The Big Idea
Dominican Republic | Strong growth, lower inflation, improving fiscals
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The Dominican Republic and other ‘BB’ credits like it should continue to offer a combination of stable fundamentals and relatively high yield as a buffer to external risks. A trip to the country in the last week reaffirmed expectations for strong growth, lower inflation and better-than-expected fiscal performance. The country has a stockpile of foreign exchange reserves and treasury deposits that would provide sufficient funding through the second half of next year. Add to that an enviably high 5% trend growth rate, effective policy management and a diversified economy that supports political stability through election cycles and economic stability through external shocks. The Dominican Republic should buck the trend of rating downgrades across the region.
The economic growth potential should continue into next year. The central bank expects only a slight deceleration to 4.5% from trend 5% growth based on still booming tourism (record amount and more diversified 7.2 million visitor arrivals in 2022 and 2023), remittances ($10 billion a year), and (record $3.8 billion) foreign direct investment. This was a similar view amongst market participants with at worst maybe downside risk to 4% GDP growth next year depending on external risk drivers.
The central bank in the last week interrupted its hiking cycle after reaching a restrictive 8.5% policy rate and a faster-than-expected normalization of inflation. The latest inflation data has been below 0.3% month-over-month for the past three months at an annualized rate of 3.5% and a subsequent improvement on inflation expectations and core inflation. The central bank communique now expects a faster convergence on inflation back within their band (4% +/- 1%) in the first half of 2023, earlier than previously expected towards 4Q23. The proactive stance and 6- to 12-month lag on the transmission mechanism suggests a sooner than expected rate cut cycle early next year. This should provide greater policy flexibility against latest external shocks into next year.
The fiscal accounts also are providing a buffer with an under execution on spending that may again allow the treasury to undershoot their fiscal target this year. The latest budget amendment pushed the fiscal deficit to 3.6% of GDP for 2022; however data through November 25 at a deficit of 2% of GDP suggest difficulty on even reaching 3% of GDP. This commitment to fiscal discipline is unique in the region and has allowed for the treasury to build upon their cushion of treasury deposits. This provides significant financing flexibility that would finance maybe ½ of the $6.4bn funding program next year. There is no urgency to come back to Eurobond markets. There is also the optionality to diversify the foreign exchange composition of their debt and even reduce their funding costs with a shift towards multilateral loans or local markets. The Dominican Republic’s strong fundamentals should provide easy access to multilateral loans.
The sophistication on budgetary and financing management would provide positive spillover to rating metrics on lower debt service/revenues and lower proportion of USD debt stock. The active central bank should continue to reduce foreign exchange volatility and discourage dollarization. The shift towards monetary policy normalization also coincides with the recent path of gradual foreign exchange depreciation and the budget assumptions of 5% annual depreciation next year. This reaffirms an attractive tradeoff between DOP rates at 13% and similar 30-year USD rates at 8% that would allow the Finance Ministry to diversify their financing alternatives. However, the economy is less vulnerable to foreign exchange shocks on a central bank track record of low foreign exchange volatility and a huge buffer of foreign exchange reserves from the cash flow USD external surplus.
The structural economic reform agenda includes the tax reform, the unwind of electricity subsidies and the recapitalization of the central bank balance sheet. However, these reforms may have to delay until after 2024 elections with a priority for economic stabilization that balances the social and political risks against the uncertain external environment. This requires that subsidies continue into 2023 at 1.3% of GDP but latent optionality for lower fuel subsidies as inflation and commodity prices recede. The next election cycle in May 2024 is viewed as a nonevent for the understood social and political pact to maintain economic stability. There are no radical political factions that would threaten 5% GDP trend growth with political moderation a unique departure from the pink tide spreading across Latin America. The elections are viewed, at worse, as a potential delay on the reform agenda or the catalyst for higher temporary expenditures but not as a threat to moderate policy management.
The overall resilient fundamentals and the track record of effective crisis management should favor DomRep ahead of a still highly uncertain 2023. The market beta remains a concern for the huge stock of Eurobonds outstanding; however, there is financing flexibility that would favor funding diversification or drawdown of the cushion of treasury deposits. The higher global rates and more restrictive capital markets are not an obvious concern for the Dominican Republic, especially considering Colombia’s re-entry to Eurobond markets. The data watch also reaffirms a stronger-than-expected fiscal performance, a quicker normalization of inflation and still resilient economic growth at 4.5%-5% for 2022 and 2023.
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