent in 1994. A comparison of social indicators during the period 1970-75 and 1987-92 demonstrates a general improvement in the well-being of the population. Life expectancy increased from 60 to 68 years, while infant mortality decreased from 80 to 41 per thousand live births, and the total fertility rate decreased from 5.8 to 3 births per woman.2 However, access to secondary education remains low (although growing rapidly), which in the long run could become a major constraint to increased productivity and economic growth.

3. The economy, traditionally based on agriculture, is now dominated by the services sector - particularly tourism - which represented 67 per cent of GDP in 1993 (Chart I.2).3 Manufacturing, heavily dominated by the free-trade-zone-based clothing industry, makes the second largest contribution to GDP, followed by agriculture and mining. The agricultural sector did not perform well during the 1980s, its share in GDP declining consistently throughout the period. The poor performance of the

2 World Bank (1995). The Dominican authorities estimate that life expectancy increased from 55 to 70 years, while infant mortality decreased from 80 to 28 per thousand live births.

3According to Table I.1 the contribution of services to GDP is 60 per cent; this is based on World Bank definitions under which construction and energy are included in industry. Chart I.2 is taken from the Boletín Trimestral ofthe Central Bank of the Dominican Republic. The authorities have indicated that services accounted for 57 per cent of GDP in 1993. Dominican Republic W/TPR/S/11 Page 3 sector can be attributed to the negative impact of macroeconomic policies, deteriorating terms of trade, unfavourable conditions for exports of traditional agricultural products, and a lack of entrepreneurial skills and new production technologies. However, agriculture is still the most important sector in terms of employment and output for domestic consumption.

4. As in many developing economies, the informal sector appears to be large. While no official data on its share of GDP exist, it is estimated that 35 per cent of the labour force was employed in agriculture, either commercial (sugar, coffee, tobacco) or food crops (rice) and subsistence farming. A further 10 per cent is engaged in the free zones and the tourist sector, while recorded unemployment is estimated at 22 per cent. On this basis, the informal sector could involve over half the work force and may make a significant but unrecorded addition to GDP. However, recent government estimates show that the size of the informal sector, including domestic staff and those working for a relative without pay, decreased from 65.3 per cent in 1991 to 40.1 per cent in 1994.

5. International trade is of utmost importance for the Dominican Republic, given the small size of the domestic market; it has been one of the main engines of economic growth. Tourism and manufacturing in the free zones, particularly clothing, have overtaken agricultural exports. As shown in Chart I.5, the share of agriculture as a source of foreign exchange has decreased since 1985, while the share of services has increased continuously, reaching 79 per cent in 1994. Tourism now accounts for more than US$1 billion in annual earnings and the free zones account for US$1.4 billion. Remittances from Dominicans living abroad, mainly in the United States, are also an important source W/TPR/S/11 Trade Policy Review Mechanism Page 4 of foreign exchange. During the period 1985-94 the average contribution of remittances to export earnings was 16 per cent.4

6. A major constraint for the growth in all sectors has been the constant shortage of electricity, caused by the lack of generation and distribution capacity. The shortage of electricity has promoted the use of small, private, electric generators that are not economically or ecologically efficient. According to the Government, the supply of electricity has improved due to technical projects financed by the World Bank and the technical collaboration of a Spanish company, Unión Eléctrica Funosa. However, further efforts are needed to eliminate shortages, and privatization plans may be helpful (Chapter V (3)(ii)(b)).

7. Government involvement in economic activities is widespread, including through direct participation in production, although this has diminished in recent years, including through private participation in electricity generation. A number of State enterprises are leaders in their sectors (Annex IV.I), and some benefit from their monopoly position (petroleum refining and flour milling). Privatization has not proceeded as rapidly as in some other developing countries; but a foreign investment bill, now before the Congress, should be helpful in this respect.

(2) Recent Economic Developments

(i) Introduction

8. The Dominican Republic, like many other small economies, had difficulty in adjusting to the various external shocks of the 1970s and 1980s, namely, the volatility of export prices, increases in the price of oil, the recession in industrialized countries, the debt crisis and increases in international interest rates. At the beginning of the 1980s, the economy was stagnating and structural economic problems became more evident. As in many other countries, the Dominican authorities had difficulties in reconciling the imperative to resume growth for development purposes with the need to stabilize and restructure the economy. Macroeconomic management became increasingly difficult, and the second half of the 1980s was characterized by stagflation.

9. From 1986, faced with social unrest, the authorities attempted to boost the economy with an extensive programme of public investment, combined with a freeze on current expenditure including wages and salaries. Public investment was financed through a combination of foreign debt arrears, and monetary creation through Central Bank and Reserve Bank borrowing. The resulting economic expansion was coupled with a sharp increase in inflation, which reached an annual average rate of 60 per cent in 1990 (Chart I.1; the authorities record a peak of 70 per cent).

10. In 1990, a stabilization and structural reform programme (the New Economic Programme, NEP), aimed at restoring internal and external equilibrium, was implemented and continued at least through 1993 (Box I.1). The first priority of the NEP was to stop inflation; key elements of the programme were the elimination of the fiscal deficit, creation of a unified, market-determined exchange rate and tightening of monetary policy. In this connection, the budget deficit was to be reduced by cutting subsidies to public enterprises and increasing revenues, primarily by raising trade taxes. The Central Bank cut back monetary expansion, reducing the supply of credit. The Bank also exercised closer control over international reserves, and servicing of external debt was resumed. The fiscal stringency and tight monetary policies caused a major slowdown of the economy in 1990. Reforms

4Central Bank of the Dominican Republic (preliminary data). Dominican Republic W/TPR/S/11 Page 5 were also initiated in the trade régime, the tax system and the rules and regulations governing foreign investment. These included the tariff reform of 1990, the approval of the new Tax Code (Código Tributario) in 1992 (Box I.2) and the financial reform of 1993 (Box I.3).

Box I.1 Main stabilization measures taken between 1990 and 19925

Fiscal Policies: 1. Domestic petroleum prices were doubled. The differential between the domestic and import prices became an important source of revenue, yielding about 2 per cent of GDP. 2. In 1990, subsidies to electricity, sugar, and wheat products were eliminated. 3. The valuation of imports was improved due to the unification of the exchange rate, and the use of c.i.f. rather than f.o.b. values. 4. A 15 per cent temporary import surcharge was established, subsequently reduced to 10 per cent and then 4 per cent, and eliminated in June 1995. The surcharge affected about 40 per cent of imports, including crude oil, but not foodstuffs. 5. In 1991, tariff rates were multiplied by a coefficient of 1.3, which was reduced in 1992 to 1.2, in 1993 to 1.1, and eliminated in September of the same year. 6. A tax of 2.5 per cent was levied on foreign exchange transactions, reduced to 2 and then to 1.5 per cent. Monetary Policy: 1. In 1991, interest rates were liberalized. During 1991 interest rates declined, followed by an increase in 1992. 2. Tight monetary policies were adopted in 1991 and 1992. Domestic credit to the public sector contracted Exchange Rate Policy: 1. A programme to eliminate the differential between the official and the market exchange rates was implemented. 2 In 1991, the exchange rate was officially unified and a managed float exchange rate system was adopted.

11. Progress in stabilizing the economy was very encouraging. Inflation was reduced to 4.6 per cent by the end of 1992. A public sector deficit, including Central Bank losses, of about 5 per cent of GDP was converted into a surplus of 0.1 per cent of GDP in 1991.6 The exchange rate system was also unified and a market-determined system was established.7 Real GDP showed a slight rise of 0.9 per cent in 1991, compared with the decline of 4.8 per cent in 1990. In 1992, the economy grew in real terms by 7.8 per cent and a fiscal surplus of 1.6 per cent was achieved (Table 1.2). The overall balance of payments showed a surplus of 3.2 per cent of GDP in 1991, in spite of a deficit on current account. Net international reserves rose by US$380 million in the same year. The positive performance of the economy and the re-establishment of relations with the international financial institutions restored credibility, encouraged the repatriation of capital and brought increased foreign direct investment. However, in 1992 the overall balance of payments again became negative, showing a deficit of US$63 million (Table I.4).

5Source: Government of the Dominican Republic

6IMF.

7It is called a unified exchange rate system, but there are still two markets: the official and the parallel. W/TPR/S/11 Trade Policy Review Mechanism Page 6

Table I.2 Economic performance of the Dominican Republic, 1980-93 (per cent and US$ million; based on 1987 prices) 1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

Income and absorption Average annual growth rate Real GNP, 4.2 0.8 5.8 6.1 (1.1) 15.9 (3.2) 1.1 8.0 4.6 ... at market prices Real GDP, 4.9 1.6 3.0 7.5 0.7 12.7 (4.8) 0.9 7.8 2.9 ... at market prices -- Private consumption 7.2 (0.6) 6.1 2.4 7.1 (1.6) (13.2) 4.6 3.5 (1.0) ... -- Government consumption 7.8 6.7 2.2 (17.7) 9.5 5.0 0.6 9.7 5.7 0.7 ... -- Gross domestic investment 4.1 (4.5) 3.9 41.6 8.2 0.1 (17.3) (10.3) 34.3 6.5 ... -- Fixed investment 4.0 (3.8) 3.3 41.0 10.4 0.7 (17.4) (12.5) 35.4 5.7 ... Resource balance -- Imports of goods & non-factor 11.7 (5.4) 7.9 7.8 (1.2) 6.3 (9.8) 2.3 23.8 (2.8) ... services -- Exports of goods & non-factor 8.7 0.1 1.4 6.0 (25.8) 69.6 14.5 1.3 14.3 1.6 ... services Competitiveness indicators GDP deflator 7.8 14.3 9.7 15.1 44.1 32.6 60.7 52.8 4.2 4.2 ... Consumer price index 9.9 16.2 9.7 15.9 44.4 45.4 59.4 53.9 4.6 5.2 ... Interest rates Per cent - Lending ...... 34.4 29.7 24.9 30.2

- Saving ...... 18.5 16.7 8.3 18 Average annual growth rate Monetary survey Money supply (broadly defined) 9.8 16.7 56.4 19.2 44.5 28.7 35.6 38.3 27.8 24.5 ...

Money 10.6 17.1 42.9 33.4 55.9 24.3 41.2 24.5 16.9 22.7 ...

Quasi-money 9.3 16.3 67.2 9.6 35.1 32.8 30.7 51.6 36.4 25.7 ...

Central government deficit (-) or Per cent of GDP surplus Current balance ...... 8.1 8.1 4.4 4.6 6.5 5.9 5.2 Capital balance ...... (9.6) (8.8) (5.3) (4.9) (7.2) (8.5) (10.1) Grants ...... 0.8 1.3 0.8 0.7 0.9 0.8 0.3 Overall balance ...... (0.7) 0.6 (0.1) 0.4 0.2 (1.8) (4.6) Public sector overall balancea ...... (6.9) (5.9) (5.0) 0.1 1.6 (0.2) ... Balance of payments Current account balance (10.9) (2.4) (3.4) (7.2) (0.4) (3.2) (1.4) (0.5) (5.1) (1.7) ... Overall balance (1.9) 2.8 2.2 (1.6) 0.0 (3.6) (5.5) 3.2 (0.7) 0.4 ... Memorandum: GDI/GDP 25.2 20.4 19.7 28.4 29.0 27.4 20.7 17.0 21.1 22.4 ...

GDS/GDP 15.4 15.1 15.5 20.7 26.0 22.0 16.9 13.5 14.2 18.1 ...

a Refers to consolidated and non-consolidated public sector (including operating losses of the Central Bank) after foreign official grants.

... Not available.

Source: Government of the Dominican Republic; World Bank 1994/95; and IMF, IFS. Dominican Republic W/TPR/S/11 Page 7

12. Towards the end of 1993, the Government again adopted an expansionary fiscal policy; the fiscal deficit, including losses of the Central Bank, reached 0.2 per cent of GDP. Growth of real GDP declined to 3 per cent and inflation, as measured by the consumer price index, increased to 5.2 per cent. On the other hand, internationalreserves rose by US$131.8 million. Following the Presidential elections of 1994, new stabilization policies were introduced from September; the authorities have indicated their intention to maintain fiscal and monetary discipline as a means of ensuring sustainable growth from 1995.

(ii) Supply and demand

13. In 1993, real GDP grew at a rate of 3 per cent, led principally by services (mainly tourism) and manufacturing in the free zones; these two sectors have led economic growth in the Dominican Republic since the early 1970s. On the demand side, private consumption has fluctuated considerably according to economic cycles, peaking in 1989 and again in 1991 after declining in 1990, the year of the austerity programme (Chart I.3). The contribution of net exports to demand before the mid-1980s, was negative; however, more recently, despite the reduction of anti-export bias in the economy, the contribution of net exports to growth has fluctuated around zero, mainly due to the importance of free-zone exports with a high share of imported inputs.

(iii) Labour market

14. The labour force in the Dominican Republic is estimated to amount to some 2.5 million workers in 1995.8 The average growth rate of the labour force during the period 1965-95 was 4.2 per cent, but it is currently growing at about 1.9 per cent. Men make up 84 per cent of the labour force.

15. The overall rate of unemployment is currently 22 per cent, with unemployment being highest among women: 87 per cent of male workers are employed, compared to only 18 per cent of women.9 Women are employed primarily in the free zones, where female employment is about 57 per cent of the total. However, according to official estimates female employment grew at a rate of more than 8.5 per cent in 1994, while male employment grew at a rate of 2.7 per cent in the same year.

16. Wages are freely negotiated, but must be set with reference to legal minimum levels for the private and public sectors. In 1991, minimum wages in the public sector were increased by 20 per cent to make up for the high level of inflation. In 1994 minimum wages were again increased in the private sector, including the free zones, but as inflation increased the unions pushed for another increase in minimum wages which was approved at the beginning of 1995. According to the authorities, this increase in salaries has been financed by the increase of the ISC (Selective Consumption Tax, Impuesto Selectivo al Consumo) levied on cigarettes, strong alcohol and beer, thus implying little or no fiscal risk. However, they entail some loss of competitiveness in the free zones, where the success of the clothing industry relies on very low wages.

8"Work force" includes workers aged 15-64.

9World Bank (1995). World Development Report 1995: Workers in an Integrating World, Oxford University Press, Oxford. W/TPR/S/11 Trade Policy Review Mechanism Page 8 Dominican Republic W/TPR/S/11 Page 9

(iv) Public finance

17. The level of government spending and of Central Bank credit, have been the main determinants of inflation in the Dominican Republic. The overall public sector deficit, including losses of the Central Bank, declined from 6.9 per cent in 1988 to 5 per cent in 1990; with the stabilization programme of the early 1990s, an overall surplus was posted in 1991 and 1992. The Central Government current account has throughout this period been kept in surplus; however, considerable deficits have occurred in the capital account which, after falling to under 5 per cent of GDP in 1991, increased sharply again to over 10 per cent in 1994 (Table I.2). The overall deficits of public enterprises have generally declined since 1989.

18. Central Government income is based mainly on indirect taxes. The two main sources of fiscal revenue are internal taxes on goods and services and on international trade taxes; in the period 1985- 1989 these two sources accounted, on average, for around 60 per cent of total fiscal income (Table I.3), with internal and external taxes equally important. Since 1990, the share of internal taxes has increased due the improvement in the tax collection system and to the Tax Reform of 1992 (Box I.2). The collection of revenues from export taxes was negligible; they were abolished in 1991. Revenue from import taxes has increased since the tariff reform (1990) despite tariff reduction (Box IV.1). Import tax collection during 1985-1989 amounted to 27 per cent of total Central Government revenue, while for the period 1990-1994 it accounted for 37 per cent. Heavy reliance on trade taxes as a source of revenue could conflict with further liberalization efforts; however, the modernization of the tax system and its administration should offset any decline in the importance of trade taxes.

Table I.3 Central Government revenue

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994a

Total revenue 1,910.4 2,515.4 3,085.4 4,910.2 7,161.8 8,042.2 13,733.7 17,774.3 20,715.2 21,961.6 R$ million

Percentage 100 100 100 100 100 100 100 100 100 100 A. Current revenue 85.2 84.8 92.4 92.0 95.2 94.1 95.7 97.2 93.7 93.7 I. Tax revenue 80.0 80.1 81.7 79.2 74.0 78.6 83.1 87.8 87.0 87.5 1. Taxes on income 17.6 16.7 16.2 17.1 17.9 19.9 17.3 15.5 15.0 14.7 2. Taxes on property 0.7 0.7 0.9 0.8 0.6 0.7 0.5 0.5 0.6 0.6 3. Taxes on goods 32.4 37.8 31.9 26.3 21.6 27.0 36.7 35.4 38.7 44.2 and services 4. Taxes on 28.1 23.9 31.6 33.6 30.4 30.4 28.3 35.9 32.3 27.6 international trade (a) Taxes on 26.0 19.8 29.1 29.9 28.6 30.4 28.2 35.9 32.3 27.6 imports (b) Taxes on 2.1 4.2 2.5 3.6 1.8 0.1 0.0 0.0 0.0 0.0 exports 5. Other taxes 1.2 1.0 1.1 1.3 3.5 0.5 0.4 0.4 0.5 0.5 II. Non-tax revenue 5.3 4.8 10.7 12.8 21.2 15.5 12.6 9.5 6.7 6.2 B. Other revenue 14.8 15.2 7.6 8.0 4.8 5.9 4.3 2.8 6.3 6.3 a Preliminary data.

Source: National Treasury of the Dominican Republic. W/TPR/S/11 Trade Policy Review Mechanism Page 10

Box I.2 Tax Reform of 199210

In 1992 the Government of the Dominican Republic, realizing the importance of overcoming the recurrent fiscal problem to attain economic stability, decided on a simpler tax code to increase fiscal revenues and improve the efficiency of tax collection. The tax reform enacted by Congress modified the income tax, the tax on the transfer of industrialized goods and services (Impuesto a las Transferencias de Bienes Industrializados y Servicios, ITBIS), and the Selective Consumption Tax (Impuesto Selectivo al Consumo, ISC).

Personal and corporate income taxes were simplified. The minimum income subject to personal income tax was raised, three rates being established for personal income tax and one for corporate income tax. The new law states that public enterprises are to pay the same income taxes as private enterprises. It abolished fiscal incentives for all sectors, except for the free zones, and new income tax incentives can now only be granted to firms with free-zone status.

The ITBIS was increased from 6 to 8 per cent. This tax will also be levied on services such as leasing; all exports are exempt, as well as some specific domestically produced and imported goods. The list of exempt domestically produced goods includes: unprocessed agricultural and livestock products, milk, cheese and butter, bread and flour, legumes, processed cereals, ground coffee, processed cocoa, rice, poultry and eggs, meat, salt, sugar and honeys, charcoal, books, oil and related products, medicines, fertilizers, and matches. The list of exempt imported goods include: books, oil and related products, fertilizer, salted cod and herring, milk, maize and wheat, and fungicides.

The ISC was converted from a specific to an ad valorem tax. Fifty individual laws containing more than 100 tax rates were eliminated and replaced by the new Tax Code which imposes rates of 10 to 15 per cent for domestically produced goods and seven rates ranging from 5 to 80 per cent for imported goods. The domestically produced goods subject to ISC are alcoholic beverages and tobacco products. The imports are mainly motor vehicles, kitchen appliances, alcoholic beverages and tobacco products.

The import surcharge established in 1987 was reduced from 15 to 10 per cent, and is schedule for elimination in 1995.

Despite this tax reform, trade taxes are still a considerable source of revenue in the Dominican Republic as demonstrated in Table 1.5. In order to increase domestic tax collection reforms should be taken further. For instance, there is a need to strengthen the administration of the tax collection system and control, to computerize information, and train personnel. Furthermore, the efficiency of tax collection is essential to meet revenue requirements due to the planned elimination of the 15 per cent temporary foreign exchange surcharge and the reduction to 1.5 per cent of the foreign exchange tax collected by the Central Bank (Chapter IV, Box IV.1).

(v) Monetary policy

19. Monetary and fiscal policies are closely linked in the Dominican Republic, since the Central Bank has been called on to finance public sector deficits. Management of monetary policy became easier in 1991 and 1992 due to the improvement in the fiscal situation. The financial system also became more efficient due to liberalization of interest rates, unification of reserve requirements and simplification of the legal framework (Box I.3). Since September 1994, the Government has followed a more cautious

10Based on Law 11-92 Tax Code of the Dominican Republic (Ley 11-92 Código Tributario de la República Dominicana) Dominican Republic W/TPR/S/11 Page 11 programme of monetary growth, and (importantly) the use of internal credit by the Central Bank has been severely limited, as shown in data for the overall public sector balance. Monetary discipline is expected to be sufficient to contain inflationary pressures during 1995.

Box I.3 Financial Reform

In 1993, the Government introduced major reforms in the financial system including the authorization of multi-service banks and the approval of new prudential regulations. The Superintendency of Banks began to modernize with the aim of strengthening banking supervision. Further reforms are contemplated by the draft Monetary and Financial Code before Congress. These reforms aim at increasing competition and reducing segmentation in the financial system, and strengthening the autonomy of the Central Bank. The new regulations will govern State-owned banks as well as private banks.

According to the IMF, the reform has been sustained and substantive, since banking supervision and regulation has evolved from practically non-existent into a framework consistent with international standards.

The reform establishes a new approach towards banking supervision and regulation. Supervision will focus on the analysis of the portfolio quality and the financial position of the institution. The reform seeks to improve transparency in the financial sector regarding prudential regulations, accounting, and disclosure of information.

The Third Resolution of the Monetary Board of December 1992 (Tercera Resolución de la Junta Monetaria) allowed the creation of multi-service banking, so that different services could be provided by one financial institution and not only by specialized banks as in the past (Chapter V(5)(ii)). This should reduce the segmentation of the banking system and make it more efficient. Since the end of 1992, by the Fifth Resolution of the Monetary Board (Quinta Resolución de la Junta Monetaria), the multi-service banks are also allowed to perform transactions in U.S. dollars and any other convertible currency.

The financial system is at present in a process of transition, moving away from a system of specialized banking and adjusting to a more strict set of rules. In fact, enforcement of the new regulations brought to light solvency problems of some institutions which have now been liquidated.

20. Interest rates remained high after being liberalized due to the contractionary monetary policy and the perceived high risk of investing in Dominican financial institutions. The spread between saving and lending rates is considerable; the average lending rate in the period 1991-1993 was 30 per cent, while the saving rate was 18 per cent (Table I.2). This spread is caused by concentration in the financial system; the high costs of financial intermediation due to a high percentage of bad loans in the banking system; and the risk involved in investing in what has been perceived as an unstable banking system. Therefore, even though there have been positive real interest rates since 1991, there has been no substantial increase in savings. In fact, there is a continuing gap between savings and investment that has to be made up by foreign resources (Chart I.3).

(vi) Prices

21. As noted above, the expansionary fiscal and monetary policies adopted at the end of the 1980s caused the inflation rate to increase to unprecedented levels. The strict monetary policies adopted as part of the stabilization package helped to reduce average annual inflation to 4.6 per cent by 1992. W/TPR/S/11 Trade Policy Review Mechanism Page 12

However, in 1993, inflation again started to increase and according to the authorities, rose to 14.3 per cent in 1994, when Central Bank credit was again used to finance public expenditure. With renewed tightening of monetary discipline in 1995, the rate of inflation was expected to fall.

(vii) Exchange rate developments

22. Between 1967 and 1980, the Dominican peso was pegged to the U.S. dollar. With prices in the Dominican Republic rising faster than those in the United States, there was a real appreciation of the peso. In that period, the Government, instead of allowing the nominal rate to depreciate, permitted the emergence of a parallel market, usable only by selected sectors; thus, while the tourism sector and the free zones were allowed to buy and sell foreign currency in the parallel market, all other exporters had to surrender foreign currency earnings to the Central Bank. Throughout this period, traditional exports declined while the tourism sector grew. Importers of inputs and basic goods were also allowed to buy foreign currency at the official rate at the Central Bank, while importers of final goods had to acquire foreign currency at the higher purchasing rate in the parallel market. This exchange rate policy effectively increased the level of protection to import-substituting industries, while partly offsetting cost increases for the tourist and other export sectors. The authorities were able to maintain the over-valued peso by borrowing abroad.

23. In 1980, the peg to the U.S. dollar could no longer be sustained and the peso was progressively devalued. In 1985, the Central Bank allowed the peso to float following trends in the parallel market; the peso continued depreciating up to 1988. During this period, especially from 1985 to 1987, the official and parallel exchange rates were practically unified. In 1987 the Central Bank set the official rate at the price prevailing in the parallel market. However, in 1988 the gap between the official and the parallel market was allowed to widen and the peso has since been appreciating in real effective terms (Chart I.4).

24. In 1991, as part of the stabilization package, the exchange rate was again unified and the official rate set according to that of the parallel inter-bank market. Moves have been made over the past few years to reduce restrictions on current account transactions, including surrender requirements. However, the market is still somewhat segmented (Annex I.1). The Central Bank has also intervened to prevent the peso from appreciating under pressure from short-term capital inflows.11 Nevertheless, the spread between the official and the inter-bank rate has varied over time, reportedly amounting to some 6.5 per cent in May 1995.12

11Dauhajre (1994), Sesgo Anti-exportador y Promoción de Exportaciones, Santo Domingo, República Dominicana.

12A spread of over 2 per cent gives rise to a "multiple currency practice" in terms of the IMF Agreement. Dominican Republic W/TPR/S/11 Page 13

25. Chart I.4 shows that the movement of the real effective exchange rate did not have the expected effect upon the trade balance; both imports and exports decreased after 1980. Imports decreased in real terms mainly because of the elimination of the preferential treatment afforded to most importers, who could no longer obtain foreign currency at a subsidized rate in the official market; and also due to the general slowdown of the economy. Exports did not respond positively to the real depreciation in the period up to 1988 because of structural constraints. On the other hand, in 1989, despite the real appreciation of the effective exchange rate, the value of exports rose, mainly due to a substantial increase in the price of ferro-nickel (Chapter V(3)(i)). The continued small surplus in the balance of trade in goods and services is explained by the increase in tourism revenues and, to a lesser extent, the growth in remittances from abroad. Thus, even though the exchange rate is an important determinant of trade flows, the relationship between these in the Dominican economy is less clear than in other countries.

26. In the past, exchange rate policy in the Dominican Republic was as cyclical as monetary and fiscal policies and appears partly responsible for external disequilibria. The current administration, however, is committed to eliminating exchange rate distortions, maintaining a stable real exchange rate that will encourage trade flows, and enforcing the exchange system reforms taken in 1991.

(viii) Balance of payments

27. For many years, the current account has run a deficit, with merchandise trade in deficit, while services trade has been in surplus (Table I.4). As already stated, revenue from traditional exports (agriculture and minerals) has fallen, due to both a decline in quantity exported and in terms of trade, W/TPR/S/11 Trade Policy Review Mechanism Page 14 while income from tourism, the free zones and remittances have increased to represent 79.4 per cent of the total in 1994 (Chart I.5). The most important source of foreign exchange is the tourism sector, which has been growing very rapidly, generating gross revenues of over US$1 billion in 1993 and 1994. The current account deficit is also reduced by the positive effect of workers' remittances from abroad, amounting to over US$400 million in recent years, or some 16 per cent of external current earnings (Chart I.5).

Table I.4 Balance of Payments (US$ million) 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Current (107.9) (183.4) (364.1) (18.9) (215.7) (106.2) (35.7) (445.2) (161.0) ... account balance Merchandise (547.4) (629.6) (880.2) (718.3) (1,039.4) (1,058.3) (1,070.5) (1,611.8) (1,606.9) (1,631.8) trade balance (f.o.b.)a Exports 738.5 722.1 711.3 889.7 924.4 734.5 658.3 562.5 511.5 644.0 Imports 1,285.9 1,351.7 1,591.5 1,608.0 1,963.8 1,792.8 1,728.8 2,174.3 2,118.4 2,275.8 Services - net 309.8 409.8 491.6 616.0 688.0 830.2 841.0 953.4 1,261.9 939.6 balance Income - net -226.3 -249.7 -306.1 (270.6) (248.7) (248.7) (192.7) (218.6) (257.6) ... balance Net unilateral 356.3 286.1 330.6 353.6 384.4 370.6 386.5 431.8 441.6 493.2 transfers

Capital 75.5 220.7 33.8 (15.6) 160.0 (17.2) (137.7) 76.3 264.4 ... account balance Foreign direct 36.2 50.0 89.0 106.1 110.0 132.8 145.0 179.7 182.8 189.5 investment, net Other capital, 39.3 170.7 (55.2) (121.7) 50.0 (150.0) (282.7) (103.4) 81.6 ... n.i.e.

Net errors and 155.7 82.3 248.9 35.6 (185.2) (294.1) 426.7 305.8 (69.1) ... omissions ... Overall 123.3 119.6 (81.4) 1.1 (240.9) (417.5) 253.3 (63.1) 34.3 ... balance

International (84.3) (96.6) 218.6 (238.8) 117.3 (75.8) (380.3) (123.5) (131.8) 464.1 reserve (increase -) a Merchandise trade data are based on customs books and do not include trade from free zones. Figures therefore vary from other merchandise trade data in this report.

Source: International Monetary Fund, Internatinal Financial Statistics (to 1993); and Dominican authorities (1994). Dominican Republic W/TPR/S/11 Page 15

28. The capital account has fluctuated throughout the period. Overall net capital inflows to the Dominican Republic have tended to vary according to the stability of the economy, largely reflecting short-term flows. Thus, as the economy stabilized at the beginning of the 1990s, short-term private capital inflows increased rapidly, slowing in 1992-93 and turning negative in 1994; nonetheless, direct foreign investment has grown steadily.

29. External debt has also played an important rôle in the external accounts of the Dominican Republic. External debt increased from US$2 billion in 1980 to US$4.6 billion in 1993, equivalent to some 58 per cent of GNP (down from a peak of 93 per cent in 1988) and 194 per cent of exports of goods and services (Table I.5).13 The country had continuing difficulty in meeting its external debt commitments and arrears had accumulated. However, since 1991, the authorities have been renegotiating their bilateral debt with the Paris Club and with non-members; an agreement with the commercial banks was achieved in 1994 and arrears with most countries have now been cleared.

13World Bank estimates. The Dominican authorities estimate that the external debt increased to US$3.9 billion in 1993, equivalent to some 47 per cent of GNP and 175 per cent of exports of goods and services. W/TPR/S/11 Trade Policy Review Mechanism Page 16

Table I.5 External debt, 1980-93 (US$ million)

1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

Debt by categories (US$million): External debt, total 2,002 3,502 3,687 3,923 3,991 4,053 4,387 4,494 441 4,559 3922 (EDT) Long term debt (by 1,473 2,842 3,076 3,353 3,400 3,439 3,533 3,834 4,160 4,248 3599 debtor) Public and publicly 1,220 2,694 2,930 3,220 3,282 3,334 3,434 3,751 4,160 4,248 3599 guaranteed Private 254 151 146 133 118 105 99 83 0 0 0 non-guaranteed Use of IMF credit 49 297 304 284 218 123 72 89 123 186 190 Short term debt 480 364 307 287 373 492 783 571 130 125 133

Memorandum: EDT / XGS % 133.8 220.8 223.4 212.5 186.8 170.4 188.1 193.2 ...... EDT / GNP % 31.2 84.0 71.1 82.0 92.5 63.8 65.2 66.0 ...... RES / EDT % 13.9 9.9 10.4 4.9 6.5 4.2 1.6 10.0 ...... Total debt service due / ...... 18.9 19.3 19.3 ...... XGS %

... Not available

Source: World Bank, World Tables (to 1991); and Dominican authorities (1992 to 1994).

(3) Composition and Direction of Trade

(i) Composition of trade14

30. Chart I.6 shows the changes that have taken place in the composition of merchandise trade since 1980. Traditional agricultural exports have diminished in importance, while manufacturing has become increasingly important (Table AI.1). Food products (sugar, coffee, cocoa, and tobacco) the traditional exports of the Dominican Republic, decreased from 64 per cent of total merchandise trade to 15 per cent in 1993. Iron and steal exports, previously an important source of revenue, also decreased from 12 to 4 per cent. However, according to more recent data provided by the authorities, exports of mineral products grew by 52 per cent in 1994, due to the increase in sales of ferro-nickel and doré. Exports of clothing manufactured in the free zones showed a steep increase of more than 40 percentage points in their share in total merchandise exports. Exports of other manufactured goods have declined. On the import side, the most relevant changes have been an increase in the share of manufactures imports from 54 per cent to 74 per cent in 1993 and a decline in fuel imports from 25 per cent to 10 per cent (Table AI.2).

14The trade data used in this Report is from the Comtrade database as reported by the Dominican Republic's trade partners; the Dominican Republic ceased reporting as of 1986. Any inconsistencies between the Secretariat data and those of the Government reflect this fact. Moreover, the Comtrade data include trade of the free zones, not included in balance-of-payments statistics (Table I.4). Dominican Republic W/TPR/S/11 Page 17

31. A combination of internal and external factors triggered the poor export performance. As discussed above, macroeconomic and structural problems generated a serious anti-export bias until recently. In addition, external factors influencing the performance of Dominican exports included heavy protection and subsidization by major trading partners, as in the case of sugar; declines in international commodity prices for coffee, cocoa and ferro-nickel; and the existence of non-tariff barriers for non- traditional exports, such as quantitative restrictions affecting bananas and phytosanitary measures on beef exports.

32. Services and transfers have become the most important sources of foreign exchange earnings (Chart I.5). Income from these sources increased from 53 to 80 per cent of total exports of goods and services between 1985 and 1994. Tourism and net proceeds of the foreign companies operating in free zones constitute most of non-factor services (NFS) exports. Remittances from abroad are also an important source of revenue; remaining constant at around 15 per cent throughout the period.

(ii) Direction of merchandise trade

33. The main trading partner of the Dominican Republic is the United States, and this link is becoming ever more concentrated. The share of merchandise exports to the United States increased from 68 to 90 per cent between 1980 and 1993 (Chart I.7 and Table AI.3). In terms of imports, the United States is also the most important supplier, followed by Latin American countries. However, the latter group has lost their relative importance, their share of imports decreasing by almost 14 per cent between 1980 and 1993, while imports from the United States increased by 13 per cent, reaching 59 per cent (Table AI.4). The concentration in trade is due to the preferential treatment of Dominican exports under the CBI and the existence of free zones which export clothing almost exclusively to the U.S. market (Chapter V(4)(i)). Trade with the European Union has not been as important in relative terms, decreasing since 1980, even though Dominican exports are granted preferential access under the Lomé Convention. Recent data provided by the Government, which do not change the essential pattern of trade, show Dominican exports to the United States, including free-zone exports, at 84.45 per cent in 1993 and 84.4 per cent in 1994, and exports to the European Union at 7.94 per cent in 1993 and 8.63 per cent in 1994. The authorities note that exports to the European Union are increasing, especially exports of bananas.

(4) Outlook

34. The Dominican Government's expectations are for real GDP to continue to grow at a rate of 4 per cent. Its objectives are to balance public finances, to keep inflation low, and to maintain a sustainable balance-of-payments position. These targets can be attained only if macroeconomic stability is sustained and growth in some sectors restored. However, fiscal discipline is a key element in achieving and maintaining stable growth; central to this is the continuation of tax reforms and reforms of public enterprises.

35. While it is expected that both tourism and output in the free zones will continue to expand, growth in the rest of the economy depends on further liberalization so that resources can be allocated where they will be most productive. Such structural adjustment, combined with a realistic, stable real exchange rate would ensure that past success can be continued and competitiveness maintained. W/TPR/S/11 Trade Policy Review Mechanism Page 18 Dominican Republic W/TPR/S/11 Page 19 W/TPR/S/11 Trade Policy Review Mechanism Page 20

Annex I Foreign Exchange Régime15

The currency of the Dominican Republic is the Dominican peso (R$). The official exchange rate of the R$ is set daily based on the previous day's inter-bank rate. The inter-bank market rate is set by market forces. The Dominican Republic formally accepted the obligations of Article VIII of the IMF in August 1953.

Exchange control policy is determined by the Monetary Board and is administered by the Central Bank (Banco Central de la República Dominicana). Commercial banks are allowed to operate in the foreign exchange market.

Settlements with certain Latin American countries (Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Peru and Uruguay) may be made through special accounts establishedunder reciprocal credit agreements within the framework of the Latin America Integration Association (Asociación Latinoamericana de Integración, ALADI). Settlements under reciprocal credit agreements with Argentina and Venezuela have been suspended. All payments must be invoiced in U.S. dollars.

Most imports are transacted through the free inter-bank market and are subject only to verification of appropriate documentation. Importers are able to obtain foreign currency from the commercial banks. Payments for oil imports for the use of the electric company are transacted through the Central Bank at the official rate16; all other imports are transacted at the free inter-bank rate, except for imports on a documents-against-payments basis, which must be denominated in U.S. dollars and for which foreign currency certification is required for customs clearance. A commission on foreign exchange sales equivalent to 3 per cent of the f.o.b. value of imports, collected by Customs, and deposited in the Central Bank for the servicing of the external debt is scheduled for gradual elimination in the Tax Code (Law 11-92); it has not been collected since June 1994.

All payments for invisibles may be made freely through commercial banks, subject to documentation requirements. Annual profit remittances cannot exceed the equivalent of 25 per cent of the net value of original and additional investment plus reinvestment minus repatriation, duly registered with the Central Bank (Chapter III). There are no restrictions on the inward movement of capital by either residents or non-residents.

Exporters of sugar, coffee, cacao, tobacco and their products, and minerals other than ferro-nickel must surrender to the Central Bank through the commercial banks the entire proceeds from exports within 30 days of the date of bill of lading; other exports, including from free zones, are free from any such requirement. Minimum export prices established by the Dominican Centre for Export Promotion (Centro Dominicano de Exportaciones, CEDOPEX) for certain exports were abolished in September 1995; firms operating in the industrial free zones were not subject to export price restrictions.

15This annex is based on IMF(1995).

16Dominican Government.