Since the 2003 financial turndown the DR has tightened its financial regulations, resulting in a robust financial sector that helped prevent the spread of the global crisis to domestic financial institutions
The Central Bank recapitalization law will contribute to the development of a public debt market, to foster growth in the Dominican stock market, increasing the efficiency of financial intermediation and, more importantly, ensuring long-term macroeconomic stability
The regulation and supervision of the Dominican financial system is the responsibility of the Financial and Monetary Administration, which is comprised of the Monetary Board as the principal body, the Central Bank and the Superintendency of Banks. The principal function of the Central Bank is to maintain price stability through the implementation of monetary, financial and exchange rate policy. Accordingly, the Superintendency of Banks has the responsibility of monitoring the Financial Intermediaries, for the purpose of guaranteeing the proper application of Monetary and Financial Law No. 183-02 and all the rules, regulations, and provisions enacted by the Monetary Board.
Currently, the country has a legal and policy framework based on best international practices and standards, which helped prevent the spread of the global crisis to domestic financial institutions. However, in response to the profound transformations in the global economy and the international financial system as a result of the crisis, the monetary authorities are devoted to strengthening the regulatory framework, incorporating lessons learned from efforts to counter the recent worldwide turbulence.
In the process of safeguarding the proper functioning of the financial system and the economy as a whole, the monetary authorities were faced with extreme and very adverse conditions in 2008 and 2009. External inflationary pressures, as demonstrated by historic international increases in the price of oil and other commodities, affected the Dominican economy during 2008. Within this context, the Central Bank took steps to reduce liquidity and lessen the impact of the external inflation shock. These provisions included increases in the monetary policy (Overnight) interest rate and the discount (Lombard) rate, changes in the composition and the calculation of the legal reserve requirement, an increase in placements of securities through open market operations and demonetization using international reserves.
On the other hand, the intensification of the financial crisis following the bankruptcy of Lehman Brothers led to a credit freeze, affecting international trade and capital flows, and pushing the world into its worst recession in the past eighty years. In this context, there was a slowdown in the growth of the Dominican economy due to its high degree of openness and commercial relationship with the United States. This situation led to a decrease in imports, and therefore, in tax revenues for the Government, which, coupled with the restrictions on access to external financing, precluded the implementation of a countercyclical fiscal policy that would have allowed an increase in government investment to counter the short-term effects of the slowdown in economic activity.
In this context, it became necessary to identify additional sources of external financing that would allow the public spending measures established in the 2009 budget to be implemented and to revitalize the economy. For this reason, the President of the Republic, Leonel Fernandez, along with the government’s economic team, deemed it necessary to sign an agreement with the IMF as a strategic component of the reactivation of the Dominican economy.
The current Stand-By Arrangement, which began in November 2009, will run for 28 months and provides the disbursement of Special Drawing Rights (SDRs), equivalent to about US$1.7 billion. On this occasion, about US$450 million will serve as funding for the Government, and the remainder will be devoted to strengthening the Central Bank’s international reserves. Approval of this agreement was a key factor in the US$750 million sovereign bond issue in 2010 and the reduction of the Dominican country risk premium.
Meanwhile, the Central Bank has established more flexible monetary conditions as of early 2009, with the aim of increasing domestic demand by making available more credit for the productive sectors and reducing interest rates, in order to reactivate economic activity. These provisions consisted of a combination of monetary policy rate cuts, reductions in legal reserve requirements, and the freeing up of these resources to fund productive sectors (construction, local manufacturing, agriculture and other consumption), specific modifications of prudential standards to benefit micro-, small- and medium-sized businesses and the provision of liquidity, the temporary closure of the issuance of securities by the Central Bank to the public, as well as other administrative measures.
Indeed, the weighted average of the lending interest rate in the banking system fell more than 11 percentage points, from 25.17% in January 2009 to 13.62% by December 2010. There have been mortgages at fixed rates up to three years of less than 12%, as well as consumer loans at rates ranging from 8% to 10%.
It is important to note that the prompt transmission of the monetary policy measures to the market interest rates was caused mainly by the stability and strength of the Dominican Financial System, especially of the multiple banking sector. Currently, this segment enjoys high capital and solvency levels that exceed the established parameters of the Basil Committee and the prudential standards in the Dominican Republic.
For the purpose of reinforcing the operational framework for monetary policy, in 2005 the authorities began working on a transition to a new monetary policy scheme. Later on, this goal was established in Objective #1 of Price Stability in the Central Bank’s 2010-2013 Strategic Plan and in the Stand-By Agreement with the IMF, initiated in November 2009. In this agreement the preparation of an implementation strategy for an Inflation Targeting scheme was included as a structural performance criterion.
The Inflation Targeting scheme is a monetary policy reference framework, characterized by the public announcement of official quantitative goals (or ranges) for inflation rates relative to one or more time horizons, with the explicit certainty that low and stable inflation is the principal long term objective. This monetary strategy should not be considered a policy rule, as it does not provide simple instructions and procedures to the central bank that is adopting it. Nevertheless, it confers a considerable level of discretion on the monetary authorities.
In the last 5 years the Central Bank has incorporated the majority of the requirements for this monetary scheme, thus guaranteeing a smooth transition to the new operational framework. To complete this process, a monitoring committee has been designated and technical assistance has been requested from Latin American Central Banks and IMF staff experts.
After the easing of monetary policy promoted by the Central Bank starting in January 2009, as evidenced in the historic low interest rate levels prevailing in the financial market, the monetary authorities maintained a policy stance that is consistent with fiscal expansion, and that permitted meeting the inflation target of 6%-7% for 2010. The institution will continue monitoring the economic growth process as it comes closer to its potential output level, for which it is prepared to adapt its monetary and exchange policy to new economic conditions, for the purpose of countering inflationary pressures and preserving macroeconomic stability.
With regard to Central Bank recapitalization, Law No. 167-07 promotes a gradual and definite solution that is financially viable. This law establishes that within ten years the Dominican Government will absorb the cumulative losses of the institution, through the issuance of State Bonds in an amount up to DOP$320 billion, under which the Treasury Ministry would undertake partial emissions in the established ten-year term.
The existence of this Recapitalization Law is important from the perspective of the foreign investor. In addition to contributing to the financial restructuring and capital strength of the Central Bank, to the unwinding of the so-called quasi-fiscal deficit, and to the gradual and timely reduction of the institution’s stock of certificates, it will also contribute to the development of a public debt market, to foster growth in our stock market, to increasing the efficiency of financial intermediation and, above all, to the long-term preservation of macroeconomic stability.
Additionally, since this Law enables, with the bonds issued, the Central Bank to carry out open market operations as a component of monetary policy, this would be of great interest to institutional investors who seek long-term instruments with sovereign guarantee at attractive rates of interest.
The economic performance of the Dominican economy in 2010, registering a GDP growth rate of 7.8%, surpassed that of 2009 when it grew by 3.5%. This has enabled the economy to reduce its un-employment rate from 14.9% in October 2009 to 14.1% in October 2010. This is equivalent to the creation of 160,208 new jobs. The fastest growing sectors were: Construction (11%), Local Manufacturing (7.7%) and Services (7.3%).
Cumulative inflation for the period January to December 2010 was 6.24%, while core inflation stood at 4.17%, well within the range of 6%-7% established in the IMF agreement. With regard to foreign exchange, the Central Bank’s policy measures have enabled the Dominican economy to recover without risking the relative stability of the exchange rate, which depreciated only 3.4% in 2010, despite an adverse external environment.
Regarding the external sector, the worldwide recovery of economic activity revitalized international trade between the Dominican Republic and its trading partners, with the exception of Europe, so by year-end 2010 the current account deficit stood at 8.5% of GDP. This external gap was fully funded by disbursements exceeding US$ 2.99 billion and foreign direct investment flows amounting to US$1.63 billion. The Dominican Republic’s legal reliability and the increasing dynamism in the economy have made the country a major recipient of foreign direct investment (FDI). Between 2005 and 2010, the flow of FDI to the economy exceeded US$10.54 billion, of which US$2.87 billion were received in 2008, the worst year of global crisis. In 2009, Dominican Republic ranked third among Latin American countries in foreign investment as a percentage of GDP.