Honduras at a Glance: 2006-07

Country Report

Honduras

Honduras at a glance: 2006-07

OVERVIEW Manuel Zelaya Rosales of the Partido Liberal (PL) took office as president of Honduras for a four-year term on January 27th 2006, having beaten the candidate of the incumbent Partido Nacional (PN), Porfirio Lobo Sosa, in the November 27th 2005 election by just 3.7% of the total vote. The PL failed narrowly to gain a simple majority in the National Congress, winning 62 of the 128 seats, and will be reliant on the support of other parties in order to pass legislation. The Economist Intelligence Unit expects broad policy continuity in 2006-07, focusing on goals agreed with the IMF under the IMF-World Bank poverty reduction and growth facility (PRGF). Honduras will benefit from debt relief under the heavily indebted poor countries (HIPC) initiative during 2006-07. Average annual GDP growth will slow to 3.6% in 2006-07, and inflation will remain outside government targets. The exchange rate will stay broadly stable in real terms against the US dollar. Slowing export growth in line with weaker global growth, and rapid growth in the import bill, associated with high oil prices and relatively strong domestic demand, will result in a widening current-account deficit.

Key changes from last month Political outlook • Despite its weak position in Congress, the government in March passed the necessary legislation in areas such as intellectual property rights, government procurement, customs procedures, phytosanitary measures and changes to the penal code, for inclusion in the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA) on April 1st. Economic policy outlook • The BCH has reduced the Tasa de Interés de Política Monetaria (TPM, the short-term interest rate that reflects the BCH’s monetary targets) from 7% to 6.75% and suspended the issue of US dollar-denominated monetary certificates used as a sterilisation tool. Economic forecast • We have revised downward our consumer price inflation (CPI) forecast for 2006-07 following signs of easing pressure on prices in early 2006. We now expect consumer price inflation to end 2006 at 7.3%, falling to 6.2% at end 2007. April 2006

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Honduras 1

Contents

Honduras

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2006-07 7 Political outlook 8 Economic policy outlook 10 Economic forecast

13 The political scene

15 Economic policy

18 The domestic economy 20 Agriculture 21 Manufacturing 22 Financial services 23 To u r i s m

23 Foreign trade and payments

List of tables 9 International assumptions summary 11 Forecast summary 15 Central government finances 17 Gross domestic product by expenditure 18 Production indicators 18 Consumer price inflation 20 Selected industrial production 21 Credit to the private sector 23 Merchandise trade 25 Balance of payments

List of figures 11 Gross domestic product 11 Consumer price inflation

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Honduras 3

Honduras April 2006 Summary

Outlook for 2006-07 Manuel Zelaya Rosales of the Partido Liberal (PL) took office as president of Honduras for a four-year term on January 27th 2006, having beaten the candidate of the incumbent Partido Nacional (PN), Porfirio Lobo Sosa, in the November 27th 2005 election by just 3.7% of the total vote. The PL failed to gain a simple majority in the National Congress, winning 62 of the 128 seats, leaving it reliant on the support of other parties in order to pass legislation. The government will seek to relax some of the programme targets agreed with the IMF under the IMF-World Bank poverty reduction and growth facility (PRGF) in order to release funds to fulfil election campaign pledges. Honduras will benefit from debt relief under the heavily indebted poor countries (HIPC) initiative during 2006-07. Average annual GDP growth will slow to 3.6% in 2006-07, and inflation will remain outside government targets. The exchange rate will stay broadly stable in real terms against the US dollar. An increasing trade deficit as a result of strong, investment-driven import demand will cause the current- account deficit to widen in 2006-07.

The political scene During his first few weeks in office, Mr Zelaya has introduced a number of measures aimed at making rapid progress on some of his campaign commitments, focusing on increasing citizen participation in political life and increasing government accountability; promoting human development, including free school enrolment; and reducing unemployment.

Economic policy Preliminary figures published by the Central Bank indicate that the central government deficit narrowed to La4.7bn (US$250m) in 2005, equivalent to 3.0% of GDP, compared with 3.4% of GDP in 2004, and in line with the target set out under the PRGF agreed with the Fund in 2004.

The domestic economy In 2005 real GDP growth slowed year on year to 4.2%, within the 4.0%-4.5% range estimated by the Central Bank. Growth was led by private consumption, following sustained growth of remittances from Hondurans working abroad and an expansion in consumer credit stimulated by lower interest rates.

Foreign trade and payments Strong growth in earnings from the services sector, attributable to the performance of maquila, tourism, and in transfers from abroad (mainly workers’ remittances) contributed to a substantial narrowing of the current- account deficit in 2005, to US$42.3m (0.5% of GDP), down from US$399.4m (5.3% of GDP) in 2004.

Editors: Ian Emery (editor); Martin Pickering (consulting editor) Editorial closing date: March 20th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report April 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 4 Honduras

Political structure

Official name Republic of Honduras

Form of state Unitary republic

The executive President, elected for a four-year term

National legislature National Congress, comprising one member and one substitute member elected for every 35,000 people or fraction over 15,000

Legal system US-style Supreme Court system

National elections November 2005 (legislative and presidential); next elections due November 2009 (legislative and presidential)

National government Following his victory in the November 27th 2005 election, Manuel Zelaya Rosales, of the Partido Liberal (PL), took office as president on January 27th 2006

Main political organisations Government (from January 27th 2006): Partido Liberal (PL) Opposition: Partido Nacional (PN); Partido de Innovación Nacional y Unidad-Social Demócrata (PINU-SD); Partido Demócrata Cristiano (PDC); Partido de Unificación Democrática (PUD)

President Manuel Zelaya Rosales

Vice-president Elvin Santos

Key ministers Agriculture Hector Hernandez Culture & sports Rodolfo Pastor Fasquel Defence Arístides Mejía Economy, industry & commerce Lizzy Azcona Bocok Education Rafael Pineda Ponce Finance Hugo Noé Pino Foreign affairs Milton Jimenez Puerto Health Orizon Velázques Interior & justice Jorge Arturo Reina Labour & social security Riccy Moncada Natural resources & environment Mayra Mejía del Cid Presidency Yani Rosenthal Hidalgo Public security Alvaro Romero Public works, transport & housing José Rosario Bonano Technical co-operation Karen Zelaya To u r i s m Ricardo Martinez

Private secretary to the presidency Raul Valladares

Central Bank president Gabriela Núñez

National Congress president Roberto Micheletti

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Economic structure

Annual indicators 2001a 2002a 2003 a 2004 a 2005a GDP at market prices (La bn) 99.0 108.1 120.5 137.2 157.7 GDP (US$ bn) 6.4 6.6 6.9 7.5 8.4 Real GDP growth (%) 3.3 2.0 3.0 5.0 4.2 Consumer price inflation (av; %) 9.7 7.7 7.7 8.1 8.8 Population (m) 6.6 6.7 6.9 7.1 b 7.2b Exports of goods fob (US$ m) 1,374.7 1,364.3 1,380.1 1,603.3 1,765.4 Imports of goods fob (US$ m) 2,769.4 2,806.1 3,035.0 3,676.7 4,187.5 Current-account balance (US$ m) -302.5 -240.9 -259.8 -399.4 -42.3 Foreign-exchange reserves excl gold (US$ m) 1,415.6 1,524.1 1,430.0 1,970.4 2,327.2 Total external debt (US$ bn) 5.0 5.4 5.6 6.2 b 5.8b Debt-service ratio, paid (%) 11.2 12.1 11.5 8.4 b 7.0b Exchange rate (av) La:US$ 15.47 16.43 17.35 18.21 18.83 a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2005 % of total Components of gross domestic product 2005 % of total Services 54.9 Private consumption 76.5 Manufacturing 20.1 Exports of goods & services 41.0 Agriculture 13.9 Fixed investment 23.2 Electricity, gas & water supply 5.0 Government consumption 13.6 Construction 4.4 Stockbuilding 6.9 Mining 1.7 Imports of goods & services -61.2

Principal exports 2005 US$ m Principal imports 2005 US$ m Coffee 334.9 Manufactures & industrial raw materials 1,848.7 Bananas 252.7 Machinery & transport equipment 991.5 Shrimp & lobster 184.1 Minerals & fuels 928.0 Gold 63.3 Food & animal products 715.4

Main destinations of exports 2005 % of total Main origins of imports 2005 % of total US 36.8 US 38.0 El Salvador 10.5 Guatemala 9.0 Germany 8.5 El Salvador 5.9 Guatemala 7.9 Costa Rica 5.5 Belgium 5.4 Mexico 5.3

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Quarterly indicators 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Prices Consumer prices, Tegucigalpa (2000=100) 132.9 136.1 139.2 141.7 145.2 148.5 151.7 153.0 Consumer prices, Tegucigalpa (% change, year on year) 6.8 7.8 8.8 9.0 9.6 9.1 9.0 8.0 Financial indicators Exchange rate La:US$ (av) 17.86 18.10 18.33 18.54 18.72 18.84 18.87 18.90 Exchange rate La:US$ (end-period) 17.99 18.20 18.44 18.63 18.78 18.86 18.89 18.90 Deposit rate rate (av; %) 11.3 11.2 11.0 10.9 11.0 11.0 10.9 10.8 Government bond yield rate (av; %) 11.9 12.5 11.4 10.9 11.2 11.6 11.3 11.2 Lending rate (av; %) 20.1 20.0 19.7 19.6 19.3 19.0 18.6 18.5 Savings rate (av; %) 6.1 6.1 6.0 6.0 6.0 6.0 6.0 6.0 M1 (end-period; La m) 16,603 16,321 16,595 20,019 20,351 20,374 20,313 24,093 M1 (% change, year on year) 20.0 18.6 25.1 16.0 22.6 24.8 22.4 20.4 M2 (end-period; La m) 70,594 73,057 74,667 80,945 84,462 87,705 89,595 97,495 M2 (% change, year on year) 17.2 17.6 17.5 20.7 19.6 20.1 20.0 20.4 Sectoral trends Coffee production (annual totals; ‘000 tonnes)a ( 185 ) ( 191 ) Foreign trade (US$ m) Exports fob 408.4 415.4 369.1 348.8 475.8 494.5 367.6 356.8 Imports cif -919.7 -935.4 -983.7 -1,078.2 -999.0 -1,132.6 -1,135.2 -1,216.9 Trade balance -511.3 -520.0 -614.6 -729.4 -523.2 -638.1 -767.6 -860.1 Foreign reserves (US$ m) Reserves excl gold (end-period) 1,501.4 1,625.4 1,695.2 1,970.4 2,067.8 2,159.7 2,177.3 2,327.2 a Estimate for 2005. Sources: Food and Agriculture Organisation (FAO); IMF, International Financial Statistics; Banco Central de Honduras.

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Outlook for 2006-07

Political outlook

Domestic politics Manuel Zelaya Rosales of the Partido Liberal (PL) took office as president of Honduras for a four-year term on January 27th, having beaten the candidate of the incumbent Partido Nacional (PN), Porfirio Lobo Sosa, in the November 27th 2005 election, by just 3.7% of the total vote. The PL narrowly failed to gain a simple majority in the National Congress, winning 62 of the 128 seats, compared with 55 for the PN. This will leave the government reliant on the support of other parties in order to pass legislation. Of the three minority parties—the Partido Unificación Democrática (PUD) with five seats, the Partido Demócrata Cristiana (PDC) with four seats and the Partido de Innovación Nacional y Unidad-Social Demócrata (PINU-SD) with two—the centre-left PINU- SD has lent its support to the PL, which still leaves the government short of a simple majority. The PN has attracted the support of the remaining two parties, leaving Congress divided, with both the government and opposition able to count on the support of 64 legislators. During his campaign, under the slogan poder ciudadano (“citizen power”), Mr Zelaya promised a more inclusive government, stressing the need for Honduras to develop a participatory democracy. Central to his bid to restore trust in state and independent institutions will be his success in reducing corruption in both the public and private sectors. Mr Zelaya’s call for openness will be backed by the introduction of a Ley de Transparencia (transparency law) and the institution of a civil assembly to monitor the government. As well as a mechanism to monitor the performance of the central government, Mr Zelaya has proposed a degree of decentralisation of power, with certain powers, including land development rights, being transferred to the local level of government. The task will be challenging, given that citizen participation in the Honduran political system has been undermined by long periods of military rule. Local political structures are based on political clientelism, and widespread poverty and low education standards have tended to discourage political participation at the local level. The Zelaya administration might struggle to satisfy the high public expectations for it to tackle corruption and crime, address the problems of widespread poverty, unemployment and—more recently—the effects of the surge in oil prices. With security a prime concern, given the upsurge in rates of violent crime in recent years, expectations for an improvement in this area will be high. Mr Zelaya’s election victory was a rejection of the hardline stance of the PN candidate, Mr Lobo Sosa, whose campaign centred on the reintroduction of the death penalty. Mr Zelaya, who favours a more comprehensive approach toward tackling crime, taking into account the social conditions that foster criminality, campaigned on a policy of reducing poverty and unemployment as a means of tackling crime, as well as the introduction of an offender-rehabilitation scheme. However, an effective strategy against violent crime will need to include a comprehensive reform of the penal system (which is badly affected by

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corruption), as well as the investigation and eradication of the links between the trade in illegal drugs, public officials and the police.

International relations The Zelaya administration will continue to foster Honduras’s close relations with the US, its most important trading partner. The coming into force of the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA) with the US, due on January 1st 2006, has been delayed because of the failure of respective legislatures to pass the necessary legislation governing certification standards. In March the Honduran Congress passed the necessary legislation in areas such as intellectual property rights, government procurement, customs procedures, phytosanitary measures and changes to the penal code, for inclusion in DR-CAFTA on April 1st. DR-CAFTA will make permanent the benefits of the Caribbean Basin Initiative (CBI) and is expected to attract new foreign investment to Honduras, particularly in export-oriented sectors.

Economic policy outlook

Policy trends Although the Economist Intelligence Unit expects the Zelaya administration to follow a prudent, broadly market-oriented policy, despite public opposition to the IMF-backed economic policy programme, there is a risk that the government’s weak position in Congress may make it more inclined to garner public support through populist measures. In 2006 the government’s economic programme will be backed by the final year of a three-year poverty reduction and growth facility (PRGF) agreed with the IMF in February 2004, which, under the outgoing PN administration, led to promised debt relief under the IMF- World Bank’s heavily indebted poor countries (HIPC) initiative. However, Mr Zelaya plans to negotiate a relaxation of some of the programme targets set out under the PRGF to release funds to fulfil campaign pledges such as job creation and increased expenditure on healthcare and education. Concerns will focus on such initiatives leading to a relaxation of fiscal discipline. For its part, the Fund will seek assurances that measures will be put in place to reduce the short-term fiscal impact of DR-CAFTA (resulting from reduced import duties), as well as measures to improve the financial health of state companies such as the Empresa Nacional de Energía Eléctrica (ENEE, the state electricity company). Implementing a new energy policy will be a primary concern given high international oil prices. The international bidding mechanism the government is introducing to control oil imports could face obstacles, while other measures intended to reduce fuel prices, such as the reduction of fuel duties, will prove difficult to implement owing to budget constraints. The government will benefit from debt relief under the HIPC initiative following a successful review of Honduras’s economic performance under the PRGF in 2005. Under HIPC, Honduras’s foreign public debt will be cut by around 24%, or US$1.2bn, over ten years. The freed resources will finance a poverty-reduction strategy in the outlook period agreed with the Fund by the outgoing administration. In 2005 the Paris Club group of bilateral creditor countries agreed to grant Honduras debt forgiveness totalling US$1.1bn (nearly 72% of the bilateral debt owed). The decision in June 2005 by the Ministers of Finance of the G8 countries to write off all of the debt of eligible HIPC-qualified

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countries, including Honduras, implies an additional debt reduction of US$1.25bn of multilateral and bilateral debt.

Fiscal policy The central government deficit narrowed marginally, to 3% of GDP in 2005, in line with the goal agreed with the Fund. A significant factor in narrowing the deficit was played by HIPC donations in 2005, without which we estimate that the deficit would have reached 3.5% of GDP. The Fund programme includes the government’s commitment gradually to reduce the heavy burden that the wage bill places on the public finances. However, a 3.5% increase in budgeted expenditure in 2006 is largely explained by the additional budgeted spending to pay for public-wage increases agreed in 2005. The 2006 budget also includes a 25% cut in spending in certain areas such as goods and services, new hiring and spending on infrastructure, to accommodate estimated fuel-price subsidies without jeopardising targets. Projects included in the poverty-reduction strategy will account for around 48% of total budgeted spending. The central government deficit target for 2006 under the PRGF is 2.5% of GDP. While tax revenue in 2006-07 will be supported by firm domestic demand, failure to rein in expenditure, or laxity on the part of the incoming government in the face of demands for wage increases, would risk making fiscal targets unattainable. The announcement of several initiatives involving increases in public expenditure by Mr Zelaya during his first months in office have raised concerns about the government’s commitment to fiscal prudence. Although the government has suggested that sufficient funds could be released by a reform of the state bureaucracy, such a comprehensive reform is likely to be too politically costly for the government to achieve. Given the benefits of debt relief and the need to avoid measures that would put the economic programme at risk, we expect government policy to include measures to meet planned reductions to the fiscal deficit. Consequently, we broadly expect the government to meet targets for reducing the fiscal deficit in the outlook period.

Monetary policy In line with commitments under the PRGF, measures are being taken to improve the monetary policy framework. The Banco Central de Honduras (BCH, the Central Bank) has moved away from targeting monetary aggregates and will rely more heavily on the use of short-term interest rates as a policy tool. This will provide it with greater flexibility and should help it to achieve its policy goals in the long run. Following signs of slowing inflation in the first months of 2006, the BCH has reduced the Tasa de Interés de Política Monetaria (TPM, the monetary policy interest rate, the short-term interest rate that reflects the BCH’s monetary targets) from 7% to 6.75% and suspended the issue of US dollar-denominated monetary certificates used as a sterilisation tool. The BCH has also reversed an increase in reserve requirements put in place in 2004, returning the total reserve requirement on lempira-denominated liabilities to 12%; and has eased foreign-exchange controls, following a sustained increase in international reserves.

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Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2004 2005 2006 2007 Real GDP growth World 5.1 4.6 4.3 4.1 US 4.2 3.5 2.8 2.5 EU25 2.4 1.6 2.1 2.3 Exchange rates US$ effective (1995=100) 86.0 84.9 84.4 80.5 ¥100:US$ 1.08 1.10 1.13 1.05 US$:€ 1.244 1.245 1.248 1.338 Financial indicators US$ 3-month commercial paper rate 1.48 3.49 5.25 4.88 US$ 3-month Libor 1.62 3.56 5.32 4.95 Commodity prices Coffee (Arabica; US cents/lb) 80.5 114.8 97.8 76.8 Oil (Brent; US$/b) 38.5 54.7 60.0 55.3 Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.2 -0.5 -2.3 Industrial raw materials (% change in US$ terms) 21.0 10.5 11.7 -15.8 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Although our central assumption is that the rate of global growth will remain relatively robust, at 4.3% in 2006 and 4.1% in 2007 (on a purchasing power parity basis), this forecast carries downside risks. High oil prices are threatening to drag down economic performance in oil-importing economies, with the US— Honduras’s main trading partner—particularly at risk, given that its economic output is more oil-intensive than most other OECD economies. We have recently revised upward our forecast for oil prices, which we expect to average US$60/barrel in 2006, falling only slightly, to US$55 in 2007, reflecting continued strong demand and ongoing capacity constraints in the industry. Although the US dollar performed relatively robustly in 2005, the US’s current- account deficit remains a vulnerability and the risk of a rapid US-dollar depreciation persists, which, if it were to occur, would damage Honduras’s export prospects. We expect prices for Honduras’s main export commodity, Arabica coffee, after rising by 43% in 2005, to fall back by around 33% in the forecast period. Meanwhile, the EU’s proposed banana tariff of €176/tonne (US$220/tonne) for Latin American producers could damage Honduras’s exports to Europe of its second-largest export commodity if the new tariff regime is accepted by the World Trade Organisation (WTO).

Economic growth Real GDP grew by 4.2% in 2005, down from 5% in 2004, led by consumption and exports. Gross fixed investment fell by close to 7%, reversing the upward trend of the past two years, as a fall in investment by the private sector (mainly in commercial and industrial construction) far outweighed increased public- sector investment. In 2006-07 economic growth will slow further, in line with slowing external demand. Despite continued growth in inward remittances, consumption growth will underperform overall economic growth, owing to the impact on real wages of above-target inflation. On the supply side, agricultural

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output in 2006-07 should recover, following a stagnant performance in 2005, which was caused by lower yields resulting from adverse weather conditions. The maquila (offshore assembly for re-export) industry and the tourism sector will continue to be major sources of growth. When DR-CAFTA comes into effect in 2006 it will attract increased investment inflows and opportunities for export- oriented business. Infrastructure projects, such as the long-awaited interoceanic road, which would connect Puerto Cortés on the Atlantic coast with ports on the Pacific, will also prosper. The telecoms and energy sectors would also attract foreign direct investment (FDI) if further sectoral liberalisation is achieved. Progress could take place in 2006-07, but will depend on the new government’s willingness and ability to move ahead with reform. However, given the government’s fragile position in Congress, its progress with liberalisation may be held back by an obstructive opposition.

Inflation Consumer price inflation overshot the Central Bank’s target rate of 6.5-7.5% in 2005, ending the year on 7.7%. The BCH has struggled to bring inflation down in the face of food-supply shortages and continued high international oil prices. The Central Bank will continue efforts to achieve a gradual reduction in the rate of inflation in the outlook period; however, we forecast that it will not manage to bring down inflation significantly in 2006 as high oil prices and relatively robust domestic demand contribute to holding inflation above the Central Bank’s target range. Inflation will fall further in 2007, on the assumption of slowing aggregate demand and easing international fuel prices, but the persistence of high oil prices for longer or at levels above those we are currently forecasting would risk inflation overshooting our current forecast.

Exchange rates Multilateral aid, debt-service relief and rapidly increasing remittances from Hondurans working in the US have boosted international reserves to record levels, helping to shield against the risk of currency instability. Official reserves increased by just over 14% in the first 11 months of 2005, to US$2.3bn, according to the IMF. We forecast that this trend will continue in 2006-07, helping to support the currency’s value. The Central Bank is overhauling monetary management by adopting indirect investments, the increasing use of which in the outlook period should lessen inflationary risks and underpin greater exchange-rate flexibility in the outlook period. Our baseline forecast is for the lempira to stay broadly stable in real terms against the US dollar, yielding year- end rates of La19.36:US$1 in 2006 and La20.22:US$1 in 2007.

External sector Following a widening of the trade deficit in 2005 to US$2.4bn, we forecast a deceleration of export earnings growth in 2006-07. With domestic demand still relatively strong, import growth will remain ahead of export growth, leading to an increasingly wide trade deficit. Growth in imports is being driven by high international fuel prices and continued strong growth in investment-related imports of machinery and electrical equipment. Domestic demand will continue to be supported by investment and growth in remittances from expatriate Hondurans, which reached US$1.7bn in 2005, double maquila earnings and more than total merchandise export earnings. The resulting continued strong demand for imports will largely offset gains made in the services account from the buoyant maquila and tourism industries, and a lower

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income deficit as interest payments fall as a result of debt-service relief. Consequently, we expect the current-account deficit, after narrowing to 0.5% of GDP in 2005 as a result of combined official external transfers and a record level of remittances, to widen to 2.3% of GDP in 2006 and 3.4% of GDP in 2007. Honduras will finance its external imbalance, mainly with aid and FDI inflows. After strong growth in 2005, we expect international reserves to average around US$2.6bn in 2006-07, equal to over five months of non-maquila imports, supported by the high level of remittances and other capital inflows.

Forecast summary (% unless otherwise indicated) 2004 a 2005 a 2006b 2007b Real GDP growth 5.0 4.2 3.7 3.5 Gross agricultural production growth 7.0 0.5 3.2 2.5 Gross fixed investment growth 17.1 -6.8 6.5 6.0 Unemployment rate (av) 28.5 c 28.0 c 27.9 27.8 Consumer price inflation (av) 8.1 8.8 7.4 6.5 Consumer price inflation (year-end) 9.2 7.7 7.3 6.2 Weighted average local currency lending rate 19.9 19.6 c 20.1 21.3 Central government balance (% of GDP) -3.4 -3.0 c -2.6 -2.4 Exports of goods fob (US$ m) 1,603.3 1,765.4 1,905.1 1,874.0 Imports of goods fob (US$ m) 3,676.7 4,187.5 4,517.4 4,748.3 Current-account balance (US$ m) -399.4 -42.3 -211.8 -332.5 Current-account balance (% of GDP) -5.3 -0.5 -2.3 -3.4 External debt (year-end; US$ bn) 6.2 c 5.8 c 5.4 5.3 Exchange rate La:US$ (av) 18.21 18.83 19.36 20.00 Exchange rate La:US$ (year-end) 18.63 18.90 19.58 20.22 Exchange rate La:€ (av) 22.64 23.44 24.15 26.75 Exchange rate La:SDR (av) 26.97 27.83 28.43 30.64 a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates.

Gross domestic product Consumer price inflation (% change, year on year) (av; %)

Honduras Latin America Honduras Latin America 6.0 11

5.0 10 4.0 9 3.0 8 2.0 7 1.0

0.0 6

-1.0 5 02 03 04 05 06 07 02 03 04 05 06 07 2001 2001

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The political scene

Mr Zelaya takes office as On January 27th 2006 José Manuel Zelaya Rosales of the Partido Liberal (PL)

president took office as president of Honduras, replacing the outgoing Ricardo Maduro Joest of the Partido Nacional (PN). Mr Zelaya’s victory in the November 27th 2005 election has been seen as a reflection of the desire for change following a PN administration that had been damaged by a number of high-profile corruption scandals that emerged during its time in office, undermining the electoral prospects of the PN candidate, Porfirio Lobo Sosa. During his campaign, Mr Zelaya distanced himself from traditional factions of the PL by including relative unknowns in a campaign team designed to appeal to an electorate eager for change. Many of these were professionals whose presence was intended to convince voters that a Zelaya administration would be capable of providing innovative solutions to meet the political and economic challenges facing the country. However, Mr Zelaya faces a weak position in Congress. The PL failed to obtain a simple majority in the National Congress, where it won 62 of the 128 seats, leaving it reliant on the support of other parties to pass legislation. The government’s difficulties were highlighted during the process to elect a new president of the legislature. Mr Zelaya’s choice was a PL congressman, Roberto Micheletti. Despite the support of the two legislators of the minority Partido de Innovación Nacional y Unidad Social-Demócrata (PINU-SD), the government lacked the majority needed to secure Mr Micheletti’s appointment. The PN, which has 55 seats, is able to block government proposals in Congress as a result of its alliance with the two other small parties, the Partido Unificación Democrática (PUD) with five seats, and the Partido Demócrata Cristiana (PDC) with four, giving the opposition 64 seats too. While the PDC is a traditional ally of the PN, the support of the leftist PUD is surprising given the party’s historical opposition to the conservative PN. Nevertheless, the promise of important posts in the National Congress proved enough to sway the PUD. Deadlock over the issue was only avoided once the government agreed to the PN, the DC and PINU-SD holding important positions at the directive board of the National Congress. While the PL will chair 30 of the 56 commissions in Congress, the PN will be in charge of 17; the PUD will chair 4; the DC 3 and the PINU 2. These commissions will be responsible for dealing with central issues, such as the revision of the contracts between the Empresa Nacional de Energía Eléctrica (ENEE, the state electricity company) and private energy suppliers, a new mining law, and a new framework for the telecommunications sector and are likely to present an obstacle to the government implementing policy. The PL is divided into two broad factions: a modern wing, which Mr Zelaya heads, and a more traditional wing, which contains members of the former PL administration (1998-2002). In a sign of Mr Zelaya’s weak position in Congress, and the need to avoid alienating his own party, the new president’s appointments to office have resulted in traditional leaders of the PL occupying important posts in the Zelaya administration. Many of the candidates whom Mr Zelaya defeated to become the party’s choice for the presidency have been appointed to important positions in the cabinet: Hugo Noé Pino is the Minister

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of Finance; Gabriela Núñez is the president of the Banco Central de Honduras (BCH, the Central Bank); and Marlon Lara is the head of the Fondo Hondureño de Inversión Social (FHIS), the social investment institute, a post formerly held by Mr Zelaya. Yani Rosenthal (son of a powerful banker who vied for the PL presidential nomination, Jaime Rosenthal Oliva) is the secretary of the presidency, a strategic post overseeing the execution of the poverty reduction strategy and also responsible for managing the funds of the Millennium Challenge Account.

Mr Zelaya seeks to deliver on During his first few weeks in office, Mr Zelaya introduced a number of

campaign promises measures aimed at making rapid progress on some of his campaign commitments. Mr Zelaya’s election proposals focused on increasing citizen participation in political life and increasing government accountability; promoting human development, including free school enrolment; and reducing unemployment. Protection of natural resources and steps to reduce fuel prices, which pose an increasing threat to the Honduran economy, were also highlighted as priorities by the Zelaya campaign in the run up to the election. The Ley de Participación Ciudadana (the citizen participation law) was passed by Congress on January 27th, the day the new president took office. The legislation aims to expand citizen empowerment in the formulation, execution and evaluation of all the policies and actions of the state. The law provides for the creation of the National Forum of Citizen Power, which will be given the task of implementing, executing and supervising the Ley de Transparencia (the transparency law). This law, passage of which is still pending, will aim to facilitate access to public information as a means of increasing accountability. In one of his first cabinet meetings in late January, Mr Zelaya also reaffirmed his pre-election commitment to ensuring free student enrolment at public schools (previously each student has had to pay to enrol at school at the beginning of each year). Public schooling at all levels (pre-school, primary and secondary) will by covered by this measure. Mr Zelaya’s Minister of Education, Rafael Pineda Ponce, who lost in the 2001 presidential election to Ricardo Maduro Joest of the PN, estimates that 2m students will be enrolled at state schools in 2006, and has calculated that the fiscal cost of providing free enrolment will amount to La600m (US$31m). The president also promised to adhere to the teaching statute, under which teachers’ salaries are reviewed on an annual basis in accordance with the adjustment of the minimum annual wage. The commitment was opposed by some within the business community, who argued that the decision would compromise the government’s ability to meet its fiscal targets. In support of their right to annual pay reviews, teachers called for limited strike action in late March to highlight their case. In an indication of the difficulties inherited from the previous government in meeting public-sector workers’ pay demands, healthcare workers have also called for strikes in demand for wage increases. As well as a vote for change, Mr Zelaya’s victory was also a rejection of the hardline stance against crime of the PN candidate, Porfirio Lobo Sosa, who campaigned in favour of the death penalty. Mr Zelaya presented a more comprehensive approach towards tackling the problem of violent crime,

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emphasizing the need to improve socio-economic conditions and promote rehabilitation programmes aimed at members of the so-called maras, or youth gangs. Nevertheless, opinion polls continue to reflect the fact that violent crime constitutes a primary concern for a majority of Hondurans, highlighting the difficulties the government could face if it fails to take actions which have an impact on crime levels. In the first 45 days of 2006 there were a total of 700 violent deaths in the capital, Tegucigalpa, and San Pedro Sula, Honduras’s second city and the industrial hub of the country. As a result, some of the initial security measures introduced by the government have focused on a more traditional approach to crime prevention. Among these are plans for a 1,000- officer increase in the number of police each year during the government's term. Mr Zelaya has also announced that 1,000 soldiers will be transferred to the police department, fuelling concerns among human rights groups of the militarisation of the police service. With the transparency law pending, Mr Zelaya has taken initial steps to address the problems of misspending and corruption in public office. Among these is the decision to revoke the contract with the UN Development Programme (UNDP), through which the purchase of medicines was conducted via public bids. The government took the decision that the bidding process was open to abuse. Corruption remains a serious problem in Honduras, which successive governments have promised to tackle. While the “pasaportazo” (the selling of passports to illegal immigrants), involving public officials under the previous administration, remains unresolved, a new scandal emerged when the new head of the Migration Department, Daniel Alfredo Ramos, accused the Secretary of Tourism, Ricardo Martinez, of abuse of power. Mr Martinez interceded on behalf of five tourists from Libya, Bosnia and Albania, who tried to enter Roatán island, a popular tourist destination off the Caribbean coast of Honduras, with visas, but without the documentation required by foreign nationals originating from countries regarded as having problems of terrorism and organised crime. Responding to the incident, the Minister of Foreign Affairs, Milton Jimenez Puerto, confirmed that Honduras has no diplomatic representation in Lebanon, so that whoever issued the visas there was not authorised to do so.

Economic policy

Central government deficit Preliminary figures published by the Banco Central de Honduras (BCH, the

narrows Central Bank) indicate that the central government deficit narrowed to La4.7bn (US$250m) in 2005, equivalent to 3.0% of GDP, compared with 3.4% of GDP in 2004. Central government revenue increased by 16.1% year on year, benefiting from strong aggregate demand and improved tax collection. Tax revenue (which accounted for just under 83% of total revenue) increased by 14.1% year on year to La26.7bn. Direct taxes, which rose by 22.5%, were the most dynamic performer, while indirect taxes, which account for around two-thirds of tax receipts, were boosted by a 17% increase in receipts from sales tax, reflecting the strength of domestic demand during the year. The Aporte Vial (the tax levied on oil and petroleum imports and sales) accounted for around 20% of tax revenue, reflecting its central role as a source of government revenue.

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Although the strong performance of revenue contributed to the slight narrowing in the fiscal deficit, a 16.6% rise in expenditure prevented the deficit narrowing further. One of the fastest growing components of current spending was expenditure on goods and services, which increased by 44% year on year to reach La4.3bn. Transfers to the public and private sectors, including subsidies, also grew strongly, by 36% to La7.3bn. The wage bill increased by 9.4%. With inflation rising by 7.7% during the year, this represented an increase of under 2% in real terms. As a percentage of GDP, the wage bill narrowed to 8.5% of GDP in 2005, down from 10% of GDP in 2004.

Central government finances (La m) 2004 2005 % change Total revenue & grants 27,821.1 32,305.1 16.1 Current revenue 26,411.2 30,095.4 13.9 Donations 1,190.0 1,285.1 8.0 HIPC donations 105.0 776.6 639.6 Total expenditure 32,548.5 37,017.9 13.7 Current expenditure 24,514.8 29,112.0 18.8 Wages 13,748.2 15,045.0 9.4 Interest on debt 2,414.2 2,472.1 2.4 Overall balance -4,727.4 -4,712.8 -0.3 % of GDP -3.4 -3.0 -

Sources: Secretaría de Finanzas; Banco Central de Honduras.

The 2005 deficit was in line with the target set out under the poverty reduction and growth facility (PRGF) agreed with the IMF in 2004. According to the Minister of Finance, Hugo Noé Pino, the government aims to reduce the central government deficit to 2% of GDP in 2006, half a percentage point below the target set out in the PRGF. However, the passage of the 2006 budget has been postponed to allow for changes introduced by the new administration, which in turn has delayed the arrival of an IMF mission to complete the fourth revision of the PRGF programme, which was due to take place in March.

Balancing discipline and social Mr Noé Pino has announced that the new budget would amount to La40.8bn,

spending an 8% increase year on year, broadly in line with inflation, and envisages a 25% cut in spending in certain areas such as goods and services, new hiring and spending on infrastructure, which will offset some of the increased spending to cover election commitments. Nevertheless, although the government has announced its commitment to a disciplined fiscal policy, some of the measures implemented in the first month of the Zelaya administration appear to pose a threat to fiscal consolidation. Implementing the subsidy ensuring free school enrolment has an estimated fiscal cost of La600m, while the commitment to take on board demands for higher wages from teachers and healthcare workers also risks pushing up expenditure on salaries. In addition, the 2006 budget will include spending to fulfil election commitments such as providing subsidies for forest preservation and additional funds to finance the increase in the size of the police force. These increases in expenditure would partly be offset by a reduction in total expenditure as part of the government’s plans to reform government bureaucracy, although this has raised concerns at the Ministry of

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Finance about the contingent expenses that might have to be met by the government to finance the dismissal of public employees. Other measures that raise doubts about fiscal discipline include the prospective increase in the tax-free threshold on personal annual income from La90,000 to La200,000. The last such modification to personal income tax was implemented in 1998, when the tax-free threshold was raised from La75,000 to La90,000 (income tax at 10% is currently levied on incomes above La90,000). The latest proposed increase, the fiscal cost of which has been estimated at La700m, would benefit around 240,000 employees. Mr Zelaya has also announced an emergency plan to stem the trade in illegal logging and to protect Honduras’s natural habitat. The government plans to invest around 1% of the national budget in reforestation, with the aim of replanting around 500,000 ha of forest.

Government puts in place a Dependence on oil imports leaves Honduras vulnerable to trends in

new energy policy international oil prices. The perception that the Maduro administration lacked a policy to moderate the effects of rising fuel prices in 2005 played a part in undermining the electoral chances of the PN candidate for the presidency. The implementation of measures to reduce fuel prices was one of the main electoral promises of the Zelaya campaign. During his campaign, Mr Zelaya announced that a government led by him would reduce the taxes levied on fuel sales, which are above the regional average. As a first step, in February the government announced that the tax levied on imports of regular gasoline would be reduced from US$1.15 to 99 US cents per gallon, at an estimated cost to the government of around La20m. The main initiative that the new government has announced in its bid to define a new energy policy is the launch of an international bidding process for the purchase of oil to supply the domestic market. Honduras consumes around 13m barrels of oil per year. At present, oil imports are supplied by four companies. The government aims to launch an international bid to purchase directly the volume of oil that Honduras consumes in a year, an operation which, according to the government, could save Honduras up to US$66m annually. However, the initiative has raised concerns. Firstly, the government’s ability to conduct a transparent process is doubted. Secondly, because of the lack of storage infrastructure, the government will have to rely on the oil firms already operating in Honduras to provide the necessary storage. Finally, depending on a single oil supplier increases the risk of oil shortage. Despite these concerns, the first bid under the new mechanism is expected to take place by mid-2006. With regard to domestic energy capacity, the government plans to build several new hydroelectric dams (Patuca II and III, Los Llanitos and el Tablón), and to promote the production of alternative sources of fuel, such as ethanol using sugar cane and biodiesel using African palm oil.

Progress in minimum wage Negotiations between trade unions and representatives from the business sector

negotiations on an increase to the minimum salary began in mid-December, with both sides agreeing by the end of March on an increase in the minimum wage (currently La2,400) of between 8.4% and 11%. The trade unions had been demanding an

increase of 9%-12%, whereas representatives from the business sector were proposing a lower increase of between 4% and 5%.

The domestic economy

Growth in 2005 was led by In 2005 real GDP growth slowed slightly to 4.2%, down from 5.0% in 2004, but

domestic consumption within the 4.0%-4.5% range estimated by the Banco Central de Honduras (BCH, the Central Bank) in its 2005 monetary programme. Growth was led by private consumption, which expanded by 7.7%, driven by sustained growth of remittances from Hondurans working abroad and an expansion in consumer credit stimulated by lower interest rates (although rates remain high by international standards). Public consumption and investment also increased, reflecting pre-electoral spending in the run-up to the November 27th 2005 poll. Growth of exports of goods and services slowed significantly year on year, mainly owing to the poor performance of coffee and banana crops, Honduras’s main merchandise exports. In contrast with the other expenditure components of GDP, private investment suffered a downturn, adversely effected by uncertainties owing to the electoral process and the delays in implementing the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA), but also suffering from the high base of comparison in 2004, when private investment grew by 23.2%. The downturn in private investment was reflected in the slight decline in import growth in 2005.

Gross domestic product by expenditure (La bn at 1978 constant prices; % change year on year in brackets unless otherwise indicated) 2003 2004 2005 Private consumption 5.4 5.7 6.1 (3.6) (4.3) (7.7) Public consumption 0.9 0.9 1.0 (0.8) (5.6) (6.7) Gross fixed investment 1.6 1.9 1.8 (8.4) (17.1) (-6.7) Private investment 1.2 1.5 1.3 (5.8) (23.2) (-11.6) Public investment 0.4 0.4 0.5 (16.8) (-0.4) (10.7) Stockbuilding 0.4 0.3 0.5 (4.7)a (4.3)a (6.0)a Exports of goods & services 2.1 2.3 2.4 (5.2) (9.7) (4.8) Imports of goods & services 2.6 2.9 3.2 (7.4) (14.0) (9.9) GDP 7.8 8.2 8.5 (3.5) (5.0) (4.2) a Contribution to growth. Source: Banco Central de Honduras.

On the supply side, the most dynamic sectors contributing to GDP growth were public administration and defence (which expanded by 10.8%), electricity, gas and water (9.8%), construction (6.9%), transport and communications (6.6%) and financial activities (6.2%). The manufacturing sector, which accounts for 16.3% of

GDP, expanded by 4.9%. By contrast, the agricultural sector (including agriculture, forestry and fishing), which accounts for nearly 25% of GDP, remained relatively static, growing by just 0.5%, as poor coffee and banana crops dragged down the sector’s performance. The short-term economic indicators published by the BCH, which are a good proxy for GDP, show one of the most dynamic subsectors to be telecommunications, which expanded by 9.3%, led by the expansion in mobile telecoms. Interurban passenger transport (which measures the number of people making journeys between major towns and is used as a proxy for tourism activity) also posted a strong performance, as did electricity production. Although industrial output expanded by just 2.4%, this was close to double the rate of expansion in 2004. By contrast, there was a significant contraction in mining activities, reflecting a fall in demand for construction materials.

Production indicators (Jan-Dec) 2004 2005 % change Agriculture & livestock index 179.7 178.7 -0.6 Metallic mining index 2,674.2 2,101.2 -21.4 Industrial production index 262.3 268.5 2.4 Passenger transporta ('000 passengers) 2,745.9 2,912.4 6.1 Telephony index 1,099.6 1,202.0 9.3 New construction area (‘000 sq metres) 899.3 868.4 -3.4 Electricity (m kwh) 4,092.3 4,258.1 4.1 Water consumed ('000 cu metres)b 99,342.2 99,655.1 0.3 a Main companies only, between towns. b Tegucigalpa and San Pedro Sula only. Source: Banco Central de Honduras.

Inflation shows signs of In the first two months of 2006 annual inflation maintained the downward slowing trend observed in the last quarter of 2005. In February monthly inflation reached 0.7%, the lowest rate recorded in this month since 1988, while annual inflation reached 6.8%, down from 9.1% a year earlier. A significant part in the slowing trend was played by the slower year-on-year increase in the food price index, which reached 4.9% in February 2005, compared with a high of 12.3% in August 2005 as supply constraints receded. The communication sector has also contributed to the moderating rate of inflation, with prices falling by 16.1% year on year in February 2005. By contrast, education is exerting upward pressure on inflation, accounting for 50.7% of the increase in consumer prices in February.

Consumer price inflation (% change) 2004 2005 2006 Monthly Annual Monthly Annual Monthly Annual Jan 0.9 6.9 0.8 9.0 0.4 7.3 Feb 1.1 6.7 1.2 9.1 0.7 6.8 Mar 0.4 6.7 0.8 9.5 - - Apr 1.1 7.3 0.9 9.4 - - May 0.8 7.9 0.4 9.0 - - Jun 0.6 8.3 0.7 9.0 - -

Consumer price inflation (% change) 2004 2005 2006 Monthly Annual Monthly Annual Monthly Annual Jul 1.3 9.3 0.9 8.6 - - Aug 0.3 8.7 0.8 9.1 - - Sep 0.1 8.4 0.4 9.3 - - Oct 0.9 8.8 0.1 8.5 - - Nov 0.9 9.1 0.2 7.7 - - Dec 0.4 9.2 0.4 7.7 - - Annual average - 8.1 - 8.8 - -

Source: Banco Central de Honduras.

The exchange rate remains Since November 2005 the exchange rate has remained virtually unchanged at stable La18.90:US$1. Exchange rate stability has been underpinned by the growth of international reserves, which reached US$2bn at end-2005, driven by increasing remittances from Hondurans working abroad and growth in export earnings. Given that domestic inflation is around double the rate in the US, the lempira is appreciating in real terms against the dollar. The BCH is engaged in a process of introducing greater flexibility to the exchange rate regime, aimed at halting the real appreciation of the lempira and at the same time arresting the decline in international competitiveness.

Agriculture

The agricultural sector remains According to data published by the BCH, agricultural output expanded by just sluggish 0.5% year on year in 2005, compared with a growth rate of 6.9% in 2004. Although the sector has been benefiting from a recovery in prices for certain major agricultural commodities, it has been held back by poor yields, adverse weather conditions, and scarce credit. Coffee output contracted by 15.9% in 2005, rice by 12.4% and banana production by 5.1%. Corn output expanded by 18.2% (after shrinking by 14.9% in 2004), while production of beans recovered, increasing by 9.7%, compared with a decline of 20.6% in 2004. Sugarcane production also increased, by 2.7%, as did African palm production, by 17.6%. A recovery in coffee prices in 2005 was reflected in a 33% increase in coffee export earnings during the year, to US$334.9m. Export prices averaged US$105.84 per 46-kg bag of coffee during the year, 53% higher than the average price in 2004. However, export volumes shrank by 13%, reaching 3.16 m 46-kg bags (down from 3.64m in 2004). Coffee output has been affected by overexploitation of land on some coffee farms and the lack of effective fertilisation programmes. Exports have also suffered from smuggling across the borders to Guatemala and El Salvador. Coffee plantations are also facing a shortage of workers to harvest their crops, as workers prefer to go to El Salvador where wages are higher. Bad weather, which has affected coffee plantations, has raised fears among growers that the estimated crop of 4m 46-kg bags in 2005/06 growing season (October-September) may not be reached. In a move designed to lessen what some growers regard as an unnecessary financial cost, a reduction from US$9 per 46-kg bag to US$4 in the fee that

coffee growers must pay to the coffee trust is being considered. The coffee trust currently charges the US$9 fee on all exports when prices are above US$90 per 46-kg bag: through this fee, indebted producers pay back the loans received from the trust when prices are depressed. However, the fee is also paid by producers who have not received loans from the trust, although their contributions are subsequently repaid to them. A similar scenario of higher export prices but falling volumes affected the banana industry in 2005. Banana prices averaged US$9.17 per box, a 27.8% increase over 2004. Although export earnings reached US$252.7m in 2005, a 21.3% year-on-year increase, export volumes, at 27.6m 40-lb boxes, were 5% lower. In a bid to reduce dependence on a narrow range of export crops, the Zelaya administration plans to increase and diversify agricultural output, with the aim of increasing the domestic supply of food as well as encouraging food exports. Although many small-scale farmers are concerned that following the implementation of DR-CAFTA they will suffer as a result of increased competition from US agricultural imports, and are demanding protection, the outlook for sugarcane growers is positive. Sugarcane growers are already benefiting as, facing high oil prices, demand for sugar as an input to produce ethanol has increased, which has also helped to increase sugar prices. Under DR-CAFTA, Honduran sugar exports will benefit further from increased quotas to the US market. Coupled with the Zelaya government's recently launched initiative to promote the use of alternative fuels, including ethanol, the prospects for cane growers look set to remain secure.

Manufacturing

Growth in the manufacturing The manufacturing sector expanded by 4.9% in 2005, compared with growth of sector accelerates 4.2% in 2004. The best performing industrial subsectors were fibre cement sheets, pasteurised milk, beer and wheat flour. By contrast, production of vegetable oils, newspapers, sugar, and rum and distilled spirits contracted.

Selected industrial production (‘000 units) Jan-Dec Dec 2004 2005 % change 2004 2005 % change Sugar (46-kg bags) 8,141 7,807 -4.1 731 549 -24.9 Wheat flour (46-kg bags) 2,637 2,802 6.3 267 275 3.0 Pasteurised milk (litres) 90,737 104,287 14.9 7,993 9,171 14.7 Vegetable oil (lbs) 171,054 160,946 -5.9 20,535 16,352 -20.4 Soft drinks (12-oz bottles) 1,329,206 1,356,046 2.0 102,478 120,704 17.8 Beer (12-oz bottles) 257,198 276,303 7.4 28,629 28,974 1.0 Rum & distilled spirits (litres) 12,799 12,400 -3.1 1,173 1,322 12.7 Cigarettes (packets of 20) 320,556 319,959 -0.2 23,096 28,106 21.7 Fabric (yards) 198,347 197,726 -0.3 10,328 9,522 -7.8 Cement (42.5-kg bags) 32,749 32,553 -0.6 2,429 3,193 31.5 Fibre cement sheets (sq metres vol) 5,173 5,986 15.7 340 412 21.2 Newspapers (copies) 69,172 65,568 -5.2 5,444 5,736 5.4

Source: Banco Central de Honduras.

According to Central Bank balance of payments statistics, in 2005 value-added earnings from maquila (offshore assembly for re-export) reached US$886.4m, a 11.5% increase year on year. Statistics from the Asociacion Hondureña de Maquiladores (whose data also includes electrical products assembled by maquiladoras), however, indicate that maquila exports reached US$1.2bn, a 12.6% year-on-year increase. Investment in the maquila industry is estimated to have reached between US$150m and US$200m in 2005, although total employment in the industry fell to 127,730 jobs from 131,000, as firms moved operations to other Central American countries where wages and energy costs are lower. Despite this, estimates suggest that investment in maquila will reach US$300m in 2006, triggered by the implementation of DR-CAFTA. With strong competition from China in the textiles sector, industry diversification has become a priority. Sectors which are thought likely to attract investment are the production of cardboard and latex products, as well as printing and dehydration of fruits and vegetables. There are opportunities for manufacturing in the south, where there is a greater supply of labour. This will increase as construction of the Canal Seco, the road that will connect Honduras’s east and west coast and Salvadoran ports in the Pacific, progresses.

Financial services

Strong growth in credit to the At the end of 2005 total deposits of the private sector in commercial banks consumer sector reached La74.1bn (US$3.9bn), a 20.5% year-on-year increase. Lempira- denominated deposits (which reached La49.4bn and accounted for 67% of the total) increased by 26.7%, and dollar-denominated deposits by 9.8%, to reach La24.7bn. The stronger growth in local currency deposits appears to reflect increased confidence in the currency following the monetary authorities easing of foreign exchange controls. Total commercial bank credit to the private sector reached La61.4bn at the end of 2005, 19.2% higher year on year. New credit from commercial banks to the private sector expanded by 31.7% in 2005, led by lending to consumers (up by 84.3%), and loans for real estate (35.3%) and industry sectors (27.9%). In December 2005 the weighted average interest rate on lempira-denominated loans reached 18.4% (5.6 percentage points lower than the year-earlier level).

Credit to the private sector (La m, from commercial banks; Dec) New credit Total stock of credit 2004 2005 % change 2004 2005 % change Agriculture & livestock 2,687.3 2,747.8 2.3 6,039.3 5,400.5 -10.7 Industry 9,329.2 11,934.5 27.9 10,280.5 11,997.9 16.7 Services 6,130.8 7,762.6 26.6 5,628.6 7,049.4 25.2 Real estate 4,921.9 6,660.9 35.3 10,638.4 12,634.7 18.8 Commerce 16,026.6 17,674.4 10.3 12,035.6 15,977.0 32.8 Consumer 8,949.9 16,496.6 84.3 6,904.7 8,379.8 21.4 Other 0.5 0.0 - 1.8 1.5 -16.7 Total 48,046.3 63,276.8 31.7 51,528.9 61,440.8 19.2

Source: Banco Central de Honduras.

Banks’ balance sheets improve In December 2005 total assets of the financial system (including commercial banks, saving and loans, and financial societies) reached La132.1bn, a 19.1% year- on-year increase. Among the main asset items, investment was the most dynamic performer, increasing by 24.6% over the period to reach La26.8bn, driven by investments in public entities. The loan portfolio expanded by 20.4% to reach La64.3bn. Liquid assets increased at a slower pace, growing by 9.6% to La15.1bn. Liabilities totalled La104.4bn, 18.4% higher year on year, while capital and reserves increased to La11.4bn, up by 17.8%. Total deposits reached La81.0bn, an 18.8% increase. As a result, the gap between loans and deposits narrowed slightly, with loans accounting for 79.5% of total deposits by the end of 2005 compared with 78.4% a year earlier. The balance sheets of commercial banks continued to improve, benefiting from higher returns. In December 2005 liquid assets accounted for 47.1% of short-term liabilities (compared with 45.3% a year earlier), while overdue loans declined to 5.47%, from 6.37% in December 2004.

Tourism

Tourism continues to grow Earnings from tourism reached US$431.3m in 2005, an increase of 7.5% compared with 2004. Total arrivals reached 1.2m, a 13% increase year-on-year, while stopover tourist arrivals, defined as those who spend more than one day in Honduras, reached 749,400, an 11.5% increase on 2004. Stopover tourists spent an average of 11.5 nights in Honduras, and their average expenditure amounted to US$56.1 per day. Visitor country of origin is heavily weighted to the Americas, with 58% of all tourist arrivals coming from other Central American countries and 30% from the US. Completion of the Los Micos beach and resort on Honduras’s north coast, better known as the Tela Bay project, is expected to provide a strong boost to the sector. Park Hyatt and Westin will be the only two chains given licence to operate in the resort. Although construction was expected to begin during the presidency of Ricardo Maduro Joest (2002-06), the date has been put back a number of times. Mr Zelaya has announced a project for a “tourism-free area” at the Bay Islands. The initiative aims to provide a legal framework for the prevention of environmental damage and migratory problems, while enhancing ecologically sound investment and economic development in the area through the elimination of import tariffs and taxes on sales and income for activities that are environmentally friendly. However, there are concerns that this could increase the attractiveness of the islands for people engaged in smuggling and tax evasion.

Foreign trade and payments

Export earnings driven up by Sustained import growth, combined with a slowing of export growth resulted

high commodity prices in the trade deficit widening by around 17% year on year in 2005. The increase in export earnings, which rose by 9.9% year on year, was driven by higher

international prices for bananas and coffee, Honduras’s main merchandise exports. Prices for these two important crops were 27.8% and 53.1% higher respectively year on year. In December 2005 export volumes of banana contracted by 52.4%, owing to the impact of tropical storm Gamma on cultivation fields. In contrast, export volumes of coffee expanded by 11% in that month, as the shipping of the 2005/06 harvest got underway. Although contributing less in absolute terms, the most dynamic export items in 2005 were sugar, earnings from which increased by 82.5% year on year, tilapia (74.6%) and fruit and vegetables (32.4%), all of which benefited from higher export volumes than from higher prices. The import bill increased by 14.5% in 2005. Almost half the increase was explained by the fuel import bill, inflated by high international oil prices during the year. Imports of consumer goods also expanded rapidly, reflecting the strength of consumer demand, which has played a major part in widening the trade deficit in the last couple of years. The 17.1% decrease in imports of capital goods illustrates how the widening trade balance is being led by consumption expansion rather than increasing capital formation, although the 15.1% rise in intermediate goods bodes well for business expansion and investment.

Merchandise trade (US$ m) Jan-Jul Jul 2004 2005 % change 2004 2005 % change Merchandise exports fob 968 1,091.10 12.7 145.7 129.9 -10.8 Banana 115.9 152.6 31.7 16.6 8.9 -46.4 Coffee 214.7 290.1 35.1 24.7 26 5.3 Shrimp 75.6 70.6 -6.6 24.2 33.6 38.8 Merchandise imports cif 2,182.80 2,610.00 19.6 322.6 400.6 24.2 Consumer goods 548.9 697.3 27.0 85.7 109.1 27.3 Fuels & lubricants 351.5 514.8 46.5 41 92.6 125.9 Capital goods 474.9 415.6 -12.5 60.7 56.3 -7.2 Raw materials & intermediate goods 666.1 815.1 22.4 115.2 114.9 -0.3 Trade balance -1,214.8 -1,518.9 25.0 -176.9 -270.7 53.0

Source: Banco Central de Honduras.

Services and transfers narrow In 2005 the services surplus reached US$396.4m, a 38.5% increase over 2004.

the current-account deficit The increase is mainly attributable to growth in maquila value-added and tourism receipts. Transfers from abroad (mainly workers’ remittances) reached around US$2bn, a 43% year-on-year increase. The combined effect of these two balance of payments items was to substantially narrow the current-account deficit in 2005, to US$42.3m, equivalent to 0.5% of GDP, down from US$399.4m (5.3% of GDP) in 2004. Capital inflows totalled US$318.3m, a 54% fall year on year. Although this may seem a poor performance, it is worth remembering that in 2004 capital inflows were boosted by new loans to the private sector to finance investments in electricity generation and telecoms. Since net capital inflows exceeded the current-account deficit, the stock of international reserves increased by US$372.4m, reaching US$2.0bn, equivalent to nearly six months of imports.

Balance of payments (US$ m) 2004 2005 % change Exports FOB 1,603.30 1,765.40 10.1 Imports CIF 3,676.70 4,187.50 13.9 Trade balance -2,073.40 -2,422.10 16.8 Services exports 1,521.40 1,678.50 10.3 Services imports -869.70 -961.10 10.5 Services balance 651.7 396.4 -39.2 Income balance -365.5 -322 -11.9 Net current transfers 1,387.80 1,984.40 43.0 Current-account balance -399.4 -42.3 -89.4 % of GDP -5.3 -0.5 n/a Long term inflows (net) 749.9 343.2 -54.2 Banking sector 62 41.5 -33.1 Public sector 212.3 24.3 -88.6 Private sector 475.6 277.4 -41.7 Short term inflows (net) 43.2 -24.9 -157.6 Capital-account balance 793.1 318.3 -59.9 Errors & omissions -20.8 -59.6 186.5 Change in international reservesa 504.3 372.4 -26.2 a A minus indicates inflow. Source: Banco Central de Honduras.