Risk drivers and outlook

The Dominican Republic, characterised by political stability, has outperformed most economies in the Americas in the past years. High growth has been complemented by low inflation and a narrowing external deficit that currently stands at its lowest level in ten years. Indeed, the Dominican Republic has benefited strongly from high tourism and remittances earnings, relatively low oil prices and robust capital inflows. Consequently, liquidity (a former traditional weakness) has continued to improve. In addition, the likelihood of financial distress is expected to remain moderate in the years to come, resulting in an upgrade of Credendo’s medium- to long-term political risk to category 3/7 earlier this month. Please note that despite the internal upgrade, the premium classification based on the OECD benchmark remains in category 5/7. The combination of low short-term debt, favourable liquidity indicators and an increasing level of foreign-exchange reserves explains the category 2/7 classification for the short-term political risk.

The commercial risk is moderate, in category B. On the positive side, there is low inflation, relatively high growth, a moderate current-account deficit, and credit is available. On the negative side, financial cost remains somewhat high and the business environment (e.g. high corruption) remains weak.

Facts & figures

Pros

  • Political stability
  • Healthy banking sector
  • High economic growth
  • Moderate external debt

Cons

  • Less economically diversified
  • Exposed to climatic events
  • Weak public finances
  • Deficient electricity sector

Head of State and government

  • President Danilo Medina (inaugurated in August 2012)

Description of electoral system

  • Presidential election: 4-year term, latest in May 2016
  • Legislative election: 4-year term, latest in May 2016

Population

  • 10.5 million

Income per capita

  • USD 6,240

Income group

  • Upper-middle

Main export products

  • Tourism (34% of current-account receipts), private transfers (23.6%), manufactured exports (excluding re-export) (13.4%), gold (7.9%), bananas (1.7%), cocoa (0.6%)

Country risk assessment

Political stability after a turbulent past

The Dominican Republic has a turbulent history. It declared its independence twice (first in 1844 after occupation by Haiti and later in 1866 following recolonisation by Spain) but it was also briefly annexed by the USA between 1916 and 1924. Furthermore, the country has known several dictatorships (e.g. Heureaux, Trujillo), a civil war (1963-65), a military coup and the authoritarian rule of Balaguer. Since 1978, the Dominican Republic has steadily moved away from autocratic rule, and towards entrenched democratic practices. Despite institutions and accountability of government officials remaining weak, electoral periods have become marked by little tension. Fostering this political stability, all main political parties have moved towards the centre, backing free-market principles. The PLD (Partido de la Liberación Dominicana) has been ruling the country since 2004. The current president is Danilo Medina, who is serving a second term in office.  Electoral rules (put in place in 1994) were even changed in 2015 to allow the very popular Medina to run for a consecutive term. Medina is the most popular president in Latin America owing to past social reforms, especially welfare cash-transfer programmes, and a fast-growing economy. That being said, there have been some recent cracks in his popularity. Corruption allegations, linked with the Brazilian construction giant Odebrecht, are spreading in Latin America, including the Dominican Republic. Also social discontent related to endemic corruption, high inequality, increasing crime rates, deficient health care provision and a weak electricity sector regularly causes protests to flare up. These issues are not likely to topple Medina, but will strengthen the opposition in the next elections in 2020.

Is a good neighbour worth more than a distant friend?

The Dominican Republic comprises almost two-thirds of the island of Hispaniola in the Greater Antilles. The other third, in the west, belongs to troubled Haiti. Though these countries share an island and are main trading partners, relations have been tense since the independence of the Dominican Republic. Despite some rapprochement in the aftermath of the devastating earthquake that hit Haiti in 2010, bilateral ties remain under considerable strain. What has particularly caused a stir is the ruling in 2013 by the Dominican Supreme Court that direct descendants of Haitians residing illegally in the Dominican Republic at the time of their birth are ineligible for citizenship. As a response, Haiti imposed a temporary ban on overland imports from the Dominican Republic from September 2015 to mid-2016, reducing Dominican exports to Haiti by a fifth. Also, in the coming years, heightened tensions between the two countries are likely.

The US is the biggest trading partner of the Dominican Republic. The importance of the US cannot be overestimated as the US accounts for 50% of Dominican exports, 41% of tourist arrivals and 71% of remittances to the island. The negative stance of the US President Donald Trump towards immigrants and trade agreements may be a risk for the Dominican Republic. A large share of Dominican exports is traded under a 2007 free-trade agreement (also known as DR-CAFTA). The cancellation of the agreement would represent the highest effective tariff increase in the region. Though it represents a high-impact event, the probability of changes in the US immigration and trade policies impacting the Dominican Republic is small. The bulk of Dominican migrants to the US are indeed legal while the US has not signalled any concerns about the DR-CAFTA agreement.

The envy of Latin America

Having attained an average GDP growth rate of 6.3% over the past decade, the Dominican Republic is the envy of Latin America. The economy was in tatters after the Dominican banking crisis of 2003 which started with a fraud-driven insolvency of the third-largest bank in the country. However, under close IMF tutelage, the country rebounded strongly and even proved to be resilient during recent crises (e.g. the financial crisis of 2009). The Dominican Republic’s success can be mainly attributed to growing revenues from tourism and free-trade zones. These sectors are now the country’s major employer and key sources of revenues, replacing the historically important agriculture sector (i.e. sugar and to a lesser extent coffee, tobacco and cocoa). Indeed, free-trade zones now account for about half of Dominican exports while the tourism sector is the largest in the Caribbean. Also, fast-growing remittances from residents living abroad have stimulated growth as they have increased Dominican family income and reduced the strain on local resources. Furthermore, the discovery of gold in the 2000s boosted the mining sector and further diversified the country’s revenues. Though the country is one of the more diversified economies in the region, further progress will be necessary if it wants to remain competitive and transition to higher value-added and more skill-intensive employment.

High GDP growth has not translated into higher inflation: on the contrary, inflation dropped from almost 9% in 2007 to less than 2% by the end of 2016. Low inflation can be attributed to the successful adoption of the inflation targeting framework by the Central Bank as of 2012. In the years to come, inflation is expected to be modest, at around the Central Bank’s target of 4%.

Economic success translated into an improving external balance

As a small country, the Dominican Republic is very dependent on trade to provide the necessary food, services and manufactured goods. On the import side, oil is very significant as it typically comprises about a quarter of imports, making the country very vulnerable to shifts in oil prices. Turning to the other side of the balance, remittances and tourism dominate the export revenues, representing more than half of current-account receipts. As of 2013, gold exports (ballooning from 1% of current-account receipts in 2012 to 7% in 2015) have also started to benefit the country.

Thanks to increasing exports and (more importantly) low oil prices in the past years, the current-account balance has improved vastly. Despite a temporary import ban from its second-largest export partner (Haiti), the current-account deficit stood at a ten-year low in 2016. The deficit is more than financed by foreign direct investment (representing 3.6% of GDP in 2016), mainly in mining, tourism, and free-trade zones. As a consequence, foreign-exchange reserves have been boosted. Once a traditional weakness, they have considerably recovered in the past years. Indeed, in March 2017, they covered a healthy 3.5 months of imports, slightly above the standard threshold. In the coming years, the current-account deficit is expected to increase moderately to around 4% of GDP in 2021. Firmer growth in the US is likely to support growth in exports and remittances whereas potentially rebounding oil prices should raise imports. Nevertheless, FDI is expected to largely finance the external deficit also in the coming years, further bolstering foreign-exchange reserves. The expectation that the Dominican Republic will allow more exchange-rate flexibility in the future could also help to strengthen reserves.

Bad debt track record on the mend

The Dominican Republic defaulted on its debt during the late 1980s and early 1990s and negotiated a debt restructuring with official and private creditors after the financial crisis of 2003. Since then, relations with external creditors have broadly normalised. Indeed, the Dominican Republic has access to the financial markets at a rather favourable spread compared to other Latin American countries. In January 2015, the Dominican Republic did restructure another debt, with Venezuela’s state-owned oil company PDVSA under the Petrocaribe agreement. However, this time it was Venezuela, in urgent need of liquidity, which requested the restructuring. The Dominican Republic bought back USD 4 billion of its debt, at a discount of about 52%. In this transaction, the country repurchased some 98% of the debt accumulated with PDVSA during 2005-14.

The Dominican Republic’s debt track record is clearly on the mend. In the past two decades, external debt sharply decreased from almost 70% of GDP in 1990 to a moderate level of 39% of GDP in 2016. It is expected to broadly stabilise in the coming years. That being said, the picture looks less rosy when compared to current-account receipts as debt grew from 100% in 2009 to around 140% in 2016. However, there is no pressing risk of financial distress given that the ratio is still sustainable. Besides, debt-servicing payments only amounted to 15% of current-account receipts in 2016. Some downside risk to the debt dynamics pertains to potential adverse external conditions. In particular, next to the normalisation of the US monetary policy, a rise in investors’ risk aversion could hurt the country.

Weak electricity sector remains the Achilles heel

The Dominican energy sector is affected by several structural problems. The country lacks domestic energy sources and consequently private energy producers have to import expensive foreign energy. To reduce costs, the Dominican Republic was an active member of the Venezuelan Petrocaribe programme which enabled the country to purchase Venezuelan oil on preferential terms. However, the severe ongoing economic crisis in Venezuela has limited this option. In addition, the public energy transportation network is poorly developed which leads to frequent blackouts, hindering the potential of the manufacturing sector. Moreover, high non-payment ratios and electricity theft exacerbate the heavy losses in the sector.

There has been some progress though. The government is building two new low-cost coal plants which are likely to come on stream in 2018. These plants will diversify energy sources, generate energy from a low-cost option and certainly reduce the risk of blackouts in the long term. Nevertheless, further reforms tackling the other structural problems will be necessary to shape up the sector.

Fiscal policy could turn into a concern in the long term

Historically, fiscal policy has been characterised by persistent public deficits and rising debt levels. Despite solid economic growth, important fiscal imbalances remained unaddressed until four years ago. The public-sector fiscal deficit surged as of 2008 and reached an elevated level of nearly 8% of GDP in 2012, an election year. To tackle the issue, the Medina administration cut back on public investment and passed tax reforms aimed at raising revenue. Consequently, the fiscal deficit decreased over the years. In 2015, an exceptionally small deficit was recorded due to the restructuring of the Petrocaribe agreement. However, the fiscal position is expected to slowly deteriorate to 5.2% of GDP by 2021. On the revenue side, additional tax reforms to widen the very narrow tax base are necessary as well as eliminating tax breaks and enhancing measures to reduce tax evasion. On the expenditure side, building the coal plants will raise the fiscal deficits and government debt until 2019. Furthermore, interest payments will increasingly be an important burden. Interest payments were estimated at an elevated level of around 3% of GDP or almost 20% of public revenues in 2016 and are likely to further surge in the coming years. Firstly, public debt is on the rise from a moderate 49.7% of GDP at the end of 2016 to an expected 55.7% of GDP in 2021. Secondly, financing costs may rise due to the tightening of the US monetary policy. Though the fiscal position is still sustainable, keeping the fiscal position in check will be a concern in the longer term.