The Big Idea
Dominican Republic | Economic slowdown
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The Dominican Republic’s central bank has announced its second straight rate cut as it tries to counter slowing growth, which could drop well below 4% this year. That pace would look like de facto recession by Dominican standards. A slowdown would also come ahead of elections next year. Slowdown should not jeopardize the country’s resilient ‘BB’ ratings, especially based on its track record of fiscal discipline and strong overall policy management. But it should provide stronger rationale for the relative value of local bonds and should support demand for any additional dual currency bond issuance.
There has been almost a whiplash at the central bank with a quick response to the collapse in the inflation data as well as the economic slowdown. Not only did the central bank cut their policy rate through May and June from 8.50% to 7.75%, but it also provided extraordinary liquidity to encourage a faster decline in bank lending rates. The preview to the May inflation data showed clear reversion back within the bank’s inflation band while the June data reaffirmed the 4% inflation target. The core inflation still remains above target through June at 5.3% year-over-year; however annualized monthly data at 0.2% to 0.4% for the past four months remains quite low. The post meeting communique explains the lower demand side inflationary pressures as well as the relief from lower global commodity prices.
There is also reference to the extraordinary liquidity injection to facilitate a faster transmission mechanism for a recovery in demand in the second half of 2023. The economy will have to show a quick rebound to the upside to reach above 3% GDP growth this year after only 1.5% year-over-year SA average growth from January to May 2023. The slowdown in the first quarter this year has been mostly concentrated in manufacturing, mining and construction with still resilient agriculture and service sectors (tourism). The central bank still expects a recovery to 4% GDP growth this year and reversion back to 5% trend GDP growth in 2024 on monetary stimulus, dynamic tourism, and greater public investment. The central bank survey expectations align with 4% GDP growth on median expectations in 2023 but are slightly lower at 3.86% on average expectations for June 2023.
The latent bias is for downside risk to growth and more aggressive monetary stimulus, especially if the Finance Ministry has minimal flexibility for any additional fiscal stimulus. The fiscal performance through May shows a slight deterioration reverting from a nominal surplus of 0.3% of GDP in 2022 to a deficit of 0.3% of GDP in 2023 (excluding the one-ff central bank transfer in February). The revenues remain resilient at a 10% year-over-year average increase (and 8% year-over-year VAT) through May; however, spending remains more robust at 12% year-over-year across most categories (excluding central bank transfer) except for private sector subsidies. This suggests underlying bias towards a fiscal deficit closer to 3.5% of GDP then the budgeted deficit of 3% of GDP. This may shift the burden for additional stimulus on the central bank. There is typical debate about the neutral policy rate with current levels at 3.75% not far from average 3.0% real rates pre Covid (2014-2019) but a slower than expected economic recovery that could encourage below-neutral policy rates.
This should reinforce the attractiveness of local rates, even after the impressive gains (12.5% to near 9.5% since February on DOP’33s). There has been renewed focus on local markets on a regional trend of FX appreciation and a peak of the monetary tightening cycles. The diversification has also been a defensive characteristic with the clear outperformance of the DOP’33 dual-currency bonds versus the USD’31s Eurobonds after multi-tranche launch in February 2023 and through broader market instability in March 2023. The recent pullback on foreign exchange weakness (unwinding most of February gains) should be only temporary if the central bank adopts a more aggressive rate cut cycle on renewed cross border inflows on local markets.
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