SOVEREIGN AND SUPRANATIONAL

ISSUER IN-DEPTH Government of Honduras – B1 stable 28 May 2018 Annual credit analysis

OVERVIEW AND OUTLOOK The credit profile of Honduras (B1 stable) balances the 's resilient growth and RATINGS improving fiscal profile against its small scale and very low GDP per capita, weak institutions Honduras and high proportion of foreign currency debt. The economy exceeded 3.5% annual growth Foreign Local Currency Currency over the last three years, benefiting from strong flows and public investment Gov. Bond Rating B1/STA B1/STA projects. Over the same period, the fiscal framework improved significantly as the authorities Country Ceiling Ba2 Ba2 implemented significant institutional enhancements to increase discipline in the budgeting Bank Deposit Ceiling B2 Ba2 process, tighten controls on expenditures and improve tax administration.

TABLE OF CONTENTS Credit challenges include very low national income measured by GDP per capita in PPP terms OVERVIEW AND OUTLOOK 1 of $5,562 in 2017, which is lower than the B median of $9,456 and the lowest level in Latin CREDIT PROFILE 2 America, as well as very weak Worldwide Governance Indicator rankings, particularly for Economic strength: Low (+) 2 Rule of Law and Government Effectiveness. Over 70% of the government's debt is in foreign Institutional strength: Very Low (+) 6 Fiscal strength: Moderate (-) 9 currency exposing the government's balance sheet to currency fluctuations. Susceptibility to event risk: Moderate Upward pressure on the credit profile could be considered if continued fiscal consolidation (-) 13 Rating range 18 supports a significant and sustained drop in debt ratios. Successful implementation of Comparatives 19 increased public investment that supports higher growth, which in turn supports fiscal DATA, CHARTS AND REFERENCES 20 improvements could also lead to a positive rating action. Conversely, negative pressure could result if future policy behavior is not consistent with Contacts newly created institutional arrangements, thus preventing additional progress on fiscal Gabriel Torres +1.212.553.3769 consolidation and stalling the positive trends observed in recent years. VP-Sr Credit Officer [email protected] This credit analysis elaborates on Honduras’ credit profile in terms of economic strength, institutional strength, fiscal strength and susceptibility to event risk, which are the four main Calyn Gelinas +1.212.553.5195 Associate Analyst analytic factors in Moody’s Sovereign Bond Rating Methodology. [email protected] Mauro Leos +1.212.553.1947 Associate Managing Director [email protected]

CLIENT SERVICES 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

CREDIT PROFILE Our determination of a sovereign’s government bond rating is based on the consideration of four rating factors: economic strength, institutional strength, fiscal strength and susceptibility to event risk. When a direct and imminent threat becomes a constraint, that can only lower the preliminary rating range. For more information please see our Sovereign Bond Rating Methodology. Economic strength: Low (+)

Factor 1: Overall score Scale VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- + Final - Factor 1: Sub-scores

Honduras Low (+) Score for Honduras Median of countries with B1 rating SCALE OF THE GROWTH DYNAMICS ECONOMY NATIONAL INCOME weight 50% weight 25% weight 25%

Average real GDP (% change) Volatility in real GDP growth (ppts) Global Competitiveness index Nominal GDP (US$ bn) GDP per capita (PPP, US$)

VERY HIGH

HIGH

MODERATE

LOW

VERY LOW

Economic strength evaluates the economic structure, primarily reflected in economic growth, the scale of the economy and wealth, as well as in structural factors that point to a country’s long-term economic robustness and shock-absorption capacity. Economic strength is adjusted in case excessive credit growth is present and the risks of a boom-bust cycle are building. This ‘credit boom’ adjustment factor can only lower the overall score of economic strength. Note: In case the Indicative and Final scores are the same, only the Final score will appear in the table above.

We assess Honduras’ economic strength as “Low (+),” which balances the economy's resilient growth against its small scale and very low GDP per capita. Honduras' nominal GDP of $23 billion in 2017 is the median for “Low (+)” peers whereas 2017 GDP per capita (PPP) of $5,562 is below the “Low (+)” median of $9,826. Other sovereigns with the same score for economic strength include Albania (B1 stable), (B1 positive) and Bolivia (Ba3 stable).

Exhibit 1

Peer comparison table factor 1: Economic strength Honduras L+ Median Albania Armenia Ethiopia Tanzania Montenegro Bolivia B1/STA B1/STA B1/POS B1/STA B1/NEG B1/STA Ba3/STA Final score L+ L+ L+ M- M- L L+ Indicative score L+ M- L+ M- M- L L- Nominal GDP (US$ bn) 21.6 21.6 11.9 10.6 70.4 47.7 4.4 33.9 GDP per capita (PPP, US$) 5,288.0 9,375.3 11,820.5 8,643.2 1,945.3 3,087.4 16,730.7 7,228.6 Average real GDP (% change) 3.7 3.7 2.9 4.5 9.0 6.7 2.6 4.6 Volatility in real GDP growth (ppts) 2.2 2.8 2.1 7.1 1.2 1.1 4.5 1.0 Global Competitiveness Index 3.9 3.9 4.2 4.2 3.8 3.7 4.2 3.5 Source: Moody's Investors Service

Honduras' small, open economy remains highly dependent on the US

Honduras is a small, open economy whose growth is derived from manufacturing (mostly maquila), agriculture and, more recently, financial intermediation and telecommunications. The economy relies on the US as its main source of remittances and its principal destination. With a nominal GDP of $23 billion recorded last year, the economy is much smaller than the $75.6 billion economy

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of (Ba1 stable) but larger than the $13.8 billion economy of (B2 positive). Despite the resiliency shown over the last five years, real GDP growth has slowed relative to the period prior to the global financial crisis and the Honduran political upheaval in 2009. During the period 2004-08, real GDP growth averaged 5.9%, it contracted by 2.4% in 2009, and has now averaged 3.6% growth during the past five years (see Exhibit 2).

Nevertheless, economic growth has remained solid in recent years despite being lower than the pre-crisis average, at around 4.1% annually between 2015-17. Real GDP grew a robust 4.8% in 2017, driven by public investment, a very strong harvest that increased and record-breaking remittances flows that fueled private consumption. Relatively low oil prices and strong US economic performance were positive external tailwinds that also contributed to boosting growth. We forecast real GDP growth of 3.8% and 3.5% in 2018 and 2019, respectively, such that growth reverts to levels more in line with historical trends.

All growth components positively contributed to the economy in 2017. Government consumption slowed significantly but was compensated by private consumption and more robust exports (see Exhibit 3). Private investment returned to positive growth of 3.1% after a substantial decline in 2016, which was attributable to a very high level of private capital formation recorded in 2015. Public investment grew 37.7% last year, following an increase in spending, which will continue to support economic activity over the coming years.

The government is currently executing its plan to invest $957 million (about 4% of GDP) in the 2015-20 period in roads, ports and airport projects. About 50% of the public investment program will be destined to highway and road projects. The infrastructure program will be partially financed by private investors using public private partnerships (PPP).

Exhibit 2 Exhibit 3 Real GDP growth Real GDP growth by components (% yoy) (2016-17 yoy%)

7.0 6.2 2016 2017 6.0 50.0 4.8 5.0 4.2 4.1 40.0 3.7 3.8 3.8 3.8 3.75 4.0 3.5 3.1 2.8 30.0 3.0 20.0 2.0 1.0 10.0

0.0 0.0 -1.0 -10.0 -2.0 -20.0 -3.0 -2.4 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E2018F 2019F Private Public Private Public Exports Consumption Consumption Investment Investment Sources: Haver Analytics; Central Bank of Honduras; Moody's Investors Service Sources: Haver Analytics, Central Bank of Honduras, Moody's Investors Service

Domestic consumption has remained a key economic growth driver, bolstered by remittances coming from the US. Current remittances fell after the financial crisis in 2009 but have steadily recovered since 2012, growing at a five-year average of 8.3% year- over-year and reaching 18.7% of GDP in 2017 (see Exhibit 4). According to government estimates, remittances finance more than 20% of private consumption over a year. We expect remittances to continue to support domestic consumption in 2018-19 based on our expectation of strong US economic performance and also taking into consideration the delayed termination of Honduras' Temporary Protected Status that expires on 5 January 2020.

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Exhibit 4 Workers’ current remittances (% of GDP) 25 21.3 20.9 20.2 20 18.7 17.4 17.8 16.9 16.5 16.7 17.0 15.8 15.6 15

10

5

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: Central Bank of Honduras, Moody's Investors Service

High rate and low education levels hamper long-term growth prospects

A high rate of poverty, low education levels and widespread crime hinder Honduras’ long-term growth outlook. GDP per capita in PPP terms in Honduras was $5,562 in 2017, lower than the B median of $9,456 and the lowest level in Latin America. According to the 2016 UN Human Development Report, 16.5% of the population in Honduras lives on less than $1.25/day, compared to 13.5% in Guatemala and 8.5% in Nicaragua. Income inequality is pronounced, with a Gini index of 57, similar to that of Guatemala at 52. Despite the income inequality, GDP per capita has increased along with GDP growth over recent years, accelerating between 2014-15 and 2016-17 (see Exhibit 5).

Exhibit 5 GDP per capita versus annual real GDP growth (GDP per capita in PPP terms)

5,700

5,600 2017E 5,500

5,400

5,300 2016 5,200

5,100 2015

5,000 2014 4,900

4,800 2013 4,700 2.5 3.0 3.5 4.0 4.5 5.0

Source: Moody's Investors Service

Education levels are low, with just above 20% of the population with at least secondary education and with the average number of years of schooling at just 5.5.1 One-third of the employed population works in the agricultural sector. The latest official unemployment rate published by the Honduran National Statistical Institute is around 7%, although this indicator does not include the large informal sector economy, a phenomenon also present in many Latin American countries.

Investment rate above peers despite high crime levels

Poverty, income inequality and Honduras’ geographic location as a drug trans-shipment route feed into Honduras’ high rate of crime; homicides, assaults, kidnappings and extortions are widespread. However, since President Hernandez took office in January 2014, the leaders of powerful drug gangs have been extradited to the US, which, in addition to a more active involvement of the military in police

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duties, may have contributed to a significant decline in violence in the last two years. According to the estimates from the National Autonomous University of Honduras observatory, the homicide rate declined 50% to 44 per 100,000 inhabitants in 2017 from its peak of 86.5 per 100,000 in 2011 (see Exhibit 6), the highest rate in the world, barring any conflict zone, at that time.

Exhibit 6 Homicide rate (per 100,000 population) 100 87 90 86 78 79 80 67 68 70 58 60 59 60 50 50 46 44 37 40 31 30 20 10 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: UNAH, Moody's Investors Service

Violent crime is also present in the region, particularly in the two other countries comprising the Northern Triangle – Guatemala and . However, while homicide rates are significantly lower in Guatemala at 26.1 per 100,000, violence in El Salvador has materially increased in recent years and overtook Honduras. While high rates are generally assumed to have a negative impact on investment, Honduras’ investment rate was 23.8% of GDP in 2017 in line with the median of B-rated countries and well above Guatemala’s and El Salvador’s investment to GDP ratios of 12.1% and 13.1%. Nicaragua, which has a much lower homicide rate (7 per 100,000) than Honduras, has a 29.0% investment rate.

Diversification efforts focused on reducing energy costs and increasing employment

While Honduras’ economy is based mostly on maquila manufacturing, agro-industry and financial intermediation, the government has made a significant effort to branch out and attract additional foreign investment, particularly in telecommunications and renewable energy. The geographic size of the country is relatively large for , but much of the land is of little use for agriculture making it attractive for these types of projects. As such, an important component of the surge in fixed capital formation that boosted economic growth in previous years was directed toward renewable energy related projects. Total investment in these projects increased by more than 350% to around $1.2 billion in 2015. Solar energy projects attracted most of the investment with more than $900 million, followed by wind energy with $160 million.

Given ongoing investment projects in renewable energy, Honduras has successfully transformed its energy matrix by reducing its dependence on hydrocarbon energy and imported oil. Following the of 10 solar plants, non-renewable energy accounted for around 41% of the country’s energy production in 2017, down from around 58% in 2013.

In partnership with the private sector, the national development program, Honduras 2020, is channeling investment to six key sectors in the economy to improve productivity and living standards, including: (1) tourism, (2) textile and apparel, (3) light manufacturing, (4) outsourcing services, (5) agribusiness, and (6) social housing. Increasing investment in sectors such as tourism and outsourcing will help broaden the economic base, and if successful, these efforts will support the country's long-term growth prospects and improve the economy's shock-absorption capacity.

Finally, Honduras' sovereign profile is exposed to climate change risks from recurring or hurricanes due to economic reliance on the agriculture sector, as identified in our recent report on environmental risks and their impact on sovereigns. Currently, Honduras does not have strong financial buffers to absorb climate-related emergencies without a direct impact on the fiscal accounts.

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Institutional strength: Very Low (+)

Factor 2: Overall score Scale VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- + Final - Factor 2: Sub-scores

Honduras Very Low (+) Score for Honduras Median of countries with B1 rating

INSTITUTIONAL FRAMEWORK AND EFFECTIVENESS POLICY CREDIBILITY AND EFFECTIVENESS weight 75% weight 25% Worldwide Government Worldwide Control of Corruption volatility (standard Effectiveness index Worldwide Rule of Law index index Inflation level (%) deviation)

VERY HIGH

HIGH

MODERATE

LOW

VERY LOW

Institutional strength evaluates whether the country’s institutional features are conducive to supporting a country’s ability and willingness to repay its debt. A related aspect of institutional strength is the capacity of the government to conduct sound economic policies that foster economic growth and prosperity. Institutional strength is adjusted for the track record of default. This adjustment can only lower the overall score of institutional strength. Note: In case the Indicative and Final scores are the same, only the Final score will appear in the table above.

We assess Honduras' institutional strength as “Very Low (+),” which mostly reflects Worldwide Governance Indicator scores that are at the bottom of our sovereign rated universe. Compared to similarly rated sovereigns, Honduras generally scores lower in institutional framework and effectiveness. Sovereigns with the same factor score include Tanzania (B1 negative), Bangladesh (Ba3 stable), Cambodia (B2 stable) and Nicaragua (B2 positive).

Exhibit 7

Peer comparison table factor 2: Institutional strength Dominican Honduras VL+ Median Tanzania Ethiopia Bangladesh Cambodia Nicaragua Republic B1/STA B1/NEG B1/STA Ba3/STA Ba3/STA B2/STA B2/POS Final score VL+ VL+ L- VL+ L- VL+ VL+ Indicative score VL+ L- L- LL VL VL- Gov. Effectiveness, percentile [1] 9.7 13.5 22.5 16.5 12.7 30.8 12.0 11.2 Rule of Law, percentile [1] 3.7 18.7 29.3 28.5 19.5 36.8 4.5 18.7 Control of Corruption, percentile [1] 21.8 21.8 27.8 32.3 16.5 17.2 3.0 11.2 Average inflation (%) 4.8 5.6 6.7 11.1 6.4 3.3 3.0 5.8 Volatility in inflation (ppts) 2.4 4.2 3.7 13.0 1.3 3.2 7.2 4.9 [1] Moody's calculations. Percentiles based on our rated universe. Source: Moody's Investors Service

Honduras’ Worldwide Governance Indicator (WGI) scores as of 2016 are at the bottom of the percentile ranking among the universe of countries we rate (see Exhibit 8). Honduras scores similarly to the B median in terms of Regulatory Quality and Voice and Accountability. Weaker scores are notably in Government Effectiveness (in the lowest 10th percentile) and Rule of Law (lowest 4th percentile). Government Effectiveness and Regulatory Quality have deteriorated in the last years; Government Effectiveness ranked in the 22nd percentile in 2011 while Rule of Law ranked at the 10th percentile. That said, Control of Corruption has improved compared to 2011, going up to the 21st percentile from the 16th percentile.

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Exhibit 8 Worldwide Governance Indicators

Honduras Median - Very Low F2 Median - B

Political Stability 40 30 Regulatory Quality 20 Government Effectiveness 10 0

Voice and Accountability Rule of Law

Control of Corruption

Sources: Worldwide Governance Indicators; Moody’s Investors Service

The ’s Ease of Doing Business ranking, which includes criteria such as time to start a business, construction permits, registering property, enforcing contracts, among others, places Honduras below its Latin American peers, with Guatemala and El Salvador (B3 stable) ranking between 70th and 100th, while Honduras ranks 115. Notably, Brazil (Ba2 stable), (B2 stable), Ecuador (B3 stable) and Nicaragua are positioned below Honduras (see Exhibit 9).2

Exhibit 9 World Bank Ease of Doing Business (Rank)

Rating Economy Ease of Doing Business Rank Ba2 61 Baa2 Indonesia 72 B3 El Salvador 73 Caa2 Ukraine 76 B3 Bosnia and Herzegovina 86 Ba1 Guatemala 97 Baa2 India 100 Ba1 Paraguay 108 B1 Honduras 115 B2 Argentina 117 B3 Ecuador 118 Ba2 Brazil 125 B2 Nicaragua 131 B3 Pakistan 147

Source: World Bank

MACCIH could reduce corruption and impunity

Corruption and weak rule of law remain important institutional shortcomings. However, the Misión de Apoyo y Combate a la Corrupción e Impunidad (MACCIH), an Organization of American States (OAS) sponsored institutional body created in 2016 whose mission is to tackle these issues in Honduras, has the potential to improve the rule of law. The MACCIH plays a similar role in the country as that of the Comisión Internacional contra la Impunidad en Guatemala (CICIG), the UN-sponsored institution created in Guatemala to strengthen the judicial system.

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However, MACCIH has encountered several setbacks. In particular, the head of the mission, Mr. Juan Jimenez, resigned from the post earlier this year. Mr. Jimenez cited a lack of support from the OAS secretary general and the Honduran authorities as reasons for his departure.

The MACCIH was created as a response to the scandal of embezzlement in the social security institute that erupted in late 2015. The organization continues to investigate cases of corruption in the country.

Sound management of monetary policy and recapitalization of the central bank signals improvements

The Central Bank of Honduras (BCH) has exhibited sound management of monetary policy. The central bank’s principal goal is inflation management, and it unofficially targets a range of 3.0%-5.0%. Inflation ended the year within the target range (4.7% year-over-year change as of December) but higher than it was in 2016, mainly driven by higher fuel prices and increased public investment and private consumption. It has nonetheless been steadily decreasing, reaching 4.2% over the first months of 2018. We expect inflation will be around 4.5% at year-end as international oil prices are projected to rise and lower economic activity cools inflationary pressures.

Greater flexibility of the exchange rate regime allows the currency to adjust to market forces. The lempira was fixed at 18.9 to the US dollar from 2005-11, at which point the BCH switched to a crawling peg. Since then, and on a weekly basis, the BCH measures three variables in order to determine the future level of the exchange rate: (1) inflation (internal vs. that of main trading partners); (2) international reserves coverage of imports; and (3) the nominal exchange rate vs. principal trading partners.

Importantly, the central bank has not extended loans to the central government since 2010, a practice that undermined central bank independence. According to the law, BCH can lend to the central government up to 10% of tax revenue of the year prior, and the loan should be paid within the same year.

Moreover, in December 2014 the government started to implement a plan to recapitalize the central bank to correct for years of operating losses through bonds that have 8 percent coupons, yielding positive real returns. The plan consists of five issuances, four of which have already been placed. The central bank is expected to have positive capital by 2020.

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Fiscal strength: Moderate (-)

Factor 3: Overall score Scale VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- + Final - Factor 3: Sub-scores

Honduras Moderate (-) Score for Honduras Median of countries with B1 rating

DEBTDEBT BURDEN BURDEN DEBT AFFORDABILITY weight 100% weight 0% General government interest payments (% General government interest payments (% General government debt (% of GDP) General government debt (% of revenues) of revenue) of GDP)

VERY HIGH

HIGH

MODERATE

LOW

VERY LOW

Fiscal strength captures the overall health of government finances, incorporating the assessment of relative debt burdens and debt affordability as well as the structure of government debt. Some governments have a greater ability to carry a higher debt burden at affordable rates than others. Fiscal strength is adjusted for the debt trend, the share of foreign currency debt in government debt, other public sector debt and for cases in which public sector financial assets or sovereign wealth funds are present. Depending on the adjustment factor the overall score of fiscal strength can be lowered or increased. Note: In case the Indicative and Final scores are the same, only the Final score will appear in the table above.

We assess Honduras' fiscal strength as “Moderate (-),” reflecting modest debt burden and debt affordability ratios. General government debt as a percentage of GDP was 40.4% in 2017, lower than the 57.5% median for B-rated peers. Additionally, interest as a percentage of general government revenues was 8.3%, also lower than the median. Sovereigns that have the same or a similar factor score as Honduras include Vietnam (B1 positive), Ethiopia (B1 stable), Cambodia, Rwanda (B2 stable) and Bangladesh.

Exhibit 10

Peer comparison table factor 3: Fiscal strength Honduras M- Median Vietnam Ethiopia Montenegro Cambodia Rwanda Bangladesh B1/STA B1/POS B1/STA B1/STA B2/STA B2/STA Ba3/STA Final score M- M- MM M- M- M- Indicative score M- M+ MH M- M- M Gen. gov. debt/GDP 38.7 38.7 52.6 27.7 64.4 33.9 38.7 27.7 Gen. gov. debt/revenue 142.8 195.8 215.0 174.6 151.2 169.7 164.9 274.5 Gen. gov. interest payments/GDP 2.5 1.9 1.9 0.5 2.2 0.4 1.0 1.9 Gen. gov. int. payments/revenue 9.3 8.2 7.9 3.0 5.1 2.1 4.2 18.9 Source: Moody's Investors Service

Significant fiscal adjustment over the past four years supports fiscal outlook

Strict compliance with targets set in the now expired IMF SBA/SCF programs continues to be the norm. The IMF has repeatedly stated in their reviews of the program that Honduras’ economic reform program has made considerable progress in restoring macroeconomic stability, reducing the fiscal deficit, and tackling some structural issues. Most performance criteria have been met and the authorities have shown continued commitment to structural reforms – the Fiscal Responsibility Law (FRL), reforms to the tax administration and bank resolution reform, among others, have been approved.

Honduras’ central government over complied by a wide margin with the IMF program fiscal deficit targets in 2017. The fiscal deficit narrowed to 2.7% of GDP in 2017 from 7.9% of GDP in 2013, even lower than the original IMF target of 2.9% of GDP (see Exhibit 11).

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Initially, the government, in tandem with the IMF, had upwardly revised the deficit target in view of the strong adherence to fiscal goals and in order to allow for an increase in public investment. Strong tax collection, partially as a result of the overhaul process of the tax collection agency, however, allowed the deficit to narrow significantly from targets in 2017.

Exhibit 11 Fiscal deficit lower than IMF targets in 2016 and 2017 (% of GDP)

Fiscal Deficit % of GDP IMF Original Target IMF Revised Target (December 2015) 8.0 7.9 7.0

6.0 6.0 6.0 5.5 5.0 4.0 4.0 4.7 4.6 3.6 4.4 3.4 3.8 3.4 3.0 2.9 2.9 3.1 2.0 2.4 2.8 2.7 1.0

0.0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E Sources: Ministry of Finance, IMF Second Review of SBA Agreement

While we track the central government accounts to monitor performance relative to IMF program targets, the general government aggregation level is what we use for our comparative analysis. At the general government level, the authorities reduced the fiscal deficit by both raising tax collections and lowering current expenditures.

To increase revenue, the authorities implemented tax reforms that included raising the sales tax rate to 15% from 12%, reducing basic product sales tax exemptions and implementing a security tax. These measures widened the tax base and increased revenue. For example, in 2017 the tax base for the sales tax was 86% larger than in 2013. These changes, along with the significant adjustments made at the tax collection agency to reduce inefficiencies and tax evasion, have increased government revenue to 26.6% of GDP in 2017 from 23.8% of GDP in 2013 (see Exhibit 12).

Total expenditures as a percentage of GDP decreased by 7.2% in 2014 and have remained relatively stable at around 27% of GDP through 2014-17. Efforts to curtail expenditures have focused on reducing the public sector wage bill by limiting salary increases, conducting a census and eliminating the extra paychecks that were not backed by actual employment. These measures have reduced the wage bill to 10.6% of GDP in 2017 from 12.8% in 2013. Other measures include restraining government transfers to municipalities and loss-making state-owned enterprises.

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Exhibit 12 Breakdown of general government finances (% of GDP)

2013 2014 2015 2016 2017 Total Revenues 23.8 24.9 25.4 27.2 26.6 Tax Revenues 15.4 16.7 17.5 19.1 18.3 Total Expenditures 29.6 27.6 26.0 27.5 27.1 Current Expenditures 23.6 21.9 21.1 22.0 21.1 Wages and Salaries 12.8 11.5 10.7 10.7 10.6 Intermediate Goods 4.4 3.7 4.0 4.0 3.7 Transfers to Private Sector 3.3 3.5 3.2 3.6 4.1 Interest Payments 1.7 1.9 2.0 2.5 2.2 Other Current Expenditures 1.4 1.3 1.2 1.2 0.4 Capital Expenditures 6.0 5.8 5.1 5.6 5.9 Fiscal Balance -5.7 -2.7 -0.8 -0.4 -0.4

Source: Ministry of Finance

Improvements but losses remain at ENEE

Government transfers to the electricity company (ENEE) have been reduced, which lowers the size of the contingent liability the company represents to the central administration.3 A $250 million debt issuance by ENEE in 2013 allowed for reduced transfers from the central government. The authorities expect transfers to be around 0.1% of GDP in 2018 and onwards.

Reforms to ENEE included increasing average electricity tariffs, reducing the company’s wage bill and lowering operational inefficiencies. The new tariff structure is based on kilowatt hours and is reviewed every three months for adjustments. The tariffs will exclude some users of the system, such as those in the poorest zones in the country. As of 2017, billed sales of energy increased 19.3% over last year and ENEE's net loss (including transfers) as a percentage of GDP was 0.6%. The authorities do not expect net loss as a percentage of GDP to increase in 2018.

Overhaul of the tax administration department (SAR) has improved tax collection

The overhaul in tax administration refers to the creation of a new tax administration department called the Servicio de Administración de Rentas (SAR) that in 2016 replaced the Dirección Ejecutiva de Ingresos (DEI). Functions relating to tax obligations or filing requirements previously processed by the DEI will now be the responsibility of the SAR, whose head was appointed by the president of Honduras. The Honduran government also removed the Dirección Adjunta de Rentas Aduaneras (DARA)—the Honduran customs agency that was formerly part of the DEI—and ascribed its authority to the Ministry of Finance.

At the time the SAR was created, the authorities dismissed close to 2,300 employees of the DEI who were found unfit. The new institution has significantly stricter hiring requirements and a higher paying schedule, as well as a clear career path for its staff. The government is also investing in IT to have a new platform to administer and pay taxes. This major reform to the tax administration system is estimated to cost $40 million and is partly financed by the IADB, which gave $27 million. The tax administration system reform benefits from the oversight and guidance of the Inter-American Center of Tax Administrations (CIAT), a non-profit international organization that provides specialized technical assistance for the modernization and strengthening of tax administrations.4

Significant progress in strengthening overall fiscal framework

The improvement in fiscal performance is also the result of an institutional overhaul in several ministries. The first was the introduction of various measures to improve the budget process in early 2014. Zero revisions were allowed to the limits set in the 2014, 2015 and 2016 budgets – in 2012-13, budget limits were revised more than 20 times throughout the year. During past administrations, if ministers secured financing from multilaterals for specific projects, the Ministry of Finance would include those projects in the budget irrespective of any fiscal priorities or targets, a practice that led to an increase in the deficit by 3 percentage points of GDP in the last quarter of 2013. Under the new rules, ministers cannot initiate projects with MDBs if they do not fall under the budget’s limit.

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Additionally, legal sanctions can now be imposed on officials who overspend, and for new projects to be approved others have to be cut or removed. A budget committee reviews ministries’ requests approving only those that fall within the budget limits.

Another institutional improvement was the creation of the macro-fiscal unit within the ministry of finance, whose purpose is to generate a medium-term fiscal framework, which is essentially a medium-term budget for the next 48 months. This unit generates the strategies to achieve those fiscal targets, sets current and capital expenditure limits broken down by sector and institutions, sets a rule to distribute possible additional revenues not included in the budget, among several other specifications.

In connection to the medium term fiscal framework, the congress approved a fiscal responsibility law, which aims to incorporate in the law the government’s commitment with medium term fiscal targets. The law establishes: (1) a maximum Non-Financial Public Sector (NFPS) deficit of 1% of GDP; (2) a limit to current expenditure, which should not increase above the 10-year average real GDP growth rate plus inflation estimate for the following year; and (3) a limit to new floating debt (arrears), which should not be greater than 0.5% of GDP in nominal terms.

The government may override the fiscal deficit targets under two exceptional circumstances: (1) a declared national emergency due to a natural disaster (with damages surpassing 1% of GDP); and (2) an economic recession defined by a drop in real GDP for two consecutive quarters, but the NFPS fiscal deficit shall not exceed 2.5%. In either scenario, the deficit ceiling can be surpassed by a maximum period of two years. At the conclusion of such period, the fiscal deficit will have to be annually reduced by at least 0.5% of GDP until reaching the 1% of GDP fiscal deficit ceiling.

The fiscal responsibility law took effect immediately but has allowed for a transition period through 2018, before reaching the definitive deficit ceiling of 1% of GDP by 2019. The FRL allows the NFPS fiscal deficit to be set at 1.2% in 2018, until reaching 1% of GDP by 2019. The authorities estimate that the central administration’s fiscal deficit will remain around 3% for the medium term (2018-2020), and is important to clarify that there is no specific fiscal target at this level of aggregation. The difference between the Non-Financial Public Sector deficit and Central Government deficit is explained by positive contributions to the Social Security and Pension systems and by achieving a fiscal balance in the state-owned enterprises (see Exhibit 13). The incorporation of a fiscal responsibility law in Honduras’ policy management represents a structural change, provides a mechanism to lock-in fiscal limits and provides guidance in fiscal policy behavior across administrations.

Exhibit 13 Fiscal deficit according to Fiscal Responsibility Law (% of GDP)

Source: Ministry of Finance, Moody’s Investors Service

12 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Susceptibility to event risk: Moderate (-)

Factor 4: Overall score Scale VL- VL VL+ L- L L+ M- M M+ H- H H+ VH- VH VH+ + Final - Factor 4: Sub-scores

Honduras Moderate (-) Score for Honduras Median of countries with B1 rating

POLITICAL GOVERNMENTDEBT BURDEN LIQUIDITY RISK BANKING SECTOR RISK EXTERNAL VULNERABILITY RISK RISK Average baseline (Current account Net international Gross borrowing Non-resident share credit assessment Total domestic bank Banking system balance + FDI External vulnerability investment Political risk requirements/GDP of gen. gov. debt (%)Market-implied rating (BCA) assets/GDP loan-to-deposit ratio inflows)/GDP indicator (EVI) position/GDP

VERY HIGH

HIGH

MODERATE

LOW

VERY LOW

Susceptibility to event risk evaluates a country’s vulnerability to the risk that sudden events may severely strain public finances, thus increasing the country’s probability of default. Such risks include political, government liquidity, banking sector and external vulnerability risks. Susceptibility of event risk is a constraint which can only lower the preliminary rating range as given by combining the first three factors. Note: In case the Indicative and Final scores are the same, only the Final score will appear in the table above.

We assess susceptibility to event risk as “Moderate (-),” reflecting Honduras' vulnerability to political shocks, government liquidity and banking sector risks. Tanzania is another sovereign with similar drivers.

Political risk: Moderate (-)

Exhibit 14

Peer comparison table factor 4a: Political risk Honduras Sri Lanka Armenia Jordan Albania Tanzania Vietnam B1/STA B1/NEG B1/POS B1/STA B1/STA B1/NEG B1/POS Final score M- M- MM L+ L+ L+ Geopolitical risk VL -- VL MM VL VL- L+ Domestic political risk M- -- M- L L+ L+ L+ L Source: Moody's Investors Service

We set the final score for political risk at “Moderate (-),” from an indicative score of “Very Low” to reflect the significant repercussions that political events have had on the country's economic and financial performance, and the possibility that a similar crisis could occur in the future.

Honduras is susceptible to domestic political risk, as seen in 2009 with the ousting of former president José Manuel Zelaya and in 2017 when the outcome of the presidential election was contested by the opposition candidate. Despite these episodes, the economic impact from the latest incident has been somewhat moderated in comparison.

The impact of the 2009 political crisis, compounded by the global financial crisis, resulted in a contraction in growth, the halving of FDI, a sharp deterioration in exports, and a drop in international reserves. Honduras’ government continued to pay its debt obligations, with the exception of some operational difficulties with the Central American Bank for Economic Integration (CABEI, A1 stable).

13 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Economic performance was impacted as a consequence of the contested 2017 election as well. Output growth performed well through the third quarter of 2017, accelerating to 6% growth, but slowed significantly in the last quarter because of political uncertainty. However, after Mr. Juan Orlando Hernandez was sworn in for his second consecutive term on 27 January the instability more or less subsided. Consequently, we do not expect there to be any significant deviations from President Hernandez' previous policy positions in his second term.

Government liquidity risk: Moderate (-)

Exhibit 15

Peer comparison table factor 4b: Government liquidity risk Honduras M- Median Albania Armenia Jordan Tanzania Montenegro Sri Lanka B1/STA B1/STA B1/POS B1/STA B1/NEG B1/STA B1/NEG Final score M- M- M- M- M- MM Indicative score L+ L+ L+ M- VL L+ M Gross borrowing req./GDP 7.4 7.4 25.7 8.8 21.6 6.8 10.1 18.5 Gen. gov. ext. debt/gen. gov. debt 71.8 65.1 42.6 74.3 32.3 74.8 78.7 43.1 Market funding stress indicator B1 B1 Ba2 B1 B2 -- Ba3 B2 Source: Moody's Investors Service

We set the final score for government liquidity risk at “Moderate (-),” above the indicative score of “Low (+)” to reflect their dependence on foreign funding.

General government debt peaked at 40.4% of GDP in 2017, an increase of more than 10 percentage points (see Exhibit 16). Because the government had limited access to concessional financing sources in 2012, it increased debt issuances in the domestic market, which had much shorter debt maturities and carried a high interest rate. The government issued two global bonds in 2013 as well.5 However, the signing of the IMF agreement in December 2014, coupled with the reduction of the fiscal deficit, opened the door to more multilateral financing, which improved the overall financing costs and maturity of the debt.

Exhibit 16 Exhibit 17 General government debt Domestic vs. external debt (% of GDP) (USD millions)

45 Domestic Debt External Debt 40.4 38.7 8,000 40 37.1 37.6 37.9 7,000 35 29.6 6,000 30 26.9 24.3 5,000 25 4,000 20 3,000 15 2,000 10 1,000 5 0 0 2013 2014 2015 2016 2017E 2010 2011 2012 2013 2014 2015 2016 2017E Sources: Ministry of Finance, Moody's Investors Service Sources: Ministry of Finance; Moody's Investors Service

Through debt management operations and a stronger appetite for government debt, the authorities have successfully increased average domestic debt maturity and decreased its average interest rate. Domestic issuances have been more concentrated in less series, with bigger amounts so as to improve market liquidity. Moreover, the government was able to swap debt due in 2015-17 for debt with tenors of 6, 7 and 10 years. In 2017, the government issued a 10-year, $700 million external bond at 6.25%, which added to the external debt stock (see Exhibit 17).

Following these actions, there is a significant spike in amortization payments in 2020 when one of the external bonds is due. About 73% of debt is external and 74% is in foreign currency. The government will continue to reduce refinancing risks if it is able to further

14 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

lengthen domestic debt maturities and if the average interest rate for domestic debt continues its downward trajectory. Priority will also be given to MDB-financing with the highest level of concessionality, in order to improve the government's debt profile.

Banking sector risk: Moderate (-)

Exhibit 18

Peer comparison table factor 4c: Banking sector risk Honduras M- Median Armenia Sri Lanka Albania Bahrain Ethiopia Nicaragua B1/STA B1/POS B1/NEG B1/STA B1/NEG B1/STA B2/POS Final score M- M- M- MM L+ L+ Indicative score -- M- L+ VL M M- L+ Baseline credit assessment -- b1 b2 b1 -- b1 -- -- Total dom. bank assets/GDP 79.3 79.3 78.6 76.0 95.4 258.2 -- 55.8 Loan-to-deposit ratio -- 92.4 111.9 88.0 53.9 52.8 116.9 96.7 Source: Moody's Investors Service

Moody's does not rate any of the 15 banks in Honduras, the latest system-wide figures provided by the National Bank and Insurance Commission (CNBS), which is the financial system supervisor, indicate that banking system assets amounted to around 93% of GDP as of December 2017. Domestic credit to GDP is large relative to peers and ended at close to 60% last year.

There are no immediate contingent liabilities for the sovereign. The only exception is the small Banco Nacional de Desarrollo Agricola (BANADESA). The government explicitly guarantees all obligations of BANADESA per article 51 of its organic law. The bank’s liabilities totaled about L7,037 million (1.3% of GDP) in 2017.

A key risk for banks is correspondent banking funding, particularly in light of the liquidation of Banco Continental (BC) in October 2015, which held 3.2% of total system deposits. All depositors received up to 208,680 Lempiras (about US$9,400)––the insured threshold of the Honduran deposit insurance fund. The CNBS conducted a resolution process involving purchase and assumption operations for almost all of BC’s loan portfolio. The liquidation occurred after the US Office of Foreign Assets Control accused the bank and other companies owned by Continental’s controlling family of being involved in international drug trafficking and money laundering. Global financial institutions have likely become more concerned about compliance risks in Honduras, notwithstanding the passage in March 2015 of a special law to prevent money laundering.

Asset quality remains well managed in the Honduran banking system. Nonperforming loans (NPL) stood relatively stable at 2.3% of gross loans in 2017. Reserve coverage continues to improve. Coverage at the end of last year was around 138%, adding a layer of protection to the banks’ core capital. Further supporting stability in the banking system is a capital adequacy ratio of 13.8%, well above the required level of 10%.

External vulnerability risk: Low (+)

Exhibit 19

Peer comparison table factor 4d: External vulnerability risk Kyrgyz Honduras L+ Median Armenia Ethiopia Jordan Albania Suriname Republic B1/STA B1/POS B1/STA B2/STA B1/STA B1/STA B2/NEG Final score L+ L+ L+ L+ M- LL Indicative score VL L+ L- VL+ ML VL- (Curr. acc. bal. + FDI inflows)/GDP 2.6 1.3 0.9 -3.8 -2.6 -5.6 1.2 2.2 External vulnerability indicator (EVI) 38.5 72.1 116.5 72.1 44.5 102.1 107.3 14.0 Source: Moody's Investors Service

We set the final score for external vulnerability risk at “Low (+),” from an indicative score of “Very Low” to reflect large and structural current account deficits, as well as its dependence on foreign flows.

Over the past ten years, the current account deficit has ranged from 3.8% to 15.3% of GDP, reaching its widest in 2008 when oil prices spiked. Oil imports and low value-added exports explain the persistent trade deficits. Net foreign direct investment (FDI) increased

15 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

to 4.4% of GDP in 2017 from 4.2% in 2016, and continues to fully cover the current account deficit (see Exhibit 20). The bulk of the FDI has gone into maquilas, industry, the financial sector, renewable energy and telecommunications, although little goes into the agricultural sector.

Over the last four years, the current account deficit has narrowed on account of relatively low oil prices and rising remittances. In 2017 specifically, the current account deficit narrowed to 1.7% of GDP, a record-low within the last decade, achieved by exceptionally strong coffee exports, relatively low oil prices and record-breaking remittance flows. FDI inflows of 4.4% of GDP completely cover the current account deficit and diminish external vulnerability risks. International reserves reached their highest historical point in 2017, supported by the global bond issuance.

Exhibit 20 FDI inflows have been covering current account deficits (% of GDP)

Current Account Deficit, % of GDP Net Foreign Direct Investment, % of GDP 12.0

9.5 10.0 8.5 8.0 8.0 6.9 6.7 6.1 5.7 6.0 5.4 4.6 4.7 4.5 4.4 4.3 4.2 4.0 4.2 4.0 2.7 1.7 2.0

0.0 2010 2011 2012 2013 2014 2015 2016 2017E 2018F Source: Central Bank of Honduras

Oil imports and maquila exports are the main balance of trade drivers. Oil imports increased by 21% driven by increasing higher prices as the quantity of oil imports actually decreased during the period. Following increased consumption and spending on gross capital formation in 2017 non-oil imports, such as machinery, equipment and metals also increased in 2017 (see Exhibit 21). Similarly, exports of goods, not including maquila exports, grew 17.7%, driven by an increase of coffee exports of 44.3%. We expect the current account will widen slightly in 2018 to 4.0% of GDP, pushed by rising oil prices and lower coffee prices.

Exhibit 21 Top five export and import products (% change) Imports Exports 50

40

30

20

10

0

-10 Machinery and Metals Fuels and energy Food products Chemical Coffee Soaps & Palm Oil equipment Products Detergents Source: Haver Analytics, Central Bank of Honduras, Moody’s Investors Service

Maquila continues to be the largest single export sector (of which, textiles are the most significant), followed by agriculture and agro- industrial products, coffee being the most important exported agricultural product. Maquilas are manufacturing facilities that import

16 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

materials and equipment on a duty-free and tariff-free basis for assembly, processing, or manufacturing and then export the finished products. Maquila exports account for 47% of total goods exports, while agricultural and agro-industrial exports account for 40% (see Exhibit 22). Other, non-maquila manufacturing account for 11% of exports, followed distantly by mining products (2%). Coffee, Honduras’ largest export product, accounts for 29.5% of goods exports (compared to 27.7% of goods exports in Guatemala and 3.4% in Costa Rica). With regard to non-maquila export markets, the US is the largest with 34% of total exports, followed by Central America at 19% and Europe at 34% (see Exhibit 23).

Last year, Honduras and Guatemala created a Customs Union. As of 1 March of this year, transit times to cross the border have been reduced to 15 minutes from 10 hours. If such efficiencies continue we would expect regional trade to increase, positively impacting both countries' GDP. Already, El Salvador is evaluating entering the union.

Exhibit 22 Exhibit 23 Export composition Non-maquila export markets (% of total, as of 2017) (% of total, as of 2017)

Rest of the World 13%

Agriculture- Agroindustrial 34% Maquila 40% 47%

Europe 34%

Mining Central America 2% Manufacturing 19% 11%

Sources: Central Bank of Honduras, Moody’s Investors Service Sources: Central Bank of Honduras, Moody’s Investors Service

17 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Rating range Combining the scores for individual factors provides an indicative rating range. While the information used to determine the grid mapping is mainly historical, our ratings incorporate expectations around future metrics and risk developments that may differ from the ones implied by the rating range. Thus, the rating process is deliberative and not mechanical, meaning that it depends on peer comparisons and should leave room for exceptional risk factors to be taken into account that may result in an assigned rating outside the indicative rating range. For more information please see our Sovereign Bond Rating Methodology.

Exhibit 24 Sovereign rating metrics: Honduras

Economic How strong is the economic structure? strength Sub-factors: growth dynamics, scale of the economy, wealth

VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- + - Economic resiliency VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- How robust are the institutions and how predictable Institutional + - strength are the policies? Sub-factors: institutional framework and effectiveness, policy credibility and effectiveness

VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- Government financial strength + - VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- + - Fiscal How does the debt burden compare with the strength government's resource mobilization capacity? Sub-factors: debt burden, debt affordability

VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- Rating range: + - Ba2 - B1

Susceptibility What is the risk of a direct and sudden threat to debt to event risk repayment? Sub-factors: political risk, government liquidity risk, banking sector risk, external vulnerability risk Assigned rating: VL- VL VL+ L- L L+ M- M M+ H- H H+ VH- VH VH+ B1 + -

Source: Moody's Investors Service

18 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Comparatives This section compares credit relevant information regarding Honduras with other sovereigns that we rate. It focuses on a comparison with sovereigns within the same rating range and shows the relevant credit metrics and factor scores.

Honduras compares favorably to its peers in terms of its moderate level of debt to GDP of 38.7%, and unfavorably with respect to the relatively small size of its economy compared to the B1 median and its very low national income (the lowest in Latin America) and indicators of institutional strength, particularly Government Effectiveness and Rule of Law.

Exhibit 25 Honduras key peers Latin America and Honduras Armenia Dominican Republic Serbia Albania Tunisia B1 Median Year Caribbean Median Rating/Outlook B1/STA B1/POS Ba3/STA Ba3/STA B1/STA B2/STA B1 Ba3 Rating Range Ba2 - B1 Ba3 - B2 Ba3 - B2 Ba2 - B1 Ba3 - B2 B1 - B3 Ba2 - B1 Ba1 - Ba3 Factor 1 L+ L+ M L+ L+ L+ M- L+ Nominal GDP (US$ bn) 2016 21.6 10.6 72.3 38.3 11.9 42.1 35.4 43.3 GDP per capita (PPP, US$) 2016 5288.0 8643.2 16070.8 14414.7 11820.5 11448.0 10231.9 14138.0 Avg. real GDP (% change) 2012-2021 3.7 4.5 5.4 2.0 2.9 2.5 4.1 2.4 Volatility in real GDP growth (ppts) 2007-2016 2.2 7.1 2.7 2.9 2.1 2.2 2.0 2.4 Global Competitiveness index 2017 3.9 4.2 3.9 4.1 4.2 3.9 4.2 4.1 Factor 2 VL+ M L- M M- M M- L Government Effectiveness, percentile [1] 2016 9.7 38.3 30.8 46.6 42.8 33.0 40.6 39.0 Rule of Law, percentile [1] 2016 3.7 45.1 36.8 44.3 30.8 51.1 46.2 33.8 Control of Corruption, percentile [1] 2016 21.8 24.8 17.2 39.8 33.8 50.3 34.2 38.3 Average inflation (% change) 2012-2021 4.8 3.0 3.3 3.4 2.2 5.3 3.9 3.2 Volatility in inflation (ppts) 2007-2016 2.4 3.1 3.2 4.1 0.8 0.9 3.4 2.5 Factor 3 M- L VL+ L- L L- L M- Gen. gov. debt/GDP 2016 38.7 56.5 37.5 73.0 73.2 61.9 60.5 44.9 Gen. gov. debt/revenue 2016 142.8 238.2 256.8 168.8 265.3 263.2 251.7 195.9 Gen. gov. interest payments/revenue 2016 9.3 8.2 19.6 7.1 8.9 9.3 9.1 9.6 Gen. gov. interest payments/GDP 2016 2.5 1.9 2.9 3.1 2.5 2.2 2.3 2.1 Gen. gov. financial balance/GDP 2016 -0.4 -5.5 -2.8 -1.3 -1.8 -6.1 -3.5 -2.8 Factor 4 M- M M- M- M H- M+ M- Current account balance/GDP 2016 -2.7 -2.3 -1.1 -3.1 -7.6 -8.8 -4.6 -2.7 Gen. gov. external debt/gen. gov. debt 2016 71.8 74.3 65.7 61.3 42.6 65.1 52.0 60.2 External vulnerability indicator (EVI) 2018F 38.5 116.5 120.4 59.2 107.3 185.1 87.1 53.3 Notes: [1] Moody's calculations. Percentiles based on our rated universe Source: Moody’s Investors Service

19 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

DATA, CHARTS AND REFERENCES Chart pack: Honduras Exhibit 26 Exhibit 27 Economic growth Investment and saving

Real GDP volatility, t-9 to t (ppts) (RHS) Gross investment/GDP Gross domestic saving/GDP Real GDP (% change) (LHS) 40 6.0 3.0 35 5.0 2.5 4.0 30 3.0 2.0 25

2.0 20 1.5 1.0 15 0.0 1.0 10 -1.0 0.5 -2.0 5 -3.0 0.0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018F 2019F 2018F 2019F Source: Moody’s Investors Service, Central Bank of Honduras Source: Moody’s Investors Service, Central Bank of Honduras

Exhibit 28 Exhibit 29 National income Population

GDP per capita (US$) GDP per capita (PPP basis, US$) Population (Mil.) (LHS) Population growth (% change) (RHS) 6000 9.0 2.00 1.80 5000 8.5 1.60 1.40 4000 8.0 1.20 3000 1.00 7.5 0.80 2000 0.60 7.0 0.40 1000 0.20 0 6.5 0.00 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018F 2019F 2018F 2019F Source: Moody’s Investors Service, Central Bank of Honduras Source: Moody’s Investors Service, IMF

Exhibit 30 Exhibit 31 Global Competitiveness Index Inflation and inflation volatility Rank 96 out of 137 countries

Inflation rate volatility, t-9 to t (ppts) (RHS) Armenia (B1/POS) Inflation rate (CPI, % change Dec/Dec) (LHS) 12.0 3.0

Albania (B1/STA) 10.0 2.5

Serbia (Ba3/STA) 8.0 2.0

6.0 1.5 Tunisia (B2/STA) 4.0 1.0 Honduras (B1/STA) 2.0 0.5

Dominican Republic (Ba3/STA) 0.0 0.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

0 20 40 60 80 100 120 2018F 2019F Source: World Economic Forum Source: Moody’s Investors Service, Central Bank of Honduras

20 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Exhibit 32 Exhibit 33 Institutional Framework and Effectiveness Debt burden

Government Effectiveness[1] Rule of Law[1] Control of Corruption[1] Gen. gov. debt/GDP (%) (LHS) 0.0 Gen. gov. debt/gen. gov. revenue (%) (RHS) 45 180 -0.2 40 160

-0.4 35 140 30 120 -0.6 25 100 -0.8 20 80 15 60 -1.0 10 40 -1.2 5 20 0 0 -1.4 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2018F 2019F Source: Worldwide Governance Indicators Source: Moody’s Investors Service, Honduras’ Ministry of Finance

Exhibit 34 Exhibit 35 Debt affordability Financial balance

Gen. gov. interest payment/GDP (%) (LHS) Gen. gov. financial balance/GDP (%) Gen. gov. interest payment/gen. gov. revenue (%) (RHS) Gen. gov. primary balance/GDP (%) 3.0 10.0 3 9.0 2 2.5 8.0 1 7.0 0 2.0 6.0 -1 1.5 5.0 -2 4.0 -3 1.0 3.0 -4 2.0 -5 0.5 1.0 -6 0.0 0.0 -7 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018F 2019F 2018F 2019F Source: Moody's Investors Service, Ministry of Finance Source: Moody's Investors Service, Ministry of Finance

Exhibit 36 Exhibit 37 Government liquidity risk External vulnerability risk

Gen. gov. debt/GDP (%) (RHS) External debt/CA receipts (%)(LHS) Gen. gov. external debt/total gen. gov. debt (%) (LHS) 70 80 90 45 External vulnerability indicator (%)(RHS) 70 80 40 60 60 70 35 50 60 30 50 40 50 25 40 40 20 30 30 30 15 20 20 20 10 10 10 5 10 0 0 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018F 2019F 2018F 2019F Source: Moody’s Investors Service, Honduras' Central Bank Source: Moody’s Investors Service, Honduras' Central Bank

21 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Rating history

Exhibit 38 Honduras[1]

Government Bonds Foreign Currency Ceilings

Bonds & Notes Bank Deposit

Foreign Currency Local Currency Outlook Long-term Short-term Long-term Short-term Date Rating Raised B1 B1 Stable Ba2 -- B2 -- Sep-17 Rating Raised B2 B2 Positive Ba3 NP B3 NP May-16 Outlook Changed -- -- Positive ------May-15 Rating Lowered B3 B3 Stable B2 -- Caa1 -- Feb-14 Outlook Changed -- -- Negative ------Feb-13 Rating Raised ------Ba3 ------May-06 Rating Assigned B2 ------Jul-99 Rating Assigned -- B2 Stable B2 NP B3 NP Sep-98

Notes: [1] Table excludes rating affirmations. Please visit the issuer page for Honduras for the full rating history. Source: Moody's Investors Service

22 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Annual statistics

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018F 2019F Economic structure and performance Nominal GDP (US$ bil.) 13.9 14.6 15.8 17.7 18.5 18.5 19.8 21.0 21.6 23.0 23.8 25.1 Population (Mil.) 7.3 7.4 7.5 7.6 7.7 7.8 8.0 8.1 8.2 8.3 8.4 8.5 GDP per capita (US$) 1,912 1,976 2,111 2,324 2,395 2,357 2,481 2,598 2,643 2,766 2,822 2,936 GDP per capita (PPP basis, US$) 4,255 4,113 4,249 4,434 4,632 4,769 4,932 5,104 5,288 5,562 -- -- Nominal GDP (% change, local currency) 12.4 5.0 8.6 11.9 7.9 4.2 10.1 11.0 7.3 9.2 7.6 7.6 Real GDP (% change) 4.2 -2.4 3.7 3.8 4.1 2.8 3.1 3.8 3.8 4.8 3.8 3.5 Inflation (CPI, % change Dec/Dec) 10.8 3.0 6.5 5.6 5.4 4.9 5.8 2.4 3.3 4.7 4.5 4.0 Gross investment/GDP 36.1 20.6 21.9 26.0 24.6 21.8 22.2 25.1 23.3 23.8 23.4 23.2 Gross domestic saving/GDP 3.0 2.8 4.0 6.3 5.2 1.3 4.3 8.2 8.1 8.5 8.2 7.9 Nominal exports of G & S (% change, US$ basis) 7.7 -19.1 25.7 25.2 3.9 -6.0 5.9 0.8 -2.7 8.5 6.7 5.4 Nominal imports of G & S (% change, US$ basis) 16.2 -28.6 20.5 24.6 3.6 -2.9 2.2 0.8 -3.8 8.0 9.6 4.9 Openness of the economy[1] 135.7 96.9 109.4 122.2 121.2 116.3 113.0 107.3 100.5 102.4 107.3 106.8 Government Effectiveness[2] -0.6 -0.7 -0.6 -0.5 -0.7 -0.7 -0.8 -0.8 -0.7 ------Government finance Gen. gov. revenue/GDP[3] 19.9 17.1 23.1 23.0 22.9 23.8 24.9 25.2 27.1 26.6 26.7 26.8 Gen. gov. expenditures/GDP[3] 22.4 23.1 26.5 25.9 26.4 29.6 27.6 26.0 27.5 27.1 27.4 27.6 Gen. gov. financial balance/GDP[3] -2.4 -6.0 -3.4 -2.9 -3.5 -5.7 -2.7 -0.8 -0.4 -0.4 -0.7 -0.8 Gen. gov. primary balance/GDP[3] -1.8 -5.3 -2.6 -1.9 -2.3 -4.0 -0.8 1.2 2.1 1.8 1.6 1.5 Gen. gov. debt (US$ bil.)[4] 2.8 3.5 3.9 4.7 5.4 6.8 7.3 7.8 8.1 9.2 9.4 9.9 Gen. gov. debt/GDP[4] 20.1 23.9 24.3 26.9 29.6 37.1 37.6 37.9 38.7 40.4 40.0 39.7 Gen. gov. debt/gen. gov. revenue[4] 100.8 140.0 105.4 117.3 129.4 155.7 150.9 150.0 142.8 151.8 149.8 148.1 Gen. gov. interest payments/gen. gov. revenue[4] 3.1 4.3 3.1 4.5 5.3 7.1 7.6 8.0 9.3 8.3 8.5 8.6 Gen. gov. FC & FC-indexed debt/gen. gov. debt[4] 76.6 65.6 68.8 64.2 65.3 74.4 74.7 73.4 71.8 73.3 72.5 72.1 External payments and debt Nominal exchange rate (local currency per US$, Dec) 18.9 18.9 18.9 19.0 20.0 20.6 21.5 22.4 23.5 23.6 24.7 25.2 Real eff. exchange rate (% change) ------Current account balance (US$ bil.) -2.1 -0.6 -0.7 -1.4 -1.6 -1.8 -1.4 -1.0 -0.6 -0.4 -1.0 -1.0 Current account balance/GDP -15.3 -3.8 -4.3 -8.0 -8.5 -9.5 -6.9 -4.7 -2.7 -1.7 -4.0 -3.9 External debt (US$ bil.)[5] 3.5 3.4 3.8 4.2 4.9 6.7 7.2 7.5 7.5 8.6 8.8 9.4 Public external debt/total external debt[5] 67.4 73.7 75.1 76.5 75.4 77.5 77.5 79.5 81.5 83.1 81.7 81.9 Short-term external debt/total external debt[5] 13.3 7.4 9.9 6.4 8.3 7.6 7.0 6.6 5.8 4.1 5.6 5.6 External debt/GDP[5] 25.2 23.1 23.9 23.8 26.2 36.3 36.3 35.5 34.6 37.4 37.1 37.5 External debt/CA receipts[6][5] 34.2 39.7 37.2 34.5 38.1 54.7 55.2 55.9 56.4 58.9 59.3 60.3 Interest paid on external debt (US$ bil.)[5] 0.1 0.1 0.0 0.1 0.1 0.1 0.2 0.2 0.2 0.3 0.3 0.3 Amortization paid on external debt (US$ bil.)[5] 0.5 0.8 0.4 0.9 0.9 0.8 1.4 1.6 1.1 2.0 1.4 1.3 Net foreign direct investment/GDP 7.3 3.5 6.1 5.7 4.6 5.4 6.7 4.5 4.2 4.4 4.2 4.6 Net international investment position/GDP -32.5 -35.1 -37.2 -39.1 -47.4 -57.8 -63.1 -65.2 -66.4 -67.2 -- -- Official forex reserves (US$ bil.) 2.5 1.9 2.5 2.6 2.3 2.8 3.3 3.6 3.7 4.5 4.2 4.6 Net foreign assets of domestic banks (US$ bil.) 0.0 0.1 0.0 0.0 -0.4 -0.6 -0.7 -0.8 -0.6 -0.6 -- --

23 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Monetary, external vulnerability and liquidity indicators M2 (% change Dec/Dec) 2.5 -0.2 13.3 13.0 4.4 8.0 10.6 10.7 12.5 14.9 -- -- Monetary policy rate (% per annum, Dec 31) 7.8 4.5 4.5 5.5 7.0 7.0 7.0 6.3 5.5 5.5 -- -- Domestic credit (% change Dec/Dec) 14.0 12.4 5.2 13.8 14.9 7.2 10.0 8.0 12.3 5.4 -- -- Domestic credit/GDP 51.6 55.2 53.5 54.4 57.9 59.6 59.5 57.9 60.6 58.4 -- -- M2/official forex reserves (X) 2.2 2.8 2.5 2.7 2.9 2.5 2.3 2.2 2.4 2.2 -- -- Total external debt/official forex reserves[5] 142.2 176.3 151.5 163.0 208.3 237.4 218.2 207.0 204.7 189.1 210.2 204.7 Debt service ratio[7][5] 5.9 9.4 4.7 8.0 7.6 7.1 12.3 13.4 10.2 15.4 11.4 10.4 External vulnerability indicator (EVI)[8][9] 34.4 49.4 35.9 51.5 45.3 50.1 68.0 63.1 44.8 66.1 38.5 42.7 Liquidity ratio[10] 16.2 10.5 12.3 19.1 32.8 20.4 19.8 19.3 11.7 8.0 -- -- Total liabilities due BIS banks/total assets held in BIS banks 48.4 35.8 37.2 46.8 63.8 44.7 59.2 58.8 47.1 44.7 -- -- "Dollarization" ratio[11] 29.0 29.4 27.2 26.8 28.8 29.1 30.9 28.6 29.1 28.0 -- -- "Dollarization" vulnerability indicator[12] 58.3 76.4 64.3 68.1 85.2 76.7 76.1 69.4 74.1 63.9 -- --

[1] Sum of Exports and Imports of Goods and Services/GDP [2] Composite index with values from about -2.50 to 2.50: higher values suggest greater maturity and responsiveness of government institutions [3] Central government until 2009; general government starting in 2010 [4] Central government until 2009; general government starting in 2010; beneficiary of the Heavily Indebted Poor Countries (HIPC) official debt relief initiative [5] Beneficiary of the Heavily Indebted Poor Countries (HIPC) official debt relief initiative [6] Current Account Receipts [7] (Interest + Current-Year Repayment of Principal)/Current Account Receipts [8] (Short-Term External Debt + Currently Maturing Long-Term External Debt + Total Nonresident Deposits Over One Year)/Official Foreign Exchange Reserves [9] Excludes total nonresident deposits over one year; Beneficiary of HIPC official debt relief [10] Liabilities to BIS Banks Falling Due Within One Year/Total Assets Held in BIS Banks [11] Total Foreign Currency Deposits in the Domestic Banking System/Total Deposits in the Domestic Banking System [12] Total Foreign Currency Deposits in the Domestic Banking System/(Official Foreign Exchange Reserves + Foreign Assets of Domestic Banks)

24 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Moody’s related publications

» Credit Opinion: Government of Honduras – B2 Positive: Regular Update, 14 March 2018

» Outlook: Sovereigns – Latin America & Caribbean: 2018 outlook stable as growth momentum offsets rising debt and policy uncertainty, 9 January 2018

» Issuer Comment: Honduras’ contested presidential election threatens economic growth, 4 December 2017

» Country Statistics: Honduras, Government of, 29 November 2017

» Rating Action: Moody's upgrades Honduras' ratings to B1 from B2; outlook stable, 22 September 2017

» Rating Methodology: Sovereign Bond Ratings, 22 December 2016

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients. Related websites and information sources

» Sovereign risk group web page

» Sovereign ratings list

» Central Bank: www.bch.hn

» Ministry of Finance: www.sefin.gob.hn

MOODY’S has provided links or references to third party World Wide Websites or URLs (“Links or References”) solely for your convenience in locating related information and services. The websites reached through these Links or References have not necessarily been reviewed by MOODY’S, and are maintained by a third party over which MOODY’S exercises no control. Accordingly, MOODY’S expressly disclaims any responsibility or liability for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on any third party web site accessed via a Link or Reference. Moreover, a Link or Reference does not imply an endorsement of any third party, any website, or the products or services provided by any third party. Endnotes 1 UN Human Development Report 2016. 2 World Bank, Doing Business 2018. 3 The largest state-owned enterprises are the electricity company (ENEE), the telecommunications company (Hondutel) and the water supplier (SANA). The most important from a central government fiscal standpoint is ENEE. 4 Founded in 1967, CIAT currently has 42 member countries and associate member countries from four continents: 32 countries of the Americas, 5 European countries, 4 African countries and 1 Asian country. 5 In March 2013, the government issued its first global bond ($500 million, sinkable, 11 year maturity, 7.5% coupon) with the intention of using part of the proceeds to pay down its stock of domestic debt. In December 2013, the government issued another global bond ($500 million, bullet, 7 year maturity, 8.75% coupon). Even though 32% of the proceeds of both bonds was used to repay domestic debt, domestic debt levels remained high.

25 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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REPORT NUMBER 1123050

26 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis