The Big Idea
Dominican Republic | Strong growth, lower inflation, improving fiscals
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
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.
Santander Investment Securities
1 (212) 692-2539
U.S. Fixed Income Trading Commentary Disclaimer
This commentary has been prepared by the U.S. fixed income trading desk of Santander Investment Securities Inc. (together with its affiliates, “Santander”) for its institutional investor clients only, and may under no circumstances be redistributed beyond the recipient in whole or in part. The recipient is an “institutional account” as defined in FINRA Rule 4512(c) that (i) is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies and (ii) will exercise independent judgment in evaluating any potential investments and any recommendations of any broker-dealers. For the avoidance of doubt, this commentary is not suitable for or intended for retail investors.
This commentary has not been produced or reviewed by, and does not otherwise reflect the views or input of, the Research Department of Santander (“Santander Research”). This commentary may conflict with the views of Santander Research, is not subject to all of the independence and disclosure standards applicable to research reports prepared for retail investors and is not independent from the interests of Santander. Santander may have positions (long or short) in, effect transactions in or make markets in the subject securities (or related derivatives) mentioned in this commentary, and such positions or trading may be inconsistent with this commentary. However, Santander is under no obligation to make a market in or otherwise provide liquidity in any security discussed herein. This material may have been previously communicated to Santander’s trading desk. Santander may have in the past or may in the future provide investment banking services (including underwriting activity and loans) or other services for the companies mentioned in this commentary.
This commentary has been provided for informational purposes only and is not a recommendation, offer or solicitation for the purchase or sale of any security or related instrument. This communication is intended to be short term and brief in nature, and therefore does not provide a full analysis of any issuer or security or a sufficient basis upon which to base an investment decision. The individual circumstances of the recipient’s investment objectives and needs have not been considered in this commentary, and nothing in this commentary constitutes investment, legal, accounting or tax advice or a representation that any investment strategy or service is suitable or appropriate to the recipient’s individual circumstances. Information contained herein has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made as to its accuracy or completeness. The recipient should not rely on this commentary for any investment decision or other action, and Santander expressly disclaims any liability for any losses arising from any reliance on or otherwise related to this commentary. This commentary reflects the personal views of the individual sender of such commentary, and no part of his or her individual compensation was, is or will be directly or indirectly related to its content. This commentary is provided as of the date and time thereof, and Santander does not undertake any responsibility to update or revise any of the information contained herein, which may change without notice. Past performance is not indicative of future results.
Fixed income securities, including those described herein, are subject to many risks, including, but not limited to, interest rate risk, the credit risk of the issuer, inflation risk, liquidity risk and risk of a downgrade by rating agencies. Emerging markets investments are additionally subject to political, economic, legal, regulatory, market, settlement, execution, currency and other risks. Fixed income, and specifically emerging markets, investments are not suitable for all investors.
Santander Investment Securities Inc. is an SEC registered broker-dealer, FINRA member and SIPC member. Santander Investment Securities Inc. is a direct, wholly-owned subsidiary of Santander Holdings USA Inc., which is a direct, wholly-owned subsidiary of Banco Santander, S.A
1 (212) 692-2539
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.