Report No. 611-DO k- . ? A(

Updating Report on the Economy ,of theDominican Republic ETUXN TO LA. & G.(In Two Volumes) 1FOPWMATTN CENTERVolume 1: Main ReportApril 18, 1975

Latin America and the CaribbeanCountr Programs Department I

NfornPublic Use

Document of the International Bank for Reconstruction and DevelopmentInternational Development Association

This report was prepared for official use only by the Bank Group. It may notbe published, quoted or cited without Bank Group authorization. The Bank Group doesnot accept responsibility tor the accuracy or completeness of the report

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CURRENCY EQUIVALE-NTS

1.00 Dominican Republic Peso (RD$) = U13$1.00

1.00 1U9$ = RD$1.00

Tables 1 through 23 are inserted in the text.Tables 1.1 through 9.2 are included in the Statistical Appendix.

UPDATING

REPORT ON THE ECONOMY OF THE

DOMINICAN REPUBLIC

TABLE OF CONTENTS

Page No.

VOLUME ONE

MAP

COUNTRY DATA

SUMMARY AND CONCLUSIONS ............... ................

I. INTRODUCTION. 1

II. THE PATTERN OF DOMINICAN DEVELOPMENT 2

A. Recent Developments. 2B. Main Sectoral Issues. 8

Agricultural Development 8Industrial Development .19Tourism .30

III. PUBLIC SECTOR ... 32A. Public Investment Program and

Social Services . .32Public Investment . .32Social Services . .36Financing of PublicInvestment . .39

B. Central Government Finances 42Taxes on Sugar . .47Prospects . .49

IV. BALANCE OF PAYMENS AND GROWTHPROSPECTS . .52

A. Short-term Prospects andCredit Policy . . 52

B. Medium-term Prospects . .57C. Creditworthiness. 62

VOLUME TWO

STATISTICAL APPENDIX

This report is based on the findings of an economic mission which visitedthe Dominican Republic in August/September 1974. The mission consisted ofRaul de Campos (Chief), G. Kaddar (Agricultural Credit Specialist), F. Thoumi(Industrial Economist) and M. Lasaga (Statistical Assistant). Owing toMr. de Campos' departure from the Bank, the report was drafted by Mr. Landau.On February 3-7, 1975, Messrs. Pfeffermann, Fernandes and Landau discussed anearlier draft of this report with the Government. The present version incor-porates information available as of February 7, 1975.

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ANNEX IFopg T o 3 pages

ODUNTR1 DATA - DOp3aICA REPUBLIC

ARBA POPULATION DINSITY4c,734 on2 4.2 million (mid-1972) 232 /A Per kll20f arable land

SOCIAL INDICATORS

Reference CountriesDominican Republic Nicara Jii S *

_ 960 1970J 1970 197

GO PER CAPITA us$ (ATLAS BASIS) / 310 lb 470 /c 470 /c 810 Ac 1,210 /c

DElOGRAPHICCrude birth rate (per thousand) 37 40 /d 46 /d 35 /e 20Crude death rate (per tho-eand) 9 6 7; 17 7; 7 8Infant ertality rate (per thoueand live birthe) 101 50 7;g 45 7; 26 /e 28Life expectancy at birth (yea") 58 .. 5O 7 69 70

Orose reproduction rate 2 .. 3.5 3.3 /d 2.5 1.4Population growth rate 127 3.6 2.8 f ,h 3.o 7? 1.6 If 1.1 IfPopulation growth rate - urban 6 /i 6 5 7j,k 6 7? 2 7Tm

Age etrocture (percent)0-14 47 48 47A/ 4

6/n 28

15-64 5° 49 50 fn 49 7f 6365 and over 3 1303 57I 9

Age dependency ratio A4 1.0 1.0 1.0 1.0 0.6Economic dependency r:iai /4 1.9 1.9 2.1 /e 1.7 1.1Urban population as prorenfof total 30 /A 40 /i 492& 37 fl 49 Ic nFamily planning: NK. of acceptors cumnulative (thcos.) 3.

No. of users (% of mcrried wcben)

EMPLOTDENTT-taTabor ftrce (thuneande) 820 1,073 /P 500 /e 750 An 12,700 /n

Percentage employed in agriculture 61 55 /P 46 7; 33 ; 29 7Percentage unenployed .. 14 7F .. 13-14T 2

INC014 DISTRIBUTIONPercent of national income received by highest 5% .. 25 fa,rPercent of national income received by highest 20% .. 53 fPercent of national inme received by lowest 20% .. 6Percent of national income received by lowaut 40% 15

DSIRISUTIO F OP LAND ObMEESSIPr owned by top 1 of owners .. 62.7% owned by esalest o0% Of owners .. 1.8

HEALTH AND NUTRITIONPcputation per physician 1,600 /a t 2,100 2,060 a 2,630 750 /uPopulation per mlrsing persen 2,070 ft 3,930 4,860 1,720 f 1,430 7)Population per hospital bed 220 7f 350 410 240- 220 7)7

Per capita calorie supply as % of requirements /5 .. 84 Ac 95 93 Ax 10/Per capita protein supply, total (gras per day}/6 .. 5o 7f 63 597 21

Of which, ntieal and pulse .. 29 7? 36 29 7)7 40 /yDeath rate 1-4 years /7 .. 6Af .. .. 0.9

EDUCATIONAJ3td /8 pricary school enrollment ratio 89 fa 107 /ab 80 86 lab 83Adjusted LS secondary school enrollment ratio 12 7 M 19 20 /a 43 49Tears of sEhooling provided, firat and second level 12 12 12 12 13Vocational enrollment as % of sec. school anrolleent 44 1 9 ,a 9 /f 20Adult literacy rate % - - 51 /Leao 53 f 86 7q,ae 94 .d.as

Average No. of persons per coos (urban) 1.6 AfPercent of occupied coitc without piped water 92 7ef.ag- .. .. 78 /lfAccess to electricity (as % of total population) 20I fPercent of Aural population connocted to electricity 3 a ..

CONSUHPTIOhRadio recaivars per 1000 population 34 39 Is 58 Ic 376 214 /aPaseenger cars per 1000 population 4 10 17 35 /q 701lectric Power consumption (loh p.c.) 115 208 312 777 1,627Newsprint consucption p.c. kg per year o.6 0.7 2.0 /a 4.3 5.8

Note,: Figures refer either to the latent periodo or to aecoont of anviroorantul tenperat-rs, bdy weights, andthe latet years. Latest periods refer in principls to distribctioo by age and ser of national poplations.the years 1956-60 or 1966-70; the lateot years in prin- /6 Protein standards (requirenents) for all nountrien a setib-ciple to 1960 and 1970. lished by DSDA Enonomic Research Service provide for a sinimouII The Per Capita GNP estinmte is at market prioeo foe allowance of 60 graes of total protein per day, and 20 graaa of

years ether than l960,calculated by the bome conversion animal and poles protein, of which 10 grams should be aninaltechnique as the 1972 World Bank Atlas. protein. Tane atandards are omneohat lower than those of 75

12 Average aurber of daughters per ocan of reproductive grazs of total protein and 23 grass of animal protein as anage. average for the world, propO3ed by F-0 in the Third Wcrld Food

Li Population growth mten are for the decodee ending in ' Survey.1960 and 1970. /7 Sone studies have soggeoted that crude death rates of children

/4 Ratio of population under 15 and 65 and over to popula- agea 1 through 4 nay be need as a fir3t approimation index oftion of ages 15-64 for age dependency ratio and to labr malnutrition.foon of ages 15-64 for econodic depnndency ratio. /l Percentage enrolled of corresponding population of school age

/5 FPO reference standards represent physiological re- as defined for each oountry.quirenento for normal activity and health, taking

/a Excluding forests end pastures; l Computed by aPPlYing to the 1970 figure the grwth rate of the .Np/cap in real tems

frm- 1960 to 1970; Is 1972; /T 1965-70, UN estimate; Ia 1971; If 1960-72; I5Rcn iso siaeisubstantiallyLhigher; lb Net iTigrats; A Administrative centers of sunicipjoc and Cnicipal districts sue

of which include suburban none of rural character; /J 1963-72; Ik Adsdnistrativ-e centers of departments codIn aunicipins; A2 Kingston smetropolitan area. and selected eats townej /a Localities of 10,000 of more; /s NEtimate;,/n Ratio Of POPul78?ion under i5 and 65 and Over to the total labor force an3dnout as defined in /4- /5 lipoyet

7- 1969; Ir Santa Domingo only; Is 1963; It Phyaicin,ui.n the hospital 0 only; In Numt'r on the register, not allworking in the country; Iv Soavernent only; /w l96h, Ix 1964-66; IY 1969-7~ Is Per thousand populatimn ofcormseponding age; Iaa M56S lab Includes overage studen-ts; /ac 10) ye-ar and ovr lad Definition unknown;

las 15 years and over; 72 Water pi'p2e inside; /aj Percentage of housing units.

* Spain has beo aelected as an objective country because it is a sore developed country having considerable culturaland social affinity with the Dominican Republic, and its recent economic growt hbaa bean greatly influence,d by tourismand the proximity to a larger, rich market.

R2 April 7, 1975

ANNEX IPage 2 of 3 pages

ECONOMIC INDICATORS

GROSS NATIONAL PRODUCT IN 1973 ANNUAL RATE OF GROWTH (%, constant prices)

US$ Mln. % 1960 -66 1964 -70 1973

GNP at Market Prices 2378 100.0 4.3 3-F 17,0

Gross Domestic Investment 480 20.2 10.8 5.7 20.0

Gross National Saving 403 16.9 -15.2 9.1 31.0

Current Account Balance -79 -3.3Exports of Goods, NFS 516 21.7 4.7 3o0 23,0

Imports of Goods, NFS 646 27.2 ll.h 2.8 15.4

OUTPUT, LABOR FORCE ANDPRODUCTIVITY IN 1970

Value Added Labor Force-/ V. A. Per Worker

US$ Mln. A EDn. % US $ %

Agriculture 345.i 23.2 o06 55.5 581 h20C

Industry 298.1 20.1 0.1 10.7 3358 242,6

Services 842.3 56.7 0.h 33,8 2073 149.8

UnallocatedTotal/Average Th05 .5 100.0 1-1 100.C l Oo

GOVERNNENT FINANCE 2'

Public Sectors Central Government

( RD & Mln.) % of GDRD :En)%of GDP19 1973 1970-72 1973 1 1970 72

Current Receipts 682.7 27.8 30.0 360.3 14.-7 16.2

Current Expenditure 466.8 19.0 21,0 220.8 9.0 10.7

Current Surplus 215.9 8¢8 9,0 13§-5 ' s.c

Capital Expenditures 228.5 9.3 9.6 157.0 6.1k 6.2

External Assistance (net) 41h 0.2 1.5 17.5 0.7 0.6

MONEY, GREDIT and PRICES 1968 196 1970 1971 1972 1973 1974(Million RD$ outstanding end periodY

Money and Quasi Money 197.9 237,7 283.8 333.5 41lO.7 517.9 759.6Bank credit to Public Sector 18304 198.6 213.3 246.9 267.3 302.5 387.2

Bank Credit to Private Sector 118.9 147.8 174.9 211.3 27 .8 375.7 561.7

(Percentages or Index Numbers)

Money and Quasi Money as % of GDP 17.0 17.9 19.1 20.0 21.7 21.1 24.3Consumer Price Index (1969 - 100) 101.9 100l 0 103.8 108,3 116.8 134.4 152.5

Annual percentage changes in:Consumer Price Index 1.7 1.9 3.8 4.3 7.8 15.1 13.5

Bank credit to Public Sector 7.4 8,3 7.4 15.8 8.3 13.2 28C

Bank credit to Private Sector 36.7 24.3 18.3 2C.8 3C.5 36.2 45.5

NOTE: All conversions to dollars in this table are at the average exchange rate prevailing daring the periodcovered.

1/ Total labor force; unemployed are allocated to sector of their normal occupation. "Unallo-ated" consistsmainly of unemployed workers seeking their first job.

not availablenot applicable

Includes public enterprises.

ANNEX IPage 3 of 3 pages

TRADE PAINTS AND CAPITAL FaWS

BALANCE OF PAYMENTS MERCHANDISE EXPORTS

At, 127Q-721971 1972 1973 US f Mm L U

(Millions US $) Su 169.0 51.6 205.8 46.6

Exports of Goods, NFS ~~~F'erronickel 32.8 104 83.5 18.9Exports of Goods, NPS 292.2 4100. 513.2 Coffee 32.3 10.t 46*4 10.5

Imports of Goods, NFS 406J 9 565.2 Tobaccv 2R 76 30. 6.9

Resource Gap (deficit = -) - 114.7 -3 -52.0 Cocoa Y 9 .1 5.5

Bauxite 15.2 4.9Interest Payments (ne - 5.7 - 7.2 - 7*2 ed Mat 5.8 1.9 10 2.2Workers' Remittances -a - - All other com-

Other Factor Payments (net) -23.1 -39.7 -70.9 modities 2241 7.0 27.O 6.oNet Transfers 41.4 46.8 50.6 Total 3117. 100.0 442i Fiod.oBalance on Current Account -iU dl 79.5

Direct Foreign Investment 50.0 44.7 54.7 EXTERNAL DEBT. DECEMBER 31. 1973

Net MLT BorrowingDisbursements 34-7 54. 3 .5 us $ Mln

Amortization 19*9 19.6 16.2

Subtotal 13T 29-3 Public Debt, incl. guarante6l 282*0

Capital Grants 7.? 5.6 7.1 Non-Guaranteed Private Debt;/ 20h.7

Other Capital (net) 27.1 20.2 2.9 Total outstanding & Disbursed T .

Other items n.e.i 9.7 50-4 _ 7___Increase in Reserves (+) - 7 19.9 .6r. DEBT SERVICE RATIO for 1971 %

Gross Reserves (end year) 67*2 67*7 82.9

Net Reserves (end year) - 5.5 11.0 15.3 Public Debt, incl. guaranteed 45

Non-Guaranteed Private Debtv 11.5

Fuel and Related Materials Total outstanding & Disbursed 15.0

Imports 30.0 33.3 51.8of which: Petroleum 24.8 33.2 48.1

Exports - - -

of which: Petroleum - - IBRD/IDA LENDING, FEBRUARY 28, 1975 (Million US $):

RATE OF EXCHANGE IBRD IDA

Outstanding & Disbursed 21.7 5.8ThrouS h 1 1973 Undisbursed 21.0 16.2

1.-0 RD C$1.00 Outstanding incl. Undisbursed 427 22.0

i/ Includes by-products.

/ Includes non-guaranteed loans to enclave ferronickel plant.

/ Ratio of Debt Service to Exports of Goods and Non-Factor Services

v Includes Direct Investment Income Payments.

VIj Included under "Net Tranfers"not availablenot applicable

Country Programs ILatin America and the CaribbeanRegional OfficeDecember 16, 1974

SUMMARY AND CONCLUSIONS

Recent Trends

1. In the last four years, the Dominican economy has enjoyed unpre-cedented growth. In 1970-73, real annual increases in GDP averaged 11percent as compared to 5 percent in 1960-70. Preliminary estimates for1974 indicate a decline in the rate of GDP growth to 6.5 percent. Theeconomic boom has been led by private investment in mining and manufacturing,greatly expanded public investment in infrastructure and by high prices forseveral traditional export products, especially sugar. Sugar export prices,which averaged 6¢ per pound in 1971, rose ' o 14.5¢ per pound in 1974.Stimulated by political stability and a favorable business climate, grossdomestic investment increased fro: 19 percent to 24 percent of GDP between1970 and 1973, an annual increase of nearly 20 percent in real terms. Therapid increase of investment was mainly financed from additional exportreceipts. Domestic savings increased from just under 12 percent of GDP in1970 to about 20 percent of GDP in 1973. Much of this increase resulted fromthe conservative fiscal policies followed by the public sector. Consolidatedpublic sector savings financed three-fourths of public capital expenditures in1969 and over nine-tenths in 1973, and contributed over one-half of total grossdonestic savings in 1969-73.

2. Mining, industry (including sugar refining), construction andservices account for the bulk of output growth. Industrial incentive laws,which offer a high degree of protection and ensure high profit rates, stimula-ted private investment in manufacturing, mostly in import substitution indus-tries. Construction activity was stimulated by the high level of publicinvestment outlays for infrastructure and by private residential construction.Almost all the increase in mining output came from the Falconbridge ferronickelplant which started production in 1972, while the growth of value added inservices resulted from the rapid rise in urban trade and the expansion oftourism. The total volume of agricultural production increased at a slowerrate, as increases in export crops were partly offset by slow growth in foodcrops.

3. Despite recent increases in output, the overall urban unemploymentrate has not been significantly reduced. A recent ILO study suggests thatin early 1973, 20 percent of the Santo Domingo labor force was unemployedand 60 percent of the remainder were partially unemployed. This reflectsthe fact that, among the growth sectors, mining is capital intensive, industryhas contributed less to employment than its potential, and employment genera-ti on in construction activity has been limited by the use of capital intensivetechniques in public investment projects. Furthermore, the urban labor forceincreased by- more than 6 percent per annum in 1968-71, reflecting migrationto the cities and an increase in the economic participation o_f women. Insoite of extensive rural enigration, underemployment in agriculture is stillwidespread.

1/ Most of the 1974 sugar crop was sold in the futures market at pricesprevailing in 1973.

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4. The net flow of banking system credit to the private sector hasincreased by 77 percent in 1972 and 55 percent in 1973 and thus stimalatedprivate investment, housing construction, trade and sales of consumer durablegoods. The inflationary potential of the fast credit expansion was partlycompensated by an increased willingness on the part of the private sector tohold time and savings deposits. This increase in the demand for financialassets is remarkable in view of the low yields paid to savers by the bankingsystem (between 5 and 7 percent). However, in spite of the satisfac.orygrowth of financial savings, the Dominican economy is experiencing an accel-eration in the rate of inflation. The Santo Domingo Consumer Price Indexincreased by 15.1 percent in 1973, compared to 7.8 percent in 1972 and 4.3percent in 1971. While this rate of inflation is not excessive when comparedto other countries, it is probable that the cost of living in Santo Domingodoes not fully reflect current inflationary pressures because wholesale priceshave been rising faster, price controls are enforced on a number of staplesin short supply and it has been necessary to prohibit exports of certain products.The management of money and credit in the present inflationary international anddomestic environment deserves special attention in the light of the currentexport boom.

5. Exports have been the most dynamic element in the economy both invalue and volume. Merchlandise exports increased from US$213 million in 1970to an estimated US$634 million in 1974. Moreover, the Dominican Republic hasbeen one of the few countries to successfully increase the volume of sugarexp.rts to take full advantage of favorable world prices. Raw sugar exportsaznounted to 764,000 tons!l in 1970, and totalled 1,016,000 tons in 1974.However, since most of the 1974 sugar crop was sold in the futures market atprices prevailing in late 1973, the average realized price in 1974 was onlyaround 14.5¢ per pound, reflected in a total value of US$324 million comparedto US,187 million in 1973. The full benefit of high sugar prices will be feltin 1975, when the average price is expected to be 330 per pound and the totalvalue of sugar exports may reach US$792 million. While sugar accounts for thehighest share of additional export receipts, other exports have also been buoyant.The gross value of ferronickel exports reached US$83.5 million in 1973, the:_Lrst full year of operation of the Falconbridge plant. Exports of cDcoa, coffee,and tobacco have also shown gains in price, volume or both. The combined exportvalue of these three products has reached about US$134 million in 197it as comparedto only US$63 million in 1970. Although tourism has only recently become asource of foreign exchat'ge, gross tourism earnings .probably came close toUS$50 million in 1974, an increase of about US$30 million since 1970. Economicgrowth has also been accompaiAed by a rapid increase in imports. Merchandiseimports increased from US$278 milJion in 1970 to an estimated US$673 millionin 1974.2/ Although no deta4led in.Lormation is available on the compositionof imports in recent years, it seems that the bulk of merchandise import growthhas consisted of industrial raw materials, capital equipment, foodstutfs (rice,corn, beans, wheat, fats, etc.)

1/ Metric tons = 2,204.6 lbs.v/ Including US$100 million attributable to higher petroleum prices.

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6. Trhe recent economic expansion was achieved without recourse toexcessive external borrowing on commercial terms, The external public andpublicly guaranteed debt including undisbursed amounts reached US$430 millionat the beginning of 1974., or about 60 percent of estimated merchandise exports.This compares to US$279 million or 130 percent of merchandise exports at thebeginning of 1970. About three-quarters of the external debt is in officialexport credits and borrowing from bilateral and multilateral developmentagencies at favorable terms. The public debt service in 1974 is in theorder of only 3.5 percent of exports of goods and non-factor services.

Main Issues

7. Despite rapid economic growth, it has not been possible to correcta number of serious problems that have long affected the country. In addition,the rapid recent growth has created some distortions in resource allocationthat require corrective action, lest they prejudice future development pros-pects. The two major structural problems demanding the attention of theauthorities are the high underemployment of human resources and the continuedreliance on a small number of primary commodity exports. In the short runit is also urgent to ensure that the country's windfall earnings from sugarare saved and used to finance future development expenditures.

8. WJhen, Ps expected, sugar prices drop from their present high levels,the balance-of-payments will once again become a major constraint to growthat a time when the fast growth of the labor force will require a rapid expansionin employment. To minimize these problems, it will be necessary for the Govern-ment to adopt policies aimed at accelerating export diversification, maximizingthe impact of investment on growth and the impact of growth on job creation,Government action in many sectors can contribute to these objectives, partic-ularly through incentives legislation and through public expenditures policy.

9. In agriculture there is widespread underutilization of land andwater, the sector's scarce resources. This has led the Government to initiatea land reform program under which land has been distributed to some 20,000families (8,000 families in 1973). Although results have been mixed owing tothe limited staff available to the Dominican Agrarian Institute, a few successesin land settlement are impressive and sizeable enough to serve as models andtraining grounds for future much expanded settlement programs. For thisreason the Dominican Republic seems in a better position to carry out landreform on a significant scale than many other countries, provided the Govern-ment allocates enough resources to these projects.

10. Management of water resources is inefficient. Inadequate maintenanceof existing irrigation systems results in heavy silting and water waste; chargesare below costs of providing water, discouraging its efficient use. There isgreat scope for increasing the contribution of scarce water to agriculturaloutput and employment by developing a more rational water-use policy. Thispolicy should aim at a better utilization of soil and water, particularly inthe main river valleys, by using water for high value labor-intensive cropsand by carefully planning the ccnservation of headwater and underground waterresources.

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11. Although credit to agriculture has increased in recent years, ithas not adequately reached small and medium-scale farmers. In view of thegreat need for supervised credit for family-sized units, the Governrient hasrecently announced a large increase in the funds to be lent by the AgriculturalBank. At the same time, the ceiling on the size of future AgricultuLral Bank'sloans was set at RD$50,000. The Integrated Agricultural Development Plan(PIDAGRO) established in 1971, also provides financing for agricultural pro-jects. In 1974, the monetary authorities created some new incentives such asthe Fund for National Agricultural Development, funded by the Government andthe Central Bank, to increase and facilitate agricultural credit through finan-cial intermediaries. Simultaneously, steps are being taken to accelerate thetraining of supervised credit personnel. Furthermore, a new credit mechanismwas created to rediscount commercial banks' credit to the sector, wa_th theobjective of stimulating private banks to take over the financing needs oflarge-scale borrowers and thus permit the Agricultural Bank to concentrate onlending to small-scale farmers. One way to facilitate this objective would beto organize small-scale farmers into "asientamientos", cooperatives and similargroups.

12. Sugar is the principal agricultural commodity in terms of -ialueof o-,-put and accounts for almost one-half of merchandise exports. rhegovernment-owned Consejo Estatal del Azucar (CEA) produces about 60 percentof -he country's sugar, using land extensive methods of cultivation. Byimpr-vrng field practices, including better use of fertilizers, more efficientwater use, and faster transportation of cut cane to the factories, and byintroducing new varities of cane, it is estimated that CEA's sugar outputcould increase from about 85O,OOO tons in 1974 to as much as 1,350,0(0 tonsby 19b0, without expanding the area cultivated. CEA intends to undertakea program to rationalize its operations towards these aims.

13. The system of industrial incentives introduced in the late sixtieshas stimulated fast growth in manufacturing. The major incentives given tork:! firms have consisted of high tariff protection to final products. lowtarifIfs on equipment and intermediate products, credit on favorable terms arltax exemptions. This system has stimulated the establishment of high-costplants, oporating at a fraction of capacity, thus immobilizing excesEive amourntsof capital for each worker emplcyed. The combined effect of high effectiveprotection (an average ]evel ofI more than 100 percent) and liberal credit haspermitted the generation of r -;-h a- secure profits in spite of low capacityutilization. By contrast, Drti.a,t -- :stment in agriculture or ir lessprotected export-oriented activitice <-cwme relatively unattractive. Thus,the otherwise successful in½ous4C1a incentives policies have tended todiscourage private investment in activities with higher employment ani foreignexchange earning potential than import-substitution industries.

14. The authorities are now considering the need to change the Lndustrialincentives legislation. Reducing the bias against exports by lowerinr tariffprotection for import-substitution would be a positive step. In addi-,icn, a-export subsidy is being considered by the authorities which might comnpensatefor a possible s]owdown in the growth of import-substituiting industries.These measures are being complemented by accelerating the construction ofexport-oriented industrial estates. In addition, the recent creation of the

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Dominican Institute of Technology (INDCTEC) should facilitate the identi-fication of industrial projects.

15. The Dominican Republic is just beginning to exploit its comparativeadvantage in tourism. The proximity to the United States, attractive climate,extensive beaches and the Dominican Republic's good agricultural potentialoffer a good basis for rapid expansion of tourism, which could become a veryimportant source of foreign exchange and employment. A large-scale tourismresort is now being developed with IBRD assistance. The creation of a TourismInfrastructure Department in the Central Bank should help to rationally planthe development of this sector. When economic conditions improve in theUnited States, tourism to the Dominican Republic could initially expand atan annual rate of 15 to 25 percent. This will require strengthening theNational Tourism Directorate to promote the country's image abroad, toincrease the local procurement of agricultural and industrial products byhotels and to encourage the establishment of new hotels.

16. The Government has pursued a conservative fiscal policy thatseverely restricted the growth of current expenditures at a time when currentrevenues were expanding at a good pace. The resulting substantial current-account surpluses were used to finance an accelerating public works program.This fiscal policy was consistent with the need to build a considerableinfrastructure in a short time without stifling economic growth with anexcessive tax burden. The rapid economic growth of recent years has createdconditions favorable for a reappraisal of fiscal policies with a view toimproving some structural weaknesses that have become apparent.

17. A major weakness, the adverse consequences of which pervade allaspects of recent Dominican growth, has been the imbalance between physicalconstruction of new structures on the one hand and the provision of fundsfor operating and maintaining those structures on the other. As a result ofthis imbalance the existing infrastructure cannot be fully used and is deteri-orating. Public health facilities lack adequate supplies and staff to theextent that some hospitals remain closed to the public for prolonged periodsafter construction. In transport, the inadequate maintenance of roads andbridges has made some impassable, requiring their reconstruction at highcost or the construction of new roads. This situation is being correctedin the case of the principal highways, owing to the introduction of tolls,whose revenues are used for their maintenance. In irrigation there is anenormous waste of water because of the neglect of existing canals. Through-out the public sector, low wages have discouraged the emergence of a well-trained civil service, although recent salary increases have improve thesituation somewhat. As a result of this imbalance between fixed investmentand operating outlays, public investment has not added as much as might havebeen expected, given its costs, to the growth potential of the country.Moreover, the neglect of public social services has reduced the benefitsreceived by the rural and urban poor from recent rapid economic growth. The1974 and 1975 budgets, however, allocated larger funds for public health.

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18. The Government has recently stated that its future programs willgive higher priority to solving the problems of rural poverty. WhiLe thisgoal had been stated earlier, it proved difficult to achieve. The need forincreased attention to rural and urban poverty is even more acute now, andfinancial conditions are favorable for implementing the Government's re-orientation of goals. As a consequence of this decision, it is likely thatfuture budgets will allocate increasing resources to the provision of ruralsocial services, particularly for agricultural extension, sanitation, health,nutrition and education. The authorities may also decide to modify thestructure of public sector investment to provide more resources for labor-intensive rural works such as feeder roads, small irrigation works, as wellas for better maintenance of the existing infrastructure. The quality ofrural dwellings could be improved at a relatively low cost to the puiblicsector by intensifying the provision of sites and services and other self-help programs, along the lines of the rural water program under way.. Inorder to facilitate this reallocation of public expenditures it would beuseful to re-examine the adequacy of existing mechanisms for the planningand selection of investment projects. One way to strengthen the capitalbudgeting sy5tem would consist in formulating a comprehensive Goverr-mentInvestment Program, which would rank the relative priorities of alternativesectors and projects to avoid the need to make investment decisionE on anad hoc basis.

19. The public health, sanitation, educational and housing servicesavailable to the lowtincome population are insufficient, relative tc theneeds and to the resources available to the Government. The economicgrowth enjoyed by the Dominican Republic in recent years has not yet beentranslated into significant improvements in social services. The problemis particularly serious as regards public health and nutrition. The problemsof the social services sector are largely a result of financial and administra-tive constraints. The financial limitations arise because budgetary allocationsfor operating outlays are being kept at low levels. Equally important, theoffices responsible for planning in social sectors such as education, healthand housing have been weak and understaffed. Strengthening of the planning,implementation and evaluation mechanisms in the various specialized agencies,and decentralizing the decision-making process particularly in the socialfields, would obviate the need to make important investment choices an anad hoc basis at the highest goverument levels.

20. The poMlation is increaFg; at the high rate of about 3 percentper year. This rapid growth is due to relatively constant high fertility(at a level of 48 live births per 1,000) and a continued decline in -:hedeath rate (from 20.3 in 1960 to lL.7 in 1965-70). Until now these pressureshave been somewhat alleviated by emigration, mainly to the U.S., butprospects for a continuation of these trends are uncertain. In the iiext 20years fertility will probably remain high unless specific programs aLmed atreducing it are vigorously pursued. The authorities have recognized theimportance of taking prompt action to reduce fertility, in view of an alreadyhigh ratio of people to land, widespread rural poverty and underemployment,

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as well as high urban unemployment. In spite of government interest, pastprograms have failed to measurably reduce birth rates, partly because theydid not reach the rural areas where the need is greatest. To be more effective,family planning is to be integrated with health care. A program of maternaland child health care seeks to attract young mothers to the clinics wherefamily planning advice and services could be provided. This is the directionin which the health authorities are moving with a concentration of effortsin rural zones.

Financial Management

21. In recent years tax revenues have expanded at a somewhat slowerrate than GNP in spite of a large increase in sugar export taxes. Thisbuoyancy is inadequate to provide for the needed expansion in public services.Although a sizable surplus is expected in 1975 and perhaps in 1976 as a resultof exceptionally high sugar prices, longer-run needs require improving theelasticity of the tax system. At the same time, it is desirable to reducethe weight of import taxes in total tax revenues, thus lowering the tariffto improve resource allocation. To compensate for the revenue loss result-ing from a general reduction in import duties and to discourage the increasedconsumption that would result from the lower taxation of imports, a generaltax on consumption could be introduced. This general tax could be supplementedby a selective additional consumption tax on items that are outside the basketof lower income groups, so as to make the system more progressive. TheNational Commission on Tax Reform, created in 1967, is studying these questions.

22. An improvement in the taxation of incomes and property could providemajor increases in revenues, improve resource allocation and make the taxstructure more equitable. It would be desirable to extend the personal incometax to encompass incomes from all sources including dividends and interest,even those currently exempted. At the same time the tax scale could be madesomewhat more progressive. However, an improvement in the structure of incometaxes will achieve little unless their administration is modernized as well,particularly the income tax on individuals not subject to withholding. Realestate taxation is negligible at present relative to its potential. To createthe bases for meaningful property taxes, it will be necessary to acceleratethe completion of the rural cadastre and to update the valuation of urbanproperty. Agricultural land could be taxed on the basis of productive potentialto discourage underutilization. As a target, improvements in the tax systemcould aim at raising the ratio of income and property taxes to total taxrevenues to around 53 percent by 1985, compared to 24 percent in 1973. Con-versely, import duties (which now account for 40 percent of tax revenues)could be allowed to decline to around 16 percent without a net loss to theTreasury. The Dominican authorities recognize the need for tax reform andhave requested specialized assistance from the OAS. This has led to thepreparation of a study discussed at a Symposium in Santo Domingo in May 1974with the participation of top government officials. The next step should beto start implementing the recommendations of that symposium.

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23. The high pricee that sugar exports are expected to command in 1975offer a unique opportunity to build up international reserves for use in lateryears, when it is expected that sugar prices will drop and foreign exchangeshortages will once again arise. To accumulate substantial reserves in 1975,fiscal action will have to play a key role by generating a large overallGovernment surplus. The sugar sector will have the capacity to make a majorcontribution to the national savings effort in 1975. Conversely, unlesswindfall revenues are sterilized, a sharp increase in inflation seemE un-avoidable. Success in tapping the extra sugar revenues in 1975 and eettingthem aside will provide strong evidence of the Government's commitment toorderly economic and social development.

24. With soaring sugar prices, and cane production reaching recordlevels, the short-term balance-of-payments situation is excellent. Since1975 sugar exports may reach US$792 million, it will be possible to generatein 1975 a current account surplus for the first time in the country'E recenteconomic history, and an overall balance-of-payments surplus that may reachUS$400 million. However, in 1975 it will be necessary to repay short-termcommitments incurred in 1974, of the order of US$160 million. Theref'ore, thenet increase -n international reserves could be around US$240 million. Asa result of this favorable situation, the monetary authorities will face anew type of challenge in 1975: the management of windfall gains.

25. The monetary authorities believe that a basic short-term problemso long as value of sugar exports exceeds us$500 million will be how to ensurethat the windfall earnings are saved and held as liquid reserves by the CentralBank without a corresponding increase in the monetization of the economy. Ifthose reserves were allowed to be monetized, the resulting increase in pur-chasing power would lead to a great expansion in aggregate demand. This inturn would create strong pressures to increase imports which, if released,would eventually use up in consumption the international reserves that theRepublic must save for later years. On the other hand, if those reserveswere fully monetized, but controls were maintained in order to restrain importgrowth to a level compatible with the desired reserves accumulation -- e.g.,imports of goods and non-factor services of around US$975 million in currentprices in 1975 compared to an estimated US$870 million in 1974 and US$56$million in 1973 -- then strong inflationary pressures would be bound toappear as a sudden expansion in aggregate demand would doubtless straLn ininelastic domestic productivrr capacity. Therefore, to minimize loss z:

reserves and domestic inflati3n L'%, prunident flnancial management callsfor sterilization in the Central b of a volume of reserves of approximauelyUS$240 million, if the assumptions regarding sugar exports materializB. Althoughan import level of US$9'l5 million in 1975 would seem to only represent a 12percent increase over 1974, in actual practice it would be equivalent to an18 percent increase, because 1974 imports included about US$45 millio.l of r'.ceand other foodstuffs that are not expected to be needed in 1975j thank<s toincreases in local production.

26. Under sugar tax legislation in effect as of early September 19Th,sugar exports were taxed at diff'erent rates depending on whether they weresold under quotas in the U.S. Preferential Quota Market (USPQ) or elsewhere

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(world market). Sales in USPQ were taxed at a low rate. Since the USPQ wasterminated in 1974, sugar tax legislation was changed by Law 13 which lowersthe export tax rates. Furthermore, Law 13 authorizes producers to retaina fraction of tax obligations to be used to improve the living conditionsof workers, particularly housing, and to improve the companies' productivityby spending on fertilizer, irrigation or other improvements. Under this law,Central Government receipts from sugar in 1975 are e8timated at almost RD$300million. If the recently enacted export taxes are fully enforced in 1975, theCentral Government current surplus could reach RD$387 million, allowing for a15 percent expansion over 1974 in current outlays. It would be prudent tokeep the growth of capital expenditures to no more than 15 percent to reduceinflationary pressures. Thus the overall Central Government surplus couldreach RD$125 million in 1975. With higher sugar taxes this overall surpluscould be increased significantly.

27. If the authorities decide to maintain sugar taxes at their existinglevels, they will probably wish to consider other mechanisms to sterilize alarge part of the sugar windfalls. It would not be advisable to adopt genera-lized tight credit policies that would penalize the non-sugar sectors. Amechanism for the selective absorption of excess liquidity in the sugarindustry is clearly preferable. The administration of such a mechanismshould be easy, because only three major sugar producers are concerned, oneof them a state-owned enterprise. If tax rates on sugar cannot be increasedover the rates established by Law 13, alternatively, these three firms couldbe required in 1975 -- and in later years, so long as the export price ofsugar remains above some 20¢ per pound -- to purchase "Sugar Bonds" with amaturity of about five years including two years grace, which would be issuedby the Central Bank.-/

28. The balance of payments in 1975 and 1976 will be favorable. Inaddition, by having held internal inflation in 1974 at levels that comparefavorably with the export price indexes of the country's major trading part-ners, when recent exchange-rate realignments are taken into account, thecompetitive position of the country has improved as reflected in a strengthen-ing of the peso. Therefore this is the best possible time to start to

2/ On February 27, 1975, legislation was adopted that (a) limits sales offoreign exchange by the Central Bank to US$800 million in 1975 and requiresthat Central Bank foreign exchange earnings in excess of that amount be setaside in a special account subject to Presidential control; (b) establishesthat government revenues in excess of 1975 budgeted amounts (about RD$150million) shall revert, on a monthly basis, to a special account in theCentral Bank that may only be used by the Presidency for investment inagriculture; (c) requires the sugar companies to deposit in separate bankaccounts that part (about one-third or RD$65 million) of their 1975 exporttaxes which they are allowed to retain for outlays to improve productivityor the living conditions of their workers and establishes that the companiesmay only make withdrawals from those accounts for programs previouslyapproved by the Presidency.

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rationalize the protective system by lowering tariffs generally, by removingquantitative restrictions to imports, and by unifying the official and the"parallel" exchange markets. Although the immediate effect of these changeswould be a tendency to increase import levels, this could be compensated byintroducing consumption taxes and by controlling credit expansion. Thesemeasures would reduce inflation and in the longer run the balance of paymentswould be strengthened by an improved cost structure and expanded non-traditionalexports. The high international reserve levels expected in the next few yearswould help finance the transition period.

29. With the sugar price expected to fall to about 12 cents/lb (1974 prices)by 1978, and with annual commitments by the three major aid donors averaging US$90million per annum, the attainment of sustained 6.5 percent annual growta in1975-80 would imply the need for the volume of sugar exports to reach 1.5 mil-lion tons by 1980; manufactured exports would have to increase at an annualrate of 18 percent in real terms and tourism earnings at an annual rate of 15percent. In addition, the growth of imports would have to be restrained to thesame rate as GDP. Under these conditions the resource gap could be brought downfrom 4.6 percent of GDP in 1974 to about 3.1 percent by 1980. Still, the current-account deficit of the balance of payments would come close to US$300 million by1980. About two-thirds of this large deficit could be financed through privatecapital inflows and official borrowing (net disbursements from the IBRD, IDB andAID are expected to approximate US$80 million by 1980). However, about US$100 millionwould remain unfinanced. The medium term prospects will, of course, continue tobe greatly affected by future sugar prices. The best safeguard against the depres-sing effects of possible drops in the world sugar price on the country's pace ofgrowth will be a sufficient build up of foreign reserves so long as sugar pricesremain high.

30. On balance, the projections suggest that the Dominican Republicwill continue to require substantial external assistance on long maturiltiesand is creditworthy for moderate amounts of commercial borrowing. In v±.ew ofthe crucial decisions that must be taken by the authorities in the near futureand the uncertainty surrounding future sugar prices, this assessment will requireclose monitoring.

I. INTRODUCTION

1. In the late 1960's, the Dominican Republic started a process ofrapid economic growth that is still under way. This process was stimulatedby large inflows of private capital into strategic sectors such as mining,agriculture and manufacturing, and by a dynamic public investment program.The rate of real GDP growth accelerated to over 11 percent per annum in 1970-73.Capital formation ratios have been high by international standards -- closeto one-fourth of GDP in 1973 -- and although foreign capital has played animportant role, by far the largest part of investment has been financedthrough a strong national savings effort. Having succeeded in raising 1973GDP to well over US$500 per capita per annum, and having strengthened the coun-try's financial situation, the authorities are now in a position to shifttheir attention to the solution of important structural problems.

2. The basic problems that require urgent solution are of two types:structural and social.

3. On the structural front, the maintenance of sustained economicgrowth -- a sine qua non if the lot of the rural and urban poor is to besignificantly improved -- requires a broadening of the Dominican Republic'scapacity to earn foreign exchange. At the moment, the balance-of-paymentssituation is good, and the level of international reserves is rising. Muchof the recent expansion in exports has been due to the combination of soaringsugar prices and the start of nperations of new mining ventures.

4. Because sugar prices are volatile and the country's mineral poten-tial is limited, it is essential to plan now to improve the competitivenessof traditional exports and to develop new exports. The best prospects arein the fields of agro-industries and tourism, in which the country has acomparative advantage. The promotion of agro-industrial exports depends onrestructuring the industrial incentives system which, by providing high effec-tive protection to import-substituting industry, discourages private invest-ment in export-oriented activities. To meet this need to create new sourcesof foreign exchange, the authorities are beginning a comprehensive effort todevelop the international tourist industry and are also undertaking studiesof the industrial incentives legislation with the purpose of introducing thenecessary reforms.

5. With regard to the urgent social problems, the greatest concernrelates to the large proportion of the Dominican population that has stillto benefit from recent rapid economic growth. Unemployment is high in thecities in spite of a decline in real wages in 1973 and 1974. Despite thecontinuing expansion in the number of jobs in industry, comnerce and services,urban population growth has been too rapid to permit a reduction in unemploy-ment. This rapid growth of the urban population, in turn, results from highbirth rates compounded by an accelerating rural drift. Underemployment, mal-nutrition and illiteracy are still prevalent in rural areas. For this reason,

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the authorities have recognized the urgency of accelerating a program of landreform, of strengthening social services available to the rural population,and of intensifying family planning activities.

6. The Government's objective to improve significantly social services,particularly in rural areas, are going to impose heavy demands on the civilservice, which is already constrained by low salaries, insufficient budgetsfor current development expenses and weak planning mechanisms. The implemen-tation of new programs would be facilitated by strengthening public admini-stration, improving the composition of public expenditure and raising theelasticity of Government revenues.

II. THE PATTERN OF DOMINICAN DEVELOPMENT

A. Recent Developments

7. In the last four years, the Dominican economy has enjoyed unpre-cedented growth. In 1970-73, annual increases in GDP averaged 11.1 percentas compared to 5.0 percent in 1960-70. Preliminary estimates for 1974 indi-cate a marked decline in the rate of GDP growth to 6.5 percent. In 1972 and1973, when the Falconbridge ferronickel plant and the new petroleum refinerybegan production, GDP growth reached 12.5 and 10.2 percent respectively.

8. Apart from the one time impact of these two projects, the economicboom has been led by high prices for several traditional export products,especially sugar, together with a rapidly rising level of public and privateinvestment. Sugar export prices, which averaged 60/lb in 1971, rose to14.5i/lb in 1974 (para. 14). Gross domestic investment increased from 18.9percent to 23.8 percent of GDP between 1970 and 1973, an annual increase ofnearly 20 percent in real terms.

Table 1: RECENT TRENDS IN EXPENDITURE ON GROSS DOMESTIC PRODUCT

Value Composition Increase1970 1973 1970 1973 1970-73(Constant RD$ (Percentage (Percent

millions of 1962) of GDP) p-a.)

Gross Domestic Product 1,272 1,742 100.0 100.0 11.1

Imports GNFS 298 458 23.4 26.3 15.4

Exports GNFS 210 392 16.5 22.5 23.0

Resource Gap 88 66 6.9 3.8 -9.2

Available Resources 1,360 1,808 106.9 103.8 9.9

Investment 240 415 18.9 23.8 20.0

(Public) (67) (144) (5.3) (8.3) (29.0)

(Private) (173) (271) (13.6) (15.5) (16.1)

Consumption 1,120 1,394 88.0 80.0 7.6

(Private) (1,013) (1,284) (79.6) (73.7) (8.2)

(Public) (107) (110) (8.4) (6.3) (0.9)

Gross Domestic Savings 152 348 11.9 20.0 32.0

(Public Sector Savings) (94) (149) (7.4) (8.6) (16.6)

Sources: Tables 2.4 and 5.6.

9. The rapid increase of investment has been financed from the addi-tional export receipts without resort to excessive external borrowing. Domes-tic savings increased from almost 12 percent of GDP in 1970 to about 20 per-cent of G.DP in 1973. Much of this increase has resulted from the prudentfiscal policy followed by the Central Government which doubled its savingsin cturrent terms from RD$ 70 million in 1970 to RD$ 139 million in 1973. 1/Current savings in 1973 financed about 90 percent of Central Governmentcapital cxpenditures.

1/ Domestic inflation was moderate during most of the period. (See para. 13).

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10. Mining, industry (including sugar refining), construction and ser-vices account for the bulk of output growth. As a result of industrial in-centive laws which offer a high degree of protection and ensure high profitrates, the bulk of private investment in manufacturing appears to have beenchannelled to small scale import substitution industries. Constructionactivity has also been stimulated by the high level of public investment out-lays for infrastructure and by private residential construction. Almost allof the increase in mining output has come from the Falconbridge ferronickelplant which started production in 1972, while the growth of value added inservices has resulted from the rapid rise in urban trade and the expansion oftourism. Although the volume of agricultural output increased at a slowerrate than GDP, higher prices for some major export crops financed much of theoverall economic expansion.

Table 2: RECENT TRENDS IN SECTOR COMPOSITIONOF GROSS DOMESTIC PRODUCT

Value Composition Increase 1970-73In RD$ mil- % of Total % Increase

1970 1973 1973 lions of Increase _.a.(Constant RD$ mil- (%) 1962lions of 1962)

Agriculture 204.3 239.2 13.7 34.9 7.4 5.4

Mining 18.1 85.8 4.9 67.7 14.4 65.5

Manufacturing 215.5 289.5 16.6 74.0 15.7 10.3

Construction 64.2 120.3 6.9 56.1 11.9 23.0

Commerce 224.6 321.5 18.5 96.9 20.6 12.7

Other 545.2 686.1 39.4 140.9 30.0 8.0

Total CDP 1,271.9 1_742.4 100.0 470.5 100.0 11.1

Source: Table 2.2.

11. Recent increases in output have not contributed significantly toreduce the over-all urban unemployment rate, although some reduction in"primary unemployment" appears tc have taken place. 1/ A recent ILO 2/ study

1/ The "primary" labor force includes men 25-54 years of age with one ormore dependents.

2/ Bases para Formular una Politica de Empleo en la Republica Dominicana,National Planning Office, July 1970. (ILO study).

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suggests that, in early 1973, 20 percent of the Santo Domingo labor forcewas unemployed, and 60 percent of the remainder were partially unemployed.Partly, this can be explained by the fact that, of the growth sectors,mining is capital intensive, industry has contributed less to employment thanits potential, and employment generation in construction activity has alsobeen reduced by the use of capital intensive techniques in public investmentprojects. Furthermore, the urban labor force increased by about 6.3 percentper annum in 1968-71, reflecting migration to the cities and an increase inthe economic participation of women. In spite of rural emigration under-employment in agriculture is still widespread.

12. The patterns of recent growth suggest that income distribution hasbecome more skewed in recent years. The gap between increasing earnings inthe modern sectors and stagnating incomes in the traditional sector gap widened.Real wages in the public sector have been falling (para. 106). Except forcertain export products agricultural growth has lagged behind urban activities.

13. Domestic credit has been expanding fast in recent years. The netflow of banking system credit to the private sector increased by 77 percentin 1972 and 55 percent in 1973 and thus stimulated private investment, housingconstruction, trade and sales of consumer durable goods. The inflationarypotential of the fast credit expansion was partly compensated by an increasedwillingness on the part of the private sector to hold financial assets, parti-cularly time and savings deposits. This increase in the demand for financialassets is remarkable in view of the low yields paid to savers by the bankingsystem: sight savings deposits yield on average 5 percent per annum, fixed-term deposits yield up to 6.5 percent per annum, and certificates of depositup to 7.0 percent per annum. However, in spite of the satisfactory growthof financial savings, the Dominican economy is experiencing an accelerationin the rate of inflation. The Santc Domingo Consumer Price Index -- the onlyprice indicator readily available -- increased by 15.1 percent in 1973, com-pared to 7.8 percent in 1972 and 4.3 in 1971. This rate of inflation is notexcessive when compared to other countries, 1/ particularly considering thatthe cost of imported goods rose by 18 percent in 1973. However, the ConsumerPrice Index may well understate domestic inflation owing to its limitedcoverage and the enforcement of price controls on a number of staples. Themanagement of money and credit in the present inflationary international anddomestic environment deserves careful scrutiny, particularly in view of theexpansionary impact that 1975 sugar export earnings will have on the economy.

14. Exports have been the most dynamic element in the economy both invalue and volume. Total merchandise exports almost tripled from US$213 mil-lion in 1970 to an estimated US$634 million in 1974. The Dominican Republichas been one of the few countries to successfully increase the volume ofsugar exports to take full advantage of favorable world prices. Raw sugar

1/ Increases in consumer prices in 1973 (%p.a.): Jamaica, 19.9; Trinidad-Tobago, 14.8; Guatemala, 13.8; Honduras, 13.6; Ecuador, 13.0; Japan,11.8; United Kingdom, 9.2; El Salvador, 6.4; United States, 6.2.

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exports, which amounted to 764,000 tons 1/ in 1970, and reached a total of1,015,700 tons in 1974. However, since most of the 1974 sugar crop was soldin the futures market at prices prevailing in late 1973, the average realizedprice in 1974 is only around 14.5,/lb, reflected in a total value of US$324million compared to US$187 million in 1973. While sugar accounts for thehighest share of additional export receipts other exports have also beenbuoyant. The gross value of ferronickel exports reached US$83.5 mil;ion in1973, the first full year of operation of the Falconbridge plant and US$93.1million in 1974. Exports of cocoa, coffee, and tobacco have also shown gainsin price, volume or both. The combined export value of these three productsis s,r) w oav_ rEac.:e i US$134 million in 1974, compared to only US$63million in 1970. Although tourism has only recently become a source of fo-reign exchange, gross tourism earnings should come close to US$50 million in1974, an increase of about US$30 million since 1970.

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Table 3: MONEY AND CREDIT

(Mlillions of RD$)

A. Net Flow of Banking System Credit

June 1973/1970 1971 1972 1973 June 1974

Credit to Private Sector 27.0 36.4 64.5 99.9 130.4

(Increase per annum) (34.8%) (77.2%) (54.9%) (30.5%)

a!Credit to Public Sector 14.7 35.1 19.0 35.2 17.2-

(Central Government) (8.8) (27.5) (25.3) (11.4) (3.5)

Total Credit 41.7 71.5 83.5 135.1 147.6

(Increase per annum) (71.5%) (16.8%) (61.8%) (9.3%)

B. Financial Savings (Stock)

End of Period June 301970 1971 1972 1973 1973 1974

Money 155.2 169.8 202.8 245.9 196.3 255.9

Quasi Money 128.6 163.7 207.9 272.0 234.9 346.3

Total Money plusQuasi Money 283.8 333.5 410.7 517.9 431.2 602.2

(Increase per annum) (17.5%)(23.1%)(26.1%) (39.7%)

(Money plus Quasi Money as% equivalent of GDP) (19.1%)(20.0%)(21.7%)(21.1%)

a/ Net Credit to Consejo Estatal del Azucar decreased RD$ 26.6 - June 30,1973- June 30, 1974.

Source: Table 6.1

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15. As in any small economy, economic growth has been accompanied bya rapid increase in imports. Merchandise imports increased from US$278 millionin 1970 to an estimated US$673 million in 1974. Detailed import statisticsare not available since 1971; an indication of recent trends can be referredfrom the classification of exports from principal trading partners to theDominican Republic. According to these data, the bulk of merchandise importgrowth has consisted of industrial raw materials and capital equipment. Inthe period 1968-72, annual imports of industrial raw materials increased fromUS$43.9 million to US$89.4 million while annual imports of capital equipmentrose from US$41 million to US$92.1 million. This trend appears to be con-sistent with the rapid import substitution process which took place duringthat period. The $250 million increase in 1974 for FOB imports is attributablein part to higher fuel prices (US$100 million), to extraordinary food imports(US$46 million), to generally higher world prices, and to certain :.nventoryaccumulation, particularly of automobiles.

16. One of the significant aspects of the recent economic expansion isthat it was achieved without recourse to excessive external borrowing on com-mercial termns. External public and publicly guaranteed debt, including undis-bursed amounts, reached US$430 million at the beginning of 1974, or about 60percent of estimated merchandise exports for the year and only 17.5 percent ofGDP. This compares to US$279 million at the beginning of 1970. Over 40percent of the increase in external indebtedness is accounted for ty officialexport credits and borrowing from bilateral and multilateral develcpmentagencies at favorable terms. The external public debt service in 1974 willprobably amount to only 3.5 percent of exports of goods and non-factor servi-ces.

B. Main Sectoral Issues

Agricultural Development

17. I/ecause it provides over one-half of the Republic's emplo,'ment anJforeign exchange, I)ominican agriculture remains the key sector for 3ocial ai.deconomic development. The sector is characterized by a sharp contrast betweenrelatively modern, profitable, largely export-oriented enterprises and a poor,traditional, mostly subsistence l;ms of peasants whose standard of health andnutrition is low. In spite of past Ccvernment programs the condition of therural poor has not improved significantly and may indeed have worsened in thelast decade, because the increasing population pressure on an overcrowdedland base was not offset by increased productivity. The highest Governmentofficials are well aware of this situation and have announced recent:ly thatthey will give high priority to trying to solve the sector's main problems.

18. The Government's objectives for the sector are of two types:social and economic. Ilighest social priority will be given to the creationof rural jobs and to the alleviation of rural poverty by raising the pro-ductivity and earnings of peasants. On the economic front, the new orienta-

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tion of public policy seems to imply the following objectives: to doublethe output of food for internal consumption by 1985, to expand and diversifythe sector's contribution to export earnings and, finally, to create thebases for agro-industrial growth. At first sight some of these objectivesmay appear to be mutually exclusive, particularly in view of the fact thatmuch of the usable land is already under cultivation. But there is avast potential for improving efficiency in the use of land and water -- thesector's scarce resources -- through better management and organization.

19. In recent years, agricultural output has been growing at a rateof about one-half that of aggregate GDP. This growth has been faster inthe case of export-oriented crops such as sugar cane, tobacco and coffee,while agricultural production for domestic consumption has lagged behind,resulting in the need to increase substantially imports of cereals. Outputof livestock products, on the other hand, has expanded at a rapid pace,stimulated by a favorable market for beef exports until 1974. As discussedbelow, the system of incentives has made private investment in import-substituting manufacturing so profitable relative to agricultural-relatedinvestments that the share of private investments going into this sector inrecent years has been low. A more neutral incentive system is analyzed inthe industrial section of this report. Private investment in agriculturehas also been discouraged by past pricing policies, inadequate marketingorganization and problems derived from the system of land tenure.

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Table 4: VOLUME OF AGRICULTURAL PRODUCTION

(Percentage Increase)

PRODUCTS 1971 1972 1973

Main Exports

Sugar Cane 22.8 3.7 3.6

Tobacco - 21.7 7.1

Coffee 11.9 -2.1 -

Cereals -0.4 -1.6 -13.2

Oil Seeds 8.4 -0.7 -2.8

Textile Fibers 7.9 0.0 15.8

Vegetables 21.5 -0.4 3.1

Root Crops and Tubers 5.2 0.7 -1.1

Fruits 2.6 5.6 3.8

Beef - 12.1 5.4

Pork 9.1 33.3 6.3

Poultry 47.1 - 8.0

Milk 7.4 3.6 4.8

Total Valued Added for Agriculture 5.5 3.6 6.6

Source: Tables 2.2 and 7.1

Land Use and Tenure

20. 2 Although agricultural land is limited and the ratio of 232 personsper km of arable land is high, 1/ important increases in productionwould be possible with improved land use. Only one-eighth of the territoryof the Republic can be classified as good for cultivation, but almost one-fourth could be used for grazing and additional areas are suitable for treecrops and forestry.

Table 5: LAND CAPABILITY CLASSIFICATION

Class Km2 % Production Capacity

I 537 1.1 Excellent for cultivation

II 2,350 4.9 Very good for cultivation

III 3,122 6.6 Good for cultivation

IV 3,639 7.7 Limited or marginal forcultivation

V 6,071 12.7 Pasture - no erosion hazard

VI 5,611 11.8 Pasture - erosion hazard

VII 25,161 52.7 Forest

VIII 1,202 2.5 Wildlife

Total 47,693 100.0

Source: National Planning Office.

21. Underutilization of land arises from three types of problems:

(a) Frequently, land is used for purpose that do not fullyuse its potential: good land for cultivation is usedfor grazing, land with access to irrigation is used forsugar cane rather than for other high valued crops withhigher employment effects, etc.

1/ Ratios of persons per km2 of arable land in other countries: Chile, 40;Ecuador, 103; Guyana, 133; Bahamas, 260; Panama, 295; iaiti, 493.

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(b) Techniques of production and use of complementary inputsare generally inadequate, owing to insufficient knowledge,scarcity of inputs, and insufficient incentives.

(c) Problems associated with the system of land tenure charac-terized by extreme inequality, uncertainty regarding legalownership, boundaries and titles. In addition, the privatetransfer of land is complicated by the shortage of long--term mortgage credit and the absence of a market place forsuch transactions. This tends to freeze the existing dis-tribution of land by restricting private sales from thepresent owners to potential new farmers. Furthermore, itis unclear which land will be subject to expropriationunder the Land Reform legislation. This uncertainty hasdiscouraged long-term private investments in agricultureand has favored the maintenance of large tracts of landeither idle or grossly underutilized.

22. This under-utilized land -- including some Government-owned estates-- could be put to better use for the benefit of some of the 100,000 land-less rural families. Of the family-operated farms, over one-half are ofinsufficient size to provide a yearly family income of RD$ 400. 1/ Thisproblem is compounded by the prevalence of fragmentation of holdings, asmany farm units are spread over several lots, making their operation par-ticularly costly and inefficient.

11 An annual income of the equivalent of iRD$ 400 (1974 prices) is con-sidered the minimum necessary to sustain an average rural family.

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Table 6: RURAL FAMILY UNITS BY LANDHOLDING

No. of Units % of Total % of Total LandSize of Units (000) Units in Farms

Sub-family Units /a(less than 1.25 ha.) 237 52 6

Family Units(1.25-31.5 ha.) 210 46 44

Medium Multi-family Units(31.6-315 ha.) 8 2 25

Large Multi-family Units(Over 315 ha.) 0.5 0 25

Total 455.5 100 100

/a Units not capable of providing a living for an average farm family,i.e., around RD$ 400 per annum.

Source: USAID Agricultural Sector Assessment, March 1974.

Water Use

23. Although the country has over 110,000 hectares under irrigationand there are programs under way that may add 60,000-80,000 hectares in thenext 5-10 years, water management remains inefficient. Maintenance ofexisting systems is inadequate, resulting in heavy silting and water waste.Charges are generally lower than the costs of providing water, discouragingits optimal use. Furthermore, since the charges are related to the acreageirrigated rather than to the amount of water actually used, there is nofinancial incentive for farmers to economize on water use. Although waterwill continue to be a scarce resource, there is great scope for increasingthe contribution of water to total agricultural output and employment throughthe development of a more rational water-use policy. The authorities havetaken the first steps in this direction by attempting to strengthen the or-ganization and management of the Hydraulic Resources Institute (INDRHI) inconnection with the Yaque del Norte project, but much remains to be done.Water-use policy should aim at maximum utilization of soil and water re-sources in the main river valleys. This can be achieved by using water forhigh-value, labor-intensive crops, and by carefully planning the conserva-tion of headwater and underground water resources.

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24. Prompt efforts to formulate a national water-use policy might goa long way to improve economic returns in new irrigation projects. A fea-sible action program could begin with the mapping of water resources in thevarious river basins, and be followed by the establishment of nationalpriorities for the use of these resources. Since much of the existingirrigation network is in poor condition, its rehabilitation is likely tobring about greater economic benefits than the initiation of new projects.In planning the scope and design of new projects, the time element deservesspecial attention. Large irrigation projects which have been emphasizedin recent years, especially if combined with power generation, normallytake much longer to complete than small dams and wells. In this respect largeprojects may well compare unfavorably with small projects. Furthermore,small works, as well as rehabilitation and maintenance works, tendl togenerate more jobs during construction than major hydroelectric dams.The urgency to develop a national water policy taking into accouni: theseconsiderations is heightened by the active consideration, by the authori-ties, of several new major hydraulic projects.

Credit

25. Although there has been an increase in the volume of credit to.griculture in recent years, the rate of growth of agricultural credithas been lower than for other sectors, reflecting in part the lower profit-ability of agriculture resulting from the biased national system cf incen-tives and administratively weak delivery systems for agricultural credit.An analysis of lending operations shows that most of the loans went torelatively easily "bankable" enterprises such as larger livestock ranches,coffee, sugercane farms; only small amounts were allocated to subsistencecrops such as corn, cassava and beans. 1I Rice as well as industrial tom-atoes are financed largely through industrial channels and credit flows arenot easily identifiable. Most of agricultural credit has benefitted arelatively small number of medium and large farms and ranches, whereas themajority of small units have had either no access at all to credit or re-lied on merchants and money lenders at extremely high rates.

26. The Agricultural Bank has been the main source of instititionalcredit for the small farmers, although it has allocated less than one-halfof its resources for this ourpose; the majority of the Agricultural Bank'scredit has gone to finance lo w-.4-'.-- ventures for which commercial 1)ankcredit was available, though not i2cessarily at the same concessionaryterms of interest ancl repayment periods. In view of the enormous need forsupervised credit for family-sized units, the Dominican Governnment hasrecently announced a program of progressively lowering the ceilings on thesize of future loans of the Agricultural Bank, to direct its credit whereit is more needed. The ceiling on the size of future Agricultural Bank'sloans was set at RD$50,000. The Integrated Agricultural Development Plan(PIDAGRO) established in 1971, also provides financing for agriculturalprojects. In 1974, the monetary authorities created some new incertives

1/ Total credit for these three crops in 1973 was RD $ 2.1 million, outof total agricultural credit of RD$ 137.6 million.

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such as the Fund for National Agricultural Development, funded by the Govern-ment and the Central Bank, to increase and facilitate agricultural creditthrough financial intermediaries. Simultaneously steps are being taken toaccelerate the training of supervised credit personnel. Furthermore, a newcredit mechanism was created to rediscount commercial banks' credit to thesector, with the objective of stimulating private banks to take over thefinancing needs of large-scale borrowers and thus permit the AgriculturalBank to concentrate on lending to small-scale farmers.

27. In the wake of its administrative reorganization the AgriculturalBank features now a few rural agencies -- "model branches" -- with enlargedtechnical staff and wider limits of authority. The expansion of these ac-tivities should halp to provide more and better credit services to smallerproducers.

28. But it seems impracticable for the Agricultural Bank to attemptto reach the majority of small farmers without resorting to organizingfarmers into some form of groups such as the "asentamientos", cooperatives,informal neighborhood groups and federations of such groups. 1/ Some prep-aratory work has been done in this field, but much more has to be accom-plished quantitatively, qualitatively and as regards involvement of theAgricultural Bank. The Dominican Development Foundation developed an in-teresting system of "nursing" groups of small farmers until they reach thestage to qualify for banking system loans.

Forestry

29. Existing legislation prohibits the exploitation of forestry re-sources. As a result, most wood used for construction, furniture, etc.,is imported. In view of the large proportion of the country's territoryoccupied by forests, it would be appropriate to formulate a plan for theirrational use providing guidelines for conservation and replanting.

Fisheries

30. Per capita consumption of seafood is low, less than eight poundsper annum, and four-fifths of this is imported. Of the total domesticcatch, about four-fifths is offshore and the rest is inland. Little isknown about the offshore seafood resources of the island. Of the approxi-mately 1,200 fishing boats in operation, the great majority are not motor-ized or capable of deep sea fishing. Average monthly earnings of fisher-men have been estimated at only RD$ 70; their low productivity can beattributed largely to inadequate equipment and technology and is probablyresponsible for the dwindling number of fishermen, which dropped by two-fifths in 1969-73.

31. In view of the high nutritional value of fish and the proteindeficiencies in the diets of a majority of Dominicans a survey of the

1/ This is done by the Dominican Development Foundation and INDECOOP (Insti-tuto de Desarrollo y Credito Cooperativo).

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offshore fishing potential is a high-priority task. Its findings mightlead to the formulation of a project suitable for external financing.

Rural Development

32. A large rural population, skewed land distribution and Lack ofalternative employment possibilities have prompted the Government's actionon land reform. Since the early 1960's land has been distributed to about20,000 families including 8,000 families in 1973 in the wake of tae expro-priation of large rice farms. Still this represents less than 8 -?ercent ofthe Republic's total crop lands and 5 percent of rural families.

33. Initially general crop land was distributed to individual fam-ilies organized by the service cooperatives, but the rice lands were dis-tributed to collectively operated farms. In both cases, the managementis performed largely with staff provided by Government agencies, particu-larly by the Dominican Agrarian Institute (IAD).

34. T'le results have been mixed: failures resulted from the DominicanAgrarian Institute's limited management capacity, insufficient in-rastruc-ture and too few titles given to settlers. But some successes are impres-sive and sizable enough to serve as models and training grounds for futuredevelopment. 1/ Given the Government's will and commitment to carry outmore extensive projects, the Dominican Republic is in a better position tocarry out land reform on a significant scale than many other countries.

35. In pursuing their objectives to transform idle or grossLy under-utilized land into viable productive units, the authorities could minimizepossible adverse effects on production by restricting and clarify-ng morethan at present the rules defining types of land subject to expropriation.The same purpose would be served by avoiding the break up of units thatare currently producing crops reasonably well. The speedy completion ofthe rural cadastre and the establishment of a land tax could usefully bebased on the productive capacity of the land, and represent a significantburden so as to encourage maximum land use.

36. TIhe fo1lowinz complementary steps would also help to increase L!t-success of (Government programs;

(a) rapid settlemerst o X and boundaries, to reduceuncertaintieFsV

(b) greatly expanded provision of extension servicestogether with supervised credit, to facilitate thecommercial initiation of the new productive units;

(c) extension of marketing mechanisms and informationon supplv and demand prospects for various crops on

1/ The "El Sisal" chain of villages, near Azua, where about 900 familiesIhave been settled, has been successful with mixed farming, growingindustrial tomatoes, plantains, vegetables and raising livestock.

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a timely and continuing basis, to facilitate produc-tion planning and minimize cases of oversupply thatmight develop seasonally with the growth of theseprograms;

(d) establishment of links between major users of agri-cultural products -- e.g., hotels, restaurants, super-markets, agro industries -- and individual producersthrough cooperatives or other types of officiallysponsored intermediaries.

37. The authorities are also planning to expand substantially the pro-vision of social services in rural areas including the execution of sitesand services projects, to encourage the improvement of rural dwellings andsanitary conditions with a maximum use of rural labor.

38. The beneficial effects of the above programs would be multipliedif they are complemented with a series of rural education projects orientedtowards improving peasants' productivity.

Sugar Cane

39. The Dominican Republic is one of the world's major exporters ofcane sugar. Total annual production amounts to about 1.2 million tons,of which about 1.0 million are exported. Ten countries produce more thana million tons annually but only four (Brazil, Cuba, the Philippines andAustralia) export more than the Dominican Republic. The crop is of vitalimportance since it contributes the bulk of foreign exchange earnings.In addition, it provides direct employment (in the fields and factories)to over 80,000 workers 1/ and indirect jobs (in transport, trade and ser-vices) to many more. About 15 percent of Government revenues have ori-ginated directly from sugar in recent years, a percentage that shouldmore than quadruple in 1975, owing to higher sugar prices (Table 19).

40. Three companies account for practically all production of rawsugar: The Government-owned Consejo Estatal del Azucar (CEA), CentralRomana, a subsidiary of the U.S. Gulf and Western Corporation and a privateDominican company (Vicini). Although these three companies grow most of thecane they process, they also buy about 15 percent of their cane needs fromseveral thousand small and medium size independent farmers.

41. CEA, which accounts for about 60 percent of the country's totalsugar production, is probably one of the largest state-owned agricul-tural enterprises in Latin America outside of Cuba. Although availableinformation on CEA's operations is incomplete, several issues stand out.

42. CEA has succeeded in increasing production rapidly by expandingareas cultivated. CEA's strategy has been using extensive rather than inten-sive methods of cultivation. Therefore, there is considerable scope for im-proving yields in the 100,000 hectares under sugar by improving field

1/ A inaljority of the field workers are lHaitian.

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operations. A firm of international consultants has recently begun astudy of CEA's operations at the request of CEA's management. Thleirrecent estimates are based on theoretical calculations, owing to theinadequate data base, and suggest that cane yields in some of CEl'slarge estates could be doubled and ultimately trebled and that averageyields on all of CEA's cane lands could be increased initially by 40percent and eventually by as much as 75 percent. These improvementswould require the immediate adoption of better fertilization techniques,more efficient water use and faster transport of cut cane to the fac-tories. In the medium term, better cane varieties would have to be de-veloped. With better practices CEA has the potential in the next fiveyears and within the existing acreage to produce at least another 5million tons of cane which, if factory capacity were available, wouldrepresent half a million tons of sugar.

43. Since CEA is required by law to fully distribute after-taxprofits (60 percent to the Central Government and 40 percent to itsworkers as a profit-sharing bonus) it has been unable to make the capitalinvestments needed to maintain operations over the long term, much lessto increase productivity. CEA's management is fully aware of the need toma3dernize and rationalize its operations and has recently initiated studiesthat may lead to the preparation of a large investment program. -he program_ould include four major aspects: cane cultivation, factory expansion andi-Tprovement, cane transport facilities and finally organization, administrationand management. The five-year program would lead to an expansion in CEA'ssugar output from about 850,000 tons to 1,350,000 tons per annum, whilereleasing land for other uses. CEA's average raw sugar costs, which wereRD 6.6 cents/lb in 1973 and are estimated at RD 10 cents/lb by 1975, woulddecline substantially when the program is completed. Therefore, the pro-gram would be justified economically and financially even if world sugarprices were to drop to about RD 11 cents/lb (1975 prices). Preliminary in-dications are that the total cost of the program could reach RD$ 100 million,which could be financed through a combination of official loans, suppliers'credits and CEA's own profits. The Government is interested in the promptexecution of the program, because it would strengthen the balance-of-pay-ments prcspects and open up new land-reform possibilities on about 200,0C0lha. of CEA's land that at present are underutilized.

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Industrial Development

Industrial Characteristics and Recent Performance

44. For the purpose of this survey, the industrial manufacturingsector is defined to exclude the sugar producing branch which is thelargest manufacturing sector of the country employing 76 percent of themanufacturing labor force and having 23 percent of the manufacturingsales. 1/ Thus defined, the industrial sector employed nearly 30,000workers in 1972, had sales of RD$ 455 million and a value added at domesticprices of RD$ 256 million. Manufacturing industry has grown in therecent past at a rate significantly higher than the economy as a wholeas its contribution to GNP rose from 7.5 percent in 1960 to 13.1 per-cent in 1971. Industrial employment growth has not been even overtime. It increased in the early sixties, fell in the late sixties re-sulting in zero growth for the 1960-1968 period, and rose sharply sincethen after the industrial incentive laws and political stability crea-ted an environment adequate to rapid industrial growth. Total salesgrew by 20 percent in constant prices during the 1968-1972 period whileindustrial employment grew at a much faster rate as it increased by46.8 percent during that period.

45. The industrial sector of the Dominical Republic is composedmostly of light industries in which food, beverages and tobacco accountfor 56.8 percent of sales. The design of most industries is fairly laborintensive as these plants are concentrated in consumer goods productioninvolving many imported intermediate goods. However, since many of thesefirms operate at a fraction of their capacity, in practice they are lesslabor intensive. Only a few heavier industries have been developed likethe cement factory and the cardboard and paper recycling plant. 2/ There-fore, industries in the Dominican Republic are not of a type for whicheconomies of scale are a critical efficiency condition and where extremelylarge investments are required to achieve minimum efficient sizes. Aver-age annual industrial wages increased from RD$ 1,312 in 1968 to RD$ 1,661in 1972, equivalent to an annual average rate of 2 percent in real terms.Iiowever, relative to GDP per capita these wages decreased from 4.3 timesto 3.5 times.

46. Industrial plant size in the Dominican Republic is small. Sizedata is not available; however, average plant employment by sectors indi-cates that less than 40 plants employ more than 100 workers and that asubstantial part of the industrial sector is made up of cottage type plantsemploying less than 10 workers. This size of industry indicates that a

1/ Data derived from Oficina Nacional de Estadistica, Estadistica In-dustrial de la Republica Dominicana 1972 and from Cuentas Nacionales1960-1971 published by the Banco Central.

'/ Which employs a very large number of people collecting the raw materials.

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large part of the industrial sector corresponds to small traditional opera-tions and to medium size firms run by their owners. Therefore, Lominicanindustry does not yet employ large numbers of professional managers andadministrators with modern training.

Industrial Policies

1. Industrial Incentives

47. The most important single industrial policy instrument is theincentive system created by Law 299 of 1968, and modified by Laws 346 of1972, 595 of 1970, and 79 of 1970. Law 299 created three industrialclassifications ("A", "B", and "C") which convey a set of tax and tariffexonerations to firms receiving those classifications.

48. Plants with classification "A" are export industries usiallylocated in free zones. The "A" classification grants complete exonera-tion of import tariffs and duties for all intermediate and capital goods,raw materials and fuel (except gasoline) imported by the plant. It alsogrants total exoneration of the income tax when the headquarters of theirm are located outside the Dominican Republic. Municipal and net worthtaxes are also waived in their totality.

;. Classification "B", which applies to industries producing goodsnot previously made in the country and which are considered of "h:.ghpriority', grants up to 95 percent exoneration of import tariffs and'Iities on raw materials, intermediate products, packing materials andf£el (except gasoline) used in the production process as long as they arenot produced domestically, subject to a minimum tariff of 10 percent.Few firms have qualified for this category (Table 7a).

50. Classification "C" may be given to any other industrial firms.It grants up to 90 percent exoneration of import tariffs on intermediategoods, ra>r. materials and fuels, also subject to the 10 percent mirimum.In the oast classiffcatlon "C" has been used broadly. (Table 7b).

51. All DlanCt are exempted from income taxes on reinvested prof-'tsas long as that exemptiok. does not exceed 50 percent of the incomr- taxeswhich they woould have to -,-,y e -'W ise The tax incentives are- vciid fora limitedl period of time. lh-n- r--t is set regionally: 8 years in Santo

Domingo, 10 In Santlago, 1) nea~r ! e border wIth Hlaiti and 15 years every-whiere else. The tariff eŽemptiOn& for category "A", "B" or "C" classifica-tions must state tthat hlis plant will be economically viable after the taxincentives h;ive expired. In addition to these incentives, Law 595 of 1970

established a tariff and, import duty draw back of 95 percent when the goodsimported are then reexported as part of another industrial product. Lhissystem involves a lengthy process before the first tax rebate is granted,but subsequent rebates are handled more promptly.

T.ghe 7a: DOMINICAN REPUBLIC: NEW EMPLOYMENT AND INVESTMENT

UNDER INDUSTRIAL INCENTIVE LEGISLATION

Total1969 1970 1971 1972 1973 1969-73

Total 1/Investment (million pesos) 48.7 43.8 27.3 17.4- 14.4 151.6Number of employees 6,245 5,480 4,037 2,432 4,167 22,361Capital per worker (thousand pesos) 7.8 8.0 6.8 7.2 3.5 6.8Number of firms 111 59 64 45 44 323

Category A 1/Investment (million pesos) 3.9 1.9 2.1 0.9- 7.0 15.8Number of employees 1,304 704 1,199 736 3,229 7,172Capital per worker (thousand pesos) 3.0 2.7 1.8 1.2 2.2 2.2Number of firms 9 9 9 11 26 64

Category BInvestment (million pesos) - 2.5 - 1.8 - 4.3Number of employees - 63 - 190 - 253Capital per worker (thousand pesos) - 39.7 - 9.5 - 17.0Number of firms - 1 - 3 - 4

Category CInvestment (million pesos) 45.8 39.4 25.2 14.7 7.4 132.5Number of employees 4,941 4,713 2,838 1,506 938 14,936Capital per worker (thousand pesos) 9.3 8.3 8.9 9.8 7.9 8.9Number of firms 102 49 55 31 18 255

1/ Does not include Oil Refinery of Azua, with an investment of RD$ 150 million, and expectedemployment of 300.

Source: IMF Report SM/74/173 (Data obtained from Ministry of Commerce and Industry on the basisof declarations of companies.)

Table 7b: DOMINICAN REPUBLIC: EMPJTLCMENT AND INVESTMENT BY SECTOR IN

CATEGORIES C AND A UNDER IIDUSTRIAi. INCENTIVE LEGISLATION, 1969-73

Category C Category AInvestment Capital per Investment Capital per(million Employ- worker (thous- (million Employ- worker (thous-

______ _ pesos) ment sand pesos) pesos) ment sand pesos)

Food 48.2 5,678 8.5 5.8 1,877 3.1

Textiles 10.0 1,404 7.1 3.0 2,436 1.2

Shoes 8.1 984 8.2 0.8 544 1.5

Furniture 6.4 777 8.2 - -

Paper products 15.3 972 15.7 - - _

Leather and rubber products 3.6 471 7.6 - - -

Chemical products 17.6 1,888 9.3 - -

Nonmetallic mineral products 6.2 858 7.2 - -

Metallic products 6.0 658 9.1 1.5 1,187 1.3

Machinery 7.6 921 8.3 1.1 40 27.5

Miscellaneous 3.5 325 10.8 3.6 1,088 3.3

Total 132.5 14,936 8.9 15.8 7,172 2.2

Source~ 'MI Pc: ort C'x'/ *'l;/177 s.C -z:-sIrted From }l .Xt:risr- of 2ocmmer: c^.od Iridustw: <- .nfl' bas<fi Drl

'e :-rti fT : -

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2. Tariffs and Protection

52. Tariffs, duties and effective protection in the Dominican Republicare difficult to ascertain as they are the result of a complex system oftariffs and quotas regulated by many laws and not systematically compiled.A 1967 study concluded that the nominal average tariff was 107 percent onconsumer durable goods, 55 percent on non-durables, 78 percent on inter-mediate goods and other inputs, and 23 percent on capital goods. Tariffexemptions existing at the time lowered the average tariffs to 85 percenton consumer durables, 48 percent on consumer non-durables, 65 percent onintermediate goods and inputs and 18 percent on capital goods. Thesetariffs generated average effective protection levels of over 100 percentfor the industrial sector as a whole. These tariffs have not changed muchsince 1967.

53. The system of import quotas and prohibitions has not added sig-nificantly to the protection resulting from tariffs. Any merchandise canbe imported, regardless of quotas or prohibitions, if the importer provideshis "own" foreign exchange (i.e., foreign exchange not purchased from thebanking system). "Own" exchange can be bought in the parallel market at apremium of 8 to 15 percent (para. 134). This higher cost is partially com-pensated by lower financial costs because "own-exchange" imports are notrequired to open letters of credit and to prepay import duties, as is thecase with regular imports. Therefore, the net effect of import quotas andprohibitions is to add about 5 percent to the cost of the restricted im-ports. (Applicable import duties are payable regardless of the origin offoreign exchange used).

Table 8: EFFECTIVE PROTECTION RATES: A SUMMARY

AssumptionsNo Partial Total

exoneration -a exoneration /b exoneration /c

Processed Food Products 38.6 48.1 52.0

Textiles 274.5 363.7 379.0

lWood Furniture 306.8 355.8 441.1

Fertilizers & Pesticides -20.6 -9.6 -7.0

Soap and Cosmetics 444.0 462.3 497.1

We:ighted Average* 99.1 122.7 140.0

/a All input prices assumed equal to international CIF price plus tariff.7l Input prices are assumed equal to international CIF prices when inputs

are not produced in the country. When there is domestic production,prices are assumed equal to (a) above.

/c All input prices are assumed equal to international CIF prices.* I;eighted by sales in 1972.Source: Table 8.15 (Based on a study by the O.A.S.)

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54. Effective protection rates are high and have been further in-creased by tariff exonerations on inputs and capital goods. The ad hoc ap-proach used in granting exonerations has produced situations in which thesame goods imported by various firms pay different tariffs depending onwhich firm imports them; this complicates any detailed effective protectionstudy. F.ffective protection rates have therefore to be considered as aguideline reflecting the ranking and the magnitude of the actual protectionreceived, but cannot be taken at face value. Furthermore, it is likelythat some of the figures exaggerate the actual protection affordec. by thetariff because the internal prices of some products are lower thar. the in-ternational prices plus the tariff. There is no doubt, however, that onbalance industrial protection levels are excessive. In most cases existingfirms may be able to operate profitably with only one-third of their cur-rent effective protection.

3. Credit Policies

55. The industrial sector receives credit from the FIDE 1/ fund, fromthree private development finance corporations (DFC's), from the bankingsystem and from CFI. 2/ FIDE funds are available at 9 percent annual in-r:erest. Commercial bank loans have an interest charge of 12 percent which.ifter minimum deposit requirements and other charges come up to approxi-rnately 18 percent during the current inflationary period. CFI lends at 10percent from its own resources and at 9 percent from FIDE's. The DFC'slending rate is 12 percent. FIDE, CFI, and DFC's funds are mostly used forfixed capital investments while commercial banks funds are used for bothfixed and working capital financing. Some DFC's currently find it diffi-cult to place their own funds because of the availability of cheaper FIDEcredit. In order to stimulate demand for their funds, some DFC's have un-dertaken to prepare feasibility studies for industrial plants whichi theythen offered to finance to the private entrepreneurial sector. Exzept forcommercial banks, all industrial credit is substantially subsidizel.

56. Domestic industrial firms are not currently constrained Dy creditshortages as they have access to the Eurodollar market through the subsid-iaries of multinatioral banks located in the country, in addition -o thecredit sources mentioned above. It is estimated that up to 30 percent ofsome banks' lending is done in foreign currency. FIDE and CFI are impor-tant suppliers of industri 21 capital. ilowever, their relative importanceis not known as ther-e is no da-a -- urodollar transactions and as mostprivate banks (lo not senarate their industrial loan portfolio from theagricultuiral and comnmercial loans. Nowever, some figures give an idea ofthe magnitude of industrial credit in the Dominican Republic. FIDE's totallending in 1966-1973 wa., RD$ 36.6 million of which RD$ 12 million were AIDfunds, RD$ 12.4 million were IDB funds and RD$ 12.2 million Central Bank

1/ FIDE, Fondo de Inversiones para el Desarrollo Economico, is a CentralBank fund that lends to private financial intermediaries.

2/ CFI, Corporation de Fomento Industrial, is an official DFC.

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funds. CFI is lending approximately RD$ 4.5 million a year of which about40 percent are FIDE funds. A large private bank has lent to industryRD$ 11.1 million over a four-year period. The DFC's are fairly new insti-tutions and their lending has not exceeded RD$ 5.0 million in the last threeyears. Two of them have received loans from the USAID. Altogether thesefunds have, therefore, averaged some RD$ 13.0 million per annum, excludingcommercial banks and Eurodollar loans.

57. Most institutional industrial credit goes to fairly large pro-jects and plants by Dominican standards. CFI's projects require financingof between RD$ 150,000 and RD$ 500,000 while a large bank had an averageindustrial loan size of RD$ 152,000. This suggests that small scale indus-try has not been reached by these institutions.

58. Credit sources require a collateral of approximately 1.5 timesthe value of the loan. Machinery and equipment financed by the loan cannotbe included in the collateral. This policy makes it difficult for smallfirms to have access to low interest rate credit of FIDE and CFI because oftheir small total collateral.

The Impact of the Industrial Policies

59. The combination of high tariffs, quotas, special exonerations ofduties on imports of machinery and intermediate goods, income tax exemptionsand liberal credit policies has fostered fast industrial development in therecent past. However, it has also fostered the development of some unde-sirable characteristics of the industrial sector which could be correctedin the future. Looking first at the positive aspects of industrial poli-cies, the development of offshore operations (category "A") and exportoriented industries has been substantial and is increasing. These indus-tries have good growth prospects, are very labor intensive, and generateforeign exchange. The extension of classification "A" to some off free-zone plants mainly in the agro-industrial and garment industry has generatedsome linkages of the offshore operation with the domestic economy. In addi-tion, industrial development has provided some training grounds for themanagerial and labor forces which have increased the human capital of thecountry.

60. on the other hand, a large part of industrial development hasleen distorteci as the incentives system has induced the proliferation ofinefficient plants producing for the domestic narket. The tariff exonera-tion on imports of intermediate goods and raw materials has induced firmsto import an excessive proportion of inputs, discouraging vertical integra-tion. An extreme case is given in the drug, medicines, soap and cosmeticssector, mostly in the "C" category, which accounts for approximately 5percent of industrial sales and which imports almost all its inputs in-cluding even packing materials, in spite of the low priority for thecountry of this sector.

61. The combined result of high protection to value added and easyavailability of subsidized credit has stimulated the entry of new firms

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and the emergence of substantial excess capacity. 1/ Given the small sizeof the domestic market, it would be more efficient for existing firms tospecialize more than at present in specific products, to enlarge produc-tion runs, operate closer to full capacity and reduce average costs.While this would tend to reduce competition between domestic firns, pricesto consumers need not increase if this rationalization is accompanied bythe lowering of import duties (para. 110).

62. The prevalence of excess capacity has greatly reduced the poten-tial of industrial investment to create jobs. CEDOPEX 2/ estimates capital-labor ratios of RD$ 4,500 in the export industries, RD$ 12,000 in the newimport substitution ones (categories B and C) and an industrial average ofRDS 7,800. Furthermore, the Government's subsidy of category B and C in-dustries has been high. The fiscal cost of the exonerations, which can beconsidered as an approximation to the Government's implicit subsidy to theindustrial sector arising from the laws affecting industrial development,is not known with precision as the records kept do not permit its determin-ation. Hlowever, it is possible to estimate the order of magnitude. Duringthe 3 yearO 1971-1973 the value of the industrial imports of cate-ory Band f firms was RDS 78.1 million. Assuming an average exoneration of 40p,ercent and an average import duty of 100 percent, the implied subsidy isW)$ 31.2 million. During the same 3 years income tax investment creditswere granted on RDS 33.0 million of reinvested profits which would other-wise have paid about RD$ 8.0 million in income taxes. Therefore, the totalimplicit subsidy was approximately RDS 40.0 million during these threeyears. The subsidy appears to be increasing over time as the 1973 estimateis of approximately RD$ 20.0 million. This is equivalent to approximatelyIDS 900 per year per job created by the exonerated industries, 3/ which isequivalent to 54.2 percent of the average industrial wage. A direct, opensubsidy of this magnitude to industrial firms for each worker employed, inlieu of all other incentives, would have been preferable for emplcymentcreation and rescu.rce allocation.

63. The exoneration, policies have, however, tended to be moxe conl-serv'ativeŽ Iluring tihe recent past. The estimated investment by excneratedfirrs-i pelakedi in 1960? and 1970 and substantially decreased since then(Table 8.4). The h .h nrotection for import substittution industrializationhas attracted funds t- 1-:'ustry which otherwise could have been invested

I In the druI, and cosmetic s r , some firms could increase output tuireetimels inl .a itil-.lla. r}fi

2/ ClDOP()X, (.entro Dominicano de 'romnocion (le Exportaciones, a recentlycreated Government agency responsible for promotion of industrialexports.

3/ The data from che Directorio de Desarrollo Industrial shows tiat theexonerated industries had created at most 22,500 jobs up to Pw h:il.tJt'r

1973, about two-thirds of the industrial work force. Hlowever, theseestimates may be based on expected, rather than actual data.

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in other sectors or in export-oriented industries. However, the next stepin the import-substitution industrialization process would be even morecapital intensive 1/ and complex, as it would require the production ofintermediate and capital goods which require more technology, managerialflexibility and larger market. Therefore there is some urgency in theneed to modify the incentive structure of the country towards a differentpattern of industrial development.

Industrial Policy Recommendations

64. The Government's industrial policy goals are to achieve substan-tial employment generation, low costs, earn foreign exchange and improveincome distribution. The achievement of these goals would be furthered byadoption of the following industrial policies.

65. The tariff structure has a high average level, which grants aver-age effective protection levels of over 100 percent to the industrial sec-tor. An overall decrease of the tariff structure would increase the com-petitiveness of the industrial sector, particularly if it also decreasedthe wide range of variation in effective protection rates. Such a changeshould, however, take place gradually to permit existing firms to adapttheir operations to changing conditions.

66. The granting of new exonerations for category "B" and "C" plantswould be phased out and the non-renewability of the existing exonerationsenforced immediately. This policy would, in the long run, eliminate thetariff exonerations on inputs and, therefore, lower the effective protec-tion level for consumer goods production forcing the existing plants to be-come more competitive and efficient. Simultaneously, this policy would in-crease the effective protection level for domestic intermediate goods andinputs and would, therefore, increase the likelihood of generating backwardlinkages in production. A measure of this nature is not likely to causethe failure of existing plants as they generally have remarkably high pro-fit levels, and, furthermore, with improved management should be able tolower their production costs.

(67. Indtustrial capital costs in the Dominican Republic are low be-cause of the income tax exoneration for reinvested profits and because ofthe concessionary credit granted to illdustry through FIDE. These two dis-tortions could be eliminated, as they are an implicit subsidy to capitallhenice worsening the income distribution, and generate a bias in favor ofinvestment in capital intensive technologies and processes which aggravatesthe unemployment problem.

1/ Signs of this tendency towards more capital intensive plants can alreadybe seen in the economy. For example, the new textile expansions haveinstalled the "most modern up-to-date" machinery; also the new cigarettefilters factory employs less than one person per RD$ 35,000 invested infixed capital.

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68. A sine qua non for the rationalization of industrial policies isto redress the imbalance against industrial exports. A more neutral incen-tive system would represent a significant improvement over existing poli-cies. However, if the Government wishes to accelerate the development ofindustrial exports to maintain the pace of manufacturing growth simultane-ously with lowering protection, it may consider introducing an export sub-sidy. CEDOPEX is working on an export subsidy scheme in the form of anexport tax credit; exporters would be given a document that could be usedin lieu of money to pay taxes. If an export subsidy of any kind is estab-lished, the following considerations would make it most effective. In thefirst place, the subsidy should be subject to income tax as otherwise itwvould benefit more the large firms paying higher marginal income taxes;it should also be proportional to the percentage of domestic value addedof the goods exported so that it does not induce the use of imported inter-mediate goods and raw materials. It is worth noticing that the long runfiscal cost of export subsidies tends to be lower than its apparent costas higher exports increase the import capacity. This extra amount of for-eign exchange would generate more profits, employment and imports, andtherefore, higher income, import and other taxes, which would decrease theactual fiscal costs of the subsidy.

5~9. The following illustrative table shows the percentage of the sub-sidy actually recovered by the Government Treasury under various plausiblehypothetical situations.

70. Regarding the free zone operations two policy changes would con-tribute to increase their benefits. First, foreign owned free zone plantsare totally exempted of income taxes. As these plants get foreign taxcredits in their home countries, this exoneration does not increase theiroverall profits and therefore may not constitute an incentive. Therefore,all free zone plants could be subject to income taxes. 1/ Second, underpresent regulations, domestic firms operating in the free zone cannot ob-tain domestic credit. There is no reason why they should not receivecredit at market interest rates, provided that their transactions in foreignexchlange take place througlh the banking system.

71. The development of new industrial policy suggested here couldalso be complemented by sectoral technical assistance aimed at industrieswhere employment potential is high and which could develop comparative ad-vantages in relatively short tinme. Some such industries are the leather,wood products, clothes, selective agro-industries like food canning, 2/processing of sugarcane by-products, tobacco, cassava, etc.

1/ The low level of the Dominican Republic's income taxes would allowfull tax credit in countries like the U.S.A.

2/ Although food canning is a capital-intensive activity, it has con-siderable indirect employment effects.

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Table 9: PERCENTAGE OF THE SUBSIDY RECOVERED BY THE TREASURY

Percentage Tariff paidof exports y increasedreceiving the mportssubsidy whichwould not have 40% 80% Equal to 150%been exported of the of the the of theotherwise subsidy subsidy subsidy subsidy

8% 16% 20% 30%20

8.6% 16.6% 20.6% 30.6%

16% 32% 40% 60%40

17.2% 33.2% 41.2% 61.2%

24% 48% 60% 90%60

25.8% 47.8% 61.8% 91.8%

32% 64% 80% 120%80

34.4% 66.4% 82.4% 122.4%

40% 80% 100% 150%100

43% 83% 103% 153%

Note: The upper figure on each cell shows the percentage of the subsidywhich is recovered by the Treasury under the assumption that itdoes not increase income taxes. The lower figure shows this samepercentage under the assumption that the increased exports areincreased sales, that extra profits are 10% of increased sales;and that there is a 30% marginal profit tax. Note also thatthese estimates underestimate the actual percentage of the sub-sidy recovered as they implicitly assume that other indirecttaxes will not increase as a result of the higher income generatedby the increase in exports. Furthermore, no allowance has beenmade for the possible multiplier effect of the additional exports.

Source: Staff Estimates.

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72. The favorable balance-of-payments prospects for the near termoffer a good opportunity to implement these reforms soon. The low-ringof protection levels, at a time whien the country will hold substantialinternational reserves, would also contribute to reduce inflationarypressures.

Tourism

73. The Dominican Republic offers considerable tourism attra^tions.Its climate is pleasantly warm year-round; its coastline includes Dver 500Inm of beautiful sandy beaches; its landscape features green pastures alter-nating with tropical fruit orchards and rice fields, rolling hills and moun-tain ranges. Its cultural heritage is enriched by many treasures of earlySpanish colonial architecture. The Republic's comparative advantages in-clude its proximity to the U.S., a large agricultural base which couldeasily meet the requirements of the Dominican tourism industry; and rela-eively low p.ices. Other important assets are the Dominican people's na-tural sense of hospitality and favorable disposition toward foreign visitors.

74. Nevertheless, the country did not participate in the Caribbeantourism boom of the first part of the 1960's. Up to 1968 the Republic'saccomimodation capacity, largely Government-owned, amounted to about 1,000rooms, catering in the main to business traffic. In recent years, how-ever, with political stability and an improved investment climate, pri-vate investors have undertaken the construction of several hotels. In1973, hotel accommodation suitable for international tourism amounted to1,600 rooms. Yearly room occupancy levels in existing hotels averageabout 65 percent, providing adequate profitability.

75. Over the period 1968-1973, foreign tourist arrivals rose from57,000 to 134,000, an annual growth rate of 19 percent. Cruise visitorsto the ports of Santo Domingo and Puerto Plata also increased rapiily inthe last five years, to 48,000 in 1973. In 1973, 86 percent of foreigntourists were i.S. nationals, two-fifths of which from Puerto Rico. Whilevacation traffic has increased in importance, the majority (about 50 per-cent) of foreign visitors are still business-motivated.

76. Altlhoughi tourism tr-fi: Lo the Dominican Republic in 1972 accountedt-or less than 3 percent of the ½' -ribean total, the economic value of tourismto the Dominican Republ½c iS significant. Gross foreign exchange earningsfrom tourism are the Republic's fourthi most important source of foreign ex-change (after sugar, ferronickel and coffee). In 1973, they amounted toabout US$38.() million, excluding air fares. The sector employs an estimated6,000 persons not counting those employed in the construction of a-commodation,

77. In spite of the growing importance of tourism, the DominLcan authori-ties have not yet geared their strategies to reaping full economic benefitsfrom the tourism sector. They have done little, for instance, to 'romote

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the marketing of agricultural or industrial output to the tourist industry;the two largest hotels catering to international tourists still import mostof the goods required for their operations. Some of the incentives grantedto hotel investors, such as the 10 to 15-year exemption from income tax andconcessionary loans, may be overly generous when compared to other Caribbeancountries. The incentive legislation has had scant applications. Its vagueterminology and the case-by-case method used to apply it may have discouragedsome potential investors from requesting benefits. With insufficient fundsand a lack of experienced staff, the National Tourism Directorate has beenunable to efficiently promote the country's tourism image abroad. IHotel in-vestors must, therefore, still rely on their own promotional efforts to filltheir rooms. Another potential problem for investors is the shortage oftrained hotel personnel. The country's only hotel training facility is in-adequate -- with a yearly output of 15 graduates -- to meet even presentrequirements for trained personnel. It is expected that these problemswill be corrected, as the authorities turn their attention to this sector.The recent creation of a Tourism Infrastructure Department (INFRATUR) inthe Central Bank has led to the development of an ambitious project, PuertoPlata. A second project, Boca Chica, is under consideration.

78. Current development plans include, in addition to the Puerto Plataand Boca Chica projects, a number of private hotel investments in variousparts of the Republic. If all these plans are implemented, a total of12,000 hotel rooms would be available by 1985. This capacity could sustainan annual growth rate of up to 25 percent in tourist traffic, in 1974-85.Given the Dominican Republic's presently small share in Caribbean tourism,and its comparative advantages, it is reasonable to expect that if domesticcosts remain competitive, this share could double to 6 percent by 1985.If economic conditions improve in the United States, Caribbean tourismshould continue to expand at an annual rate of at least 7-8 percent andprobably higher, because higher fuel costs have made the Caribbean a moreattractive destination than areas more distant from the continental EastCoast. Under these conditions, Dominican tourism could expand at anannual rate of 15-25 percent.

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III. PUBLIC SECTOR

A. Public Investment Program and Social Services

Public Investment

79. Public sector fixed investment increased at the fast rate of 18percent per annum in 1968-1973 (in real terms) and its share in GDI} grewfrom 4.9 percent to 8.3 percent in the same period. This expansiorL wasachieved at the expense of current outlays of the public sector whose realannual growth rate in 1968-73 did not reach one percent. The policy torestrict severely the growth of current expenditures at a time when cur-rent revenues were expanding at a good pace led to the emergence of a sub-stantial current surplus, which was used to finance the acceleratirLg publicworks program with modest recourse to foreign or domestic borrowings. Thisfiscal rolicy was consistent with the need to build a considerable infra-structure in a short period of time, without stifling economic growth withan excessive tax burden. The rapid economic growth of recent years has_reated conditions favorable for a reappraisal of fiscal policies, with aV!,3,v to improving some structural weaknesses that have become apparent.

80. The major weakness, whose adverse consequences pervade all aspectsof recent Dominican growth, has been the imbalance between physical con-struction of new structures and the provision of funds for operatir.g andmaintaining those structures. As a result of this imbalance the existinginfrastructure cannot be fully used and is rapidly deteriorating. Publichealth facilities lack adequate supplies and staff, to the extent that somehospitals remain closed to the public for prolonged periods, after theirconstruction is completed, for lack of staff. In transport, the iradequatemaintenance of some roads and bridges has made them intransitable, requir-ing the corstruction of new roads or their reconstruction at high cost. 'n-irri4ation there is an enormous waste of water because of the neglcct ofexisting canals. Throughout the public sector, inadequate staffing andlow wages have disccura.cd the formation of a competent, well-trained civil

service (para. 106)f. As ; :esult of this imbalance between fixed investmentand operating outlays, public ><'e -.ent, relative to its size, has notadded as much as might havw. ''Ber _-ected to the growth potential cf theDominican RepubIIc.

81. Compounding the prohlem, thie composition of fixed investmeat hasemphasized major investments, such as In transport, which have had longgestation periods, required the iuse of capital-intensive construction tech-niques and have contributed relatively little to employment creatlin, eitherdirectlv during construction or indirectly, after completion.

82. The Government has recently stated that its future programs w'l-

give a higher priority than in the past to solving the problems of rural

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Table 10a: PUBLIC SECTOR FIXED EXPENDITURE, 1968-1973

(Percentage Distribution)

1968/1970 1971/1973

Public Administration 4.5 4.1

Social Services 21.3 26.0

Education 5.3 5.6

Housing 7.2 11.0

Public Health 1.3 1.5

Water and Sewerage 7.0 7.5

Community Development 0.5 0.4

Economic Services 68.9 54.2

Agriculture 6.6 4.9

Sugar 8.7 6.0

Irrigation and Flood Controla/ 5.4 10.1

Transport 30.9 23.4

Power 17.3 8.5

Industry - 1.3

Ni iscell aneo us 5-3 15.7

TOTAL FIXED INVESTMENT 100.0 100.0

a/ For 1972, includes Valdesia Dam, which will be used for power genera-tion as well as irrigation.

Source: Table 5.7

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poverty. As a consequence of this decision, it is likely that futurebudgets will allocate increasing resources for the provision of rural socialservices, particularly for agricultural extension, environmental sanitation,health, nutrition and education. The authorities may also decide to modifythe structure of public sector investment to provide more resources intosmall labor-intensive rural works such as feeder roads, small irrigationworks, as well as for better maintenance of the existing infrastructure.The quality of rural dwellings could be improved at a relatively low costto the public sector by intensifying the provision of sites and servicesand other self-help programs, along the lines of the rural water programunder way. In order to facilitate this reallocation of public expendituresit would be useful to re-examine the adequacy of existing mechanisms for theplanning and selection of investment projects. A way to strengthen thecapital budgeting system could begin by stating explicitly the Government'spriorities for a three to five-year period and then introducing greaterrealism in the budgeting of resources, with the objective of incorporatinginto the capital budget the great majority of Government investment ratherthan continue adopting investment decisions on an ad hoc basis.

Transport

83. Owing to the small size of the country and its economic structure,transport flows are limited. Main exports (sugar and bauxite) are transport-ed over very short distances (less than 100 km). Agricultural productstransported from the Cibao Valley to Santo Domingo and the other centers ofconsumption, and industrial products and imports originating from SantoDomingo constitute the only important transport flows. The average dis-tance of transport is about 125 km. As a result, road transport is welldeveloped relative to other transport modes.

84. T'ith about 10,000 km for about 75,000 vehicles the highway networkis densc and gives access to all the currently producing areas of the country.'lore than 55 percent of the networkc is paved, but, because of lack of mainte-nanceL and use of inadequate materials at the time of construction, the networkis deterioralting rapidly and needs improvement. Nevertheless, the presenttransport network does not constitute a bottleneck to the economic develop-ment of the country, except for the central west area, near the Haitianborder, and the region of the Samana Province. Investment in new transportfacilities shiould certainly not have first priority among public and privateinvestments. P'ublic transport Investment, which exceeded 30 percent of fixedpublic investment in 1968-1970, .-as substantially reduced to 23 percent in1971-73; a level of 20 percent should be adequate for the foreseeable future.However, this assessment may have to be reconsidered when the results of aplanned national transport survey, expected in mid-1976, are known.

85. Considering the complexity of the existing structure, with over-lapping responsibility between agencies for roads, ports and highways, aswell as the almost complete lack of planning, a restructuring of the trans-port sector is urgently needed. As a first step, the Government requested

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a UNDP sponsored study of highway rehabilitation, maintenance and administra-tion. The Government now intends to implement the consultant's recommenda-tions regarding maintenance administration. After maintenance administra-tion, the next priority would be strengthening planning and administrationof the transport sector as a whole. The planned national transport surveyis expected to make recommendations on the subject, including the possibleneed for improved inter-ministerial coordination.

86. All inter-city passenger traffic has been handled by private orpublic cars. A newly created bus service between Santo Domingo and Santiagowill improve the situation, but there is a need to develop inter-city busservices and to regulate the use of public cars in order to reduce theirexcessive number. This would also contribute to contain petroleum imports.

87. The major issue in the transport sector is the excessive emphasison highway construction at the expense of expenditures on maintenance andon the construction of rural access roads. Much of the present road invest-ment is required because of the lack of maintenance in the past. While theGovernment's road rehabilitation programs deserve high priority, futurepublic spending in the sector will have a far greater effect on employmentif it is reoriented in favor of preventive maintenance and feeder roads.Every peso spent in maintenance is estimated to generate 2.5 times moreemployment than a peso spent in highway construction, and the import contentis also far less. The construction of rural access roads is also relativelylabor intensive (1.5 to 2.0 times more so than highways, depending on theclhoice of techniques). Even more important, an intensive campaign of feederroad construction, if concentrated in areas incorporated to land reform pro-grams, would help to ensure the viability of the latter, and thus help toraise the income levels of large numbers of peasants.

Power

88. In spite of the inauguration, in November 1973, of the 80 MW Taverahydroelectric station, the bulk of power generation in the Dominican Republicstill depends on imported fuels. This characteristic is not likely to changein the future, in view of the limited availability of untapped water resourceswitlh a hydroelectric potential and the high priority that agriculture shouldcommand for the use of those resources. Therefore, it is essential for thelong-run financial viability of the Corporacion Dominicana de Electricidad(CDE) that its tariffs be fully adjusted to reflect current high fuel prices.In the first half of 1974 CDE was allowed to include a fuel cost adjustmentin its bills to industrial but not to residential consumers. The resultingoperat.ing shortfall led the company to borrow US$11 million in the Eurodollarmarket in mid-1974. Later In the year the Government authorized CDE to in-crease residential rates and in addition it established a subsidy to CDE,to be financed out of increased domestic prices for sugar. However, thefull impact of these measures on CDE's financial position is not yet known.

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89. Although the power sector has been one of the most efficientlymanaged in the country, demand for electricity is outpacing installedcapacity. 1/ This has resulted in the temporary shutdown of industrialfirms, the installation of small, less efficient, generating units by pri-vate firms who cannot rely on the public utility, and more recently, theinstallation by CDE of gas-oil fired turbines, which are costly, lut bettersuited for peak requirements than fuel-oil fired turbines. These problemsarose in part as a result of an excessive emphasis on hydroelectric projectshaving a long gestation period, which led to the neglect of short and medium-term needs, and required the adoption of emergency measures. A balancedlong-term planning of the nation's power sector would have to give dueweight to the full costs of further hydroelectric development, includingthe water foregone for irrigation. With timely planning and an adequatefinancial base, it should be possible for CDE to increase the nation'spower generating capacity at a lower unit cost, both in terms of capitaland of fuel consumption.

Social Services

The public health, sanitation, educational and housing servicesavailable to the low-income population are insufficient, relative to thent_ed, and to the resources available to the Government. The economic growthenjoyed by the Dominican Republic in recent years has not yet been translatedinto sigruficant improvements in social services, because other prioritieslhxive attracted the bulk of public spending (Table 12 in Chapter IV below).Th-e r,roblem is particularly serious as regards public health and natrition.

'31 The problems of the social services sector are the consequence offinanciai and administrative constraints. The financial limitation arosebecaus- ,'Uagetaim allocations for operating outlays have been kept at low'evels. Equally important, the offices responsible for planning in socialsectors such as education, health and housing have been weak and understaffe,A strer.gthWning of the planning mechanisms in the various speciali ted agerc Ac-woul eliminate the need to make important investment decisions on an achoc basis at the hig.!-et Government levels.

Health

92. A nutrition snrvy <.u by the Government in 1971 among lowand middle income gIcOps i.tdiated t',at thie majority of people examinedhad been un(dernourished almost from birth. Among children under 13 years

1 / Iven without tak4ng 1iar account the shortfall In supply attr:butableto delavs in thl completion o- the Vallesia Dam.

2/ lKncueita Nl_cional _le Nitritc[on, ~;anto D)omingo, 1971.

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of age, 51 percent were anemic and among people 13 years old and older,63 percent of the men and 34 percent of the women were anemic. The overallpicture was that nutritional levels were below requirements, although theydid not reach famine conditions. This situation may have worsened sincethen, according to a more recent Government-sponsored nutrition and healthsurvey not yet released. A major effort to improve nutritional standardswould have a high economic payoff in terms of improved productivity of thelabor force and reduced demand for medical care.

93. In 1966-73, total Government spending for health virtually did notincrease in real terms, in spite of the greater needs of a rapidly growingpopulation (Table 12). This is reflected in shortages of operational sup-plies and of human resources, particularly para-medical personnel. The pro-blem is complicated because an excessive share of Government spending inhealth is allocated to the construction of new hospital facilities, insteadof providing for better staffing and maintenance of existing facilities.To relieve the manpower constraints it will be necessary to improve work-ing conditions, including better pay (see para. 106), provision of adequatesupplies, better opportunities for training and specialization, greateradministrative decentralization and professional recognition for para-medicalstaff.

94. The Ministry of Public Health have recently published a publichealth master plan based on the creation of five major regions with decen-tralized administration. This plan, which has not yet been officiallyadopted by the Government, would constitute a positive first step towardsmore effective health care. However, the plan pays insufficient attentionto preventive medicine and environmental sanitation.

Population

95. The population of the Dominican Republic is increasing at a rapidrate of over 3 percent per year. This rapid growth is due to relativelyconstant high fertility (at a level of 48 live births per 1,000) and acontinued decline in the death rate (from 20.3 in 1950 to 14.7 in 1965-70).Until now these pressures have been somewhat alleviated by large scaleemigration, mainly to the U.S., but prospects for a continuation of thesetrends are clouded by a tightening of U.S. immigration policies. In thenext 20 years fertility will probably remain high unless specific programsaimed at reducing it are vigorously pursued. The authorities have recognizedthe importance of taking prompt action to reduce fertility, in view of analready high people/land ratio, widespread rural poverty and underemploymentas well as high urban unemployment.

96. In spite of the Government interest, past programs have not beensuccessful in reducing birth rates, because they did not reach the rural areaswhere the programs are most needed. Furthermore, too much emphasis was placedon propaganda, rather than education by which couples are involved in thedecision-making process and thereby become personally committed to the pro-gram. To be effective, family planning must be integrated with health care.

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A program of maternal and child health care would have good prospects of

attracting young mothers to the clinics, where family planning advice and

services could be provided to start with. This is the direction in which thehealth authorities are moving, with a concentration of efforts in rural zones.

Housing

97. In spite of the large deficit in low-income housing, there are no

clear priorities for public housing location, standards and income levels

of beneficiaries. Considering that the housing and mortgage credit needs

of the higher income groups can be adequately served by the Housing Bankand by private institutions, the social benefits of public housing programswould be maximized if they were directed toward low-cost units, geographical-ly diversified, assigned equitably according to waiting lists and objective

need standards, and if repayment commitments were enforced. In the ruralareas, the low-income housing needs might be met at a low cost to the budget

by providing the basic infrastructure - "sites and services" -- and en-

couraging the beneficiaries to build their own dwellings with a minimum of

official assistance.

Water and Sewerage

98. The Government has been making steady progress in the provision of

water to urban and rural areas. At present one-fourth of the rural populationhave access to piped water and current plans are to raise this ratio to two-fifths by 1980. The rural water programs have been designed to maximize the

participation of the beneficiaries through the organization of self-help local

cooperatives, with considerable success. In urban areas, nearly four-fifthsof the-population have easy access to potable water; because of the rapid rate

of urban growth, it will be difficult to increase this proportion in theseventies, in spite of a substantial effort under way.

99. In contrast to the progress being made to increase water supply,sewage disposal remains a critical problem. In Santo Domingo, only one-third

of the population is served by the existing sewerage system and the latrine

program in rural areas has lagged behind. To control the incidence of gastro-

intestinal and parasitic disease it would be essential to accelerate thesewerage programs.

Education

100. The main problem in this sector has been the neglect of rural areas.

Only seven out of 100 students enrolled in the first grade complete primary

education. Most rural schools are incomplete, offering only one or two grades.Only 9 percent of the teachers are qualified. Classrooms are small and in-

adequate for the establishment of a multigrade teaching system which would be

essential if education opportunities were to be extended to the dispersedrural population. The existing pattern in the sector is exacerbated by theGovernment's priorities in its school construction program, which emphasizesurban and roadside location for new schools.

101. Some action to remedy the situation has been initiated. A mappingand inventory of school facilities has been completed and this will allow thedevelopment of a national plan to provide educational opportunities to themore dispersed rural population. Already such Dlanning activity has beencompleted for some of the poorer rural areas. A broader planning effort isalso being undertaken in which sectoral priorities and investment requirementswill be determined.

102. While the supply of qualified teachers is expected to increasesharply with the recent commencing of operations of five new expanded teachertraining institutions, sharp differences in teacher salaries need to be re-duced to provide appropriate incentives for teacher service in rural areas.Teachers' earnings in rural areas are substantially lower than in the cities;the range of monthly rural salaries for 7-1/2 hours' daily work is RD$ 75/135compared to RD$ 135/180 in most cities and RD$ 160/210 in Santo Domingo. Theactual salary within these ranges is largely determined by the individualteacher's academic qualifications. Since the proportion of teachers holdinga diploma is much smaller in rural areas than in the cities, average salariesare probably closer to the bottom of the respective range in the case of ruralteachers. Furthermore, teachers who live in cities have better possibilitiesfor outside paid employment, although this advantage may be offset by thepossibility to grow some foodstuff and by the generally lower cost of food andhousing in rural areas. On balance, however, the spread appears to be exces-sive and creates an additional obstacle to the recruitment of qualified teachersfor rural schools.

103. Practically all city public primary schools but only four-fifths ofrural schools participate in a CARE program that provides the equivalent ofabout four pounds of cereal annually for each student; at present no milk isoffered by this program. The primary public school system could play agreater role in the improvement of child nutrition.

Financing of Public Investment

104. Prudent fiscal management has permitted the public sector to financea growing share of its capital expenditures. Consolidated public sectorsavings financed three-fourths of capital expenditures in 1969 and over nine-tenths in 1973, and contributed over one-half of total gross domestic savingsthroughout the period 1969-73.

105. Major components of the public sector are the Central Government,public enterprises, municipalities and other decentralized agencies. TheCentral Government generates the largest share by far of public savings,although the relative contribution of the rest of the public sector to publicsavings has been increasing rapidly, largely as a result of the operations of

Table Al: CONSOLITATED PUBLIC SF,CTOR FINANCT'S, 1969--7'

Fstimate1969 1970 1971 1972 19,3 1974

(in millions of RMDS)

A. Current Savings

Central Government/a 78.7 95.6 119.0 147.6 167.2 '09Rest of Public Sector .0 8.4 23.5 40.2 45.8 75

TOTAL 78.7 104.0 142.5 187.8 213.0 284

(Percentages)

Central Government 100 92 84 79 78 74'Rest of Public Sector 0 8 16 21 22 26

TOTAL 100 100 100 100 100 100

(in millions of RD$)

B. Overall Surplus (-= Deficit)

Central Government/b 29.7 37.2 32.9 44.2 43.0 53Rest of Public Sector -67.5 -60.8 -63.9 -40.6 -50.0 -83

TOTAL -37.8 -23.6 -31.0 3.6 -7.0 -30

/=a Adjusted for current tranfers to rest of public sector.

/b Adjusted for current and capital transfers to rest of public sector.

Source: Tables 5.2 anti 5.6.

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CEA, 1/ CDE, 2/ the Social Security Institute and, to a lesser degree, CORDE. 3/In 1972 these four institutions generated current account surpluses of RD$ 13.4!dllion. 13.7 million, 3.5 million and 1.2 million respectively. CDE's con-tinuing profitability is contingent on its ability to charge realistic tariffsto reflect higher fuel costs. When due account is taken of current and capitaltransfers within tihe public sector, the Central Government emerges as havinga large and growing overall surplus, while the rest of the public sector hasbeen a steady but moderate net borrower.

106. 'rhe low level of salaries paid to civil servants has been an un-favorable consequence of the conservative financial practices of the publicsector. In 1970 the average annual salary in the Central Government was aboutRD$ 1,340, in the municipalities RD$ 1,013, and in the rest of the public sectorRD$ 2,200. This compares to average annual blue collar wages of aroundRD$ 1,500 in the manufacturing sector in the same year. In the CentralGovernment average real salaries fell by 10 percent in 1970-73. The Governmentannounced in November 1974 the establishment of a special RD$1 million annualfund to increase the salaries of some 87,000 public sector workers whoseearnings were below RD$200 per month. While this measure will contributeto redress the problem affecting the poorest, it will not improve the situationfor technical and professional personnel.

Table 10c: CENTRAL GOVERNMENT SALARIES

1970 1973

Wtages and Salaries Paid (Million RD$) 109.0 124.3

Total Workers (Thousands) 81.4 82.2

Average Salary (RD$ - Current Prices) 1,339 1,513

Santo Domingo Consumer Price Index 100.0 129.5

Average Real Salary (RDS - 1970 Prices) 1,339 1,168

Source: Tables 5.2, 5.8 and 9.2.

1/ CEA, State Sugar Council.

2/ (.1CE, State Electric Power EFnterprise.

:3/ CORDE., Corporacion cle l.mpresas d(l Estado, a holding company of manu-facturing firms. Although CORDE is profitable as a whole, some of thefirms that it controls are not.

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107. As indicated earlier, low salaries have been an obstacle to thedevelopment of a strong civil service. Many public employees must hold morethan one job to provide an adequate family income. Recognizing this situation,the work-week in most public agencies is short, about 30 hours. To implementthe Government's ambitious social development programs will require the full-time dedication of large numbers of competent staff. One way to stimulatethose selected employees, whose efforts are essential to the development pro-gram, to devote all their energy exclusively to the civil service would be tooffer them higher salaries in exchange for full-time dedication. The financialburden imposed by such a measure could be easily absorbed, given the currentstrength of public finances. In 1973, for example, total employment in thepublic sector, excluding state enterprises, was about 100,000 at an averagesalary of about RD$ 1,500. This gives a total wage bill of RD$ 150 million.Assuming that in a first stage 20 percent of the employees had qualified forthe selective increase, and that the average salary increase had been 50 per-cent, the total wage bill would have increased by 10 percent, or RD$ 15 mil-lion. In 1973 this was equivalent to only 7 percent of public sector current-account savings and to 6.6 percent of public sector investment. This programcould be phased-in gradually, and its financial cost compensated by a slowergrowth of public investment, which need no longer expand at the fast rate ofthe recent past, as discussed in the preceding section.

B. Central Government Finances

108. The same as in the case of the public sector, recent trends inCentral Government finances are characterized by the prudent financial policiesthat led to the emergence of a large current-account surplus at the expenseof the growth of current outlays. These trends are summarized in Tables 11,12 and 13.

109. In recent years tax revenues have expanded at a somewhat slowerrate than GNP, in spite of a large increase in sugar export taxes. Thiselasticity -- which is higher with respect to real growth than with respectto price increases -- is inadequate to provide for the needed expansion inpublic services. Although a sizable surplus is expected in 1975, and perhapsin 1976 as a result of exceptionally high sugar prices, in the longer run itwill be necessary to strengthen the elasticity of the tax system. At the sametime, it is desirable to reduce the Teight of import taxes in total tax re-venues, to enable the authorities to lover the tariff to improve resource allo-cation. Since it will take considerable time until the share of import dutiesbecomes small their structure and administration must be improved. To compen-sate for the revenue loss resulting from the generalized reduction in importduties and to discourage the increased consumption that would result from thelower taxation of imports, a general tax on consumption could be introduced,preferably a value-added tax, of around 3 percent. This general tax could besupplemented by a selective additional consumption tax on items that are out-side the basket of lower income groups, in order to make the system more pro-gressive.

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Table 1l : SUMMARY OF CENTRAL GOVERNMENT OPERATIONS, 1966-1973

As Percentage RFate of IncreaseValue (RD$ ml.) oI' GNP 1966-19731966 1973 1966 1973 (% p.a.)

Current Revenues 161 360 15.3 15.1 12.2

Current Expenditures 155 221 14.7 9.3 5.2

Current Surplus 6 139 0.6 5.8 57.0

Capital Expenditure 36 157 3.4 6.6 23.5

Fixed Investment ( 15) (114) ( 1.4) ( 4.8) 33.5Other ( 21) ( 143) ( 2.0) ( 1.8) 11.0

Overall Deficit 30 18 2.8 o.8 - 7.0

Net External Financing 38 10 3.6 0.5 -17.5

Net Domestic Financing - 8 8 - 0.8 0.3 -

Gross National Product 1,051 2,378 1OC.O 100.0 12.4Consumer Price Index 100.0 136.7 _ - 14.6

Source: Tables 2.5 and 5.2.

- h4 -

Table 12: STRUCTURE OF CENTRAL GOVERNMElN]T TIOTAL EXPENDITURE(AUTHORIZATION BASIS)

As Percentage Rate of IncreaeValue(RD$ mil.) of GNP 1966-19731966 1973 1966 1973 (% p.a.)

General Administration .69 10C 6.6 4.2 5.4

Social Services 58 120 5.5 5.c0 11.0

Education 29 59 2.e 2 .5 10.5Health 21 29 2.0 1.2 4.7Housing 1 15 0.1 o.6 47.5Other 7 17 0.7 0.7 13.5

Economic Services 48 137 4.6 5.8 16.2

Agriculture 14 31 1.3 1.3 12.0a ratind C nication6 23 o.6 1.0 21.5

Transport and Communication 25 43 2.4 1.8 8.1UI anization and Baildings - 36 - 1.5 _ct'rh,er 3 4 0.3 0.2 4.2

Other 20 24 1.9 1.C' 2.6

TjtaZl 195 381 18.6 16.0 10.1

Gross Ma-bional Product 1,05i 2,378 100.0 1Co.0 12.4

Consumer Price Index 100 136.7 - - 4.6

SouI-ce: Tables 2.5 and 5.3.

Discrepancles are due to rounding.

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Table la. STSRUCTURE OF CENTRAL GOVERNMET REVENUES

As Percentage Rate of IncreaseValue(RD$ rail.) of iC P 1 966-177-31966 1973 1966 1973 (%p.a.)

Tax Revenues 148 320 14.1 13.5 11.6

Direct Taxes 36 102 3.4 4.3 12.5

Income Taxes 25 75 2.4 3.2 17.0Property and Inheritance 6 13 o.6 0.5 11.6Other 5 14 0.5 o.6 15.9

Indirect Taxes 112 218 10.7 9.2 10.0

Import Duties 72 131 6.9 5.5 9.0Export Duties 3 30 0.3 1.3 39.0Other 37 57 3.5 2.4 6.4

Non-Tax Revenues 13 40 1.2 1.7 17.4

(CEA's Contribution)-/ (_ ) ( 2) ( _ ) ( 0.1) ( -

Total Central GovernmentCurrent Revenues 161 360 15.3 15.1 12.2

Gross National Product 1,051 2,378 100.0 100.0 12.4

Memorandam

Income Taxes paid by CEA - 4 - 0.2 -Export Taxes paid by CEA 2 16 0.2 0.7 34.5Consumer Price Index 100.0 136.7 - - 4.6

' CEA's contribution of 60% profits net of income taxes.

Source: Tables 2.5 and 5.1.

Discrepancies are due to rounding.

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110. There is much room for improvement in the taxation of incDmes andproperty. By strengthening it, it will be possible to provide major increasesin revenues, to improve resource allocation and to make the total tax struc-ture more equitable. To achieve this, it would be desirable to modify the per-sonal income tax to include incomes from all sources including dividends and

interest. This step could be accompanied by making the tax scale somewhatmore progressive. However, it is not enough to improve the structure of incometaxes if their administration is not modernized as well, particularly the in-come tax on individuals not subject to withholding. Real estate taxation isnegligible relative to its potential. To create the bases for meaningful pro-perty taxes, it will be necessary to accelerate the completion of thle ruralcadastre and to update the valuation of urban property. Agricultural landshould be taxed on the basis of productive potential to discourage :ts under-utilization. As a target, these measures could aim at bringing the ratio ofincome and property taxes to total tax revenues to around 53 percent: by 1985,compared to 24 percent in 1973. Conversely, import duties which now accountfor 40 percent of tax revenues, could be allowed to decline to around 16 per-cent without loss to the treasury.

121. Since the tax system should not discourage efficient productiveartivity, any export taxes should be carefully graduated to world prices inorder to ensure adequate margins to the producers. The complex industrialincentives legislation and draw-back regime, and the type of changes thatwou a De desirable to stimulate the growth of an efficient industrial sectorwere discussed in a previous section (paras. 64 to 72).

112. The Dominican authorities recognize the need for tax reform and haverequested specialized assistance from the OAS. This led to the preparationof a study that was discussed at a Symposium held in Santo Domingo in May 1974with the participation of top Government officials. The next step should bethe establishment of a working party to start implementing the recomnendationsof that Symposium. A feasible timetable could be the following'

First Stage (From April 1975 to July 1976)

IFt,Dort Taxes consolidate all duties into a single one;transform duties from specific to ad-valorem; introduce the Brussels ValueDefi'nitlon.

Income Taxes adjust progressivity of personal tax;improve tax administration.

Real Estate 'rax coinplete rural cadastre; initiate urbanLcadastre.

-4 7 -

Second Stage kFrom August 1976 to December 1977)

Import Taxes introduce a new tariff, with lower protec-tion.

Consumption Tax introduce selective consumption taxes onnon-essential products, simultaneous withlowering tariff.

Income Tax unify all incomes into one personal incometax;

Real Estate Tax introduce effective tax on rural property;complete urban cadastre.

Third Stage (From January 1978 to December 1978)

Consumption Taxes introduce Value Added Tax.

Real Estate Tax generalize rural tax and make it more pro-gressive; introduce an effective urban tax.

Taxes on Sugar

113. The high prices that Dominican sugar exports are expected to com-mand in 1975 offer a unique opportunity to build up the nation's internationalreserves for use in later years when it is expected that sugar prices willdrop and foreign exchange shortages will once again arise. To accumulatethose reserves in 1975, fiscal action must play a key role by generating alarge overall Government surplus. The sugar sector will have the capacity tomake a major contribution to the national savings effort in 1975 because aver-age sugar export prices are expected to exceed RD 30 cents/lb., while averageproduction costs will be around RD 10 cents/lb. Because the taxable capa-city exists, success in tapping the extra sugar revenues in 1975 and to setthem aside will provide strong evidence of the Government's commitment tomobilize domestic resources for economic and social development.

114. Under sugar tax legislation in effect as of early September 1974,sugar exports were taxed at different rates depending on whether they weresold under quotas In the U.S. Preferential Quota Market (USPQ) or elsewhere(world market). Sales in l'SPQ were taxed at a low, flat rate, while exportsto the world market were taxed at a progressive, higher rate. Since the USPQwas terminated in 1974, sugar tax legislation was changed in September 1974.Law 13 was passed lowering the export tax rates substantially (Table 14).Furthermore, Law 13 authorized the producers to retain about one-third of thenew tax (the actual percentage depends on the export prices), 1/ to be used

1/ The tax to be retained is equivalent to one-half of the marginal taxaccruing when the sugar price exceeds 20 cents/lb.

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Table l: SUGAR EXPORT TAX RATES: COMPARISON UNDER OLD AND NEWLEGISLATION FOR ALTERINATIVE EXPORT PRICES(Cents per Poun(d of Raw Sugar Exported)

EXPORT PRICE30 32 37.50 50.0 60.0

A. Former Legislation (Up to September, 1974)

Tax Bracket Basic Tax Rate

Up to 3.20 Free - - -3.20 - 3.60 25% of excess over 3020 o10 010 1o0 .10 .103.61 - 4.10 35% " " 3.60 o18 .18 .13 .18 .18Over 4.10 50% " it ' 4.10 12095 13-95 16.70 ?2.95 27095

Additional Tax ,L5 .45 .45 o45 -45

Total Tax (¢/lbo) 13068 14.68 17.43 23.58 28.68

B. Law 13, 1974 (After Septenber, 1974)

Tax Bracket Basic Tax Rate

First 100.000 Shortt Tons Exp.orted

Up to 10 Free10 _ 20 25' of excess over 10 26o50 2.50 2.20 260 250Over 20 50, " 20 5000 (>00 8075 l -O °0.00

Total tax (0/lb.) 7r o 8Fo F

Exvorts 100.00 - 200.000 short tons

Up to 10 28' of total 2080 208C 2.80 208C 2.E010.01 - 15 36% of excess over 10 1.80 l8O 1.30 1080 1.8015.01 - 20 45,0 of 1 " 5 2,2 5 2~25 2o25 2.25 2525Over 20 50': of " 20 5.00 6s0o 8.75 15.00 20.00

Total tax (hlb) ,I•35 12 85 15.60 21.85 26.85

Exports over 300,000 short tons

TJp to 10 16% of total 1.60 1.60 1.60 1.6C0 106010.01 - 15 25% of excess over 10 1.25 1.25 1.25 1.25 1.2515.01~- 20 /45%" II 15 2.25 2.25 2,25 2.22 2.25Over 20 50% " t 20 5.oo 6,.o 8.75 15.00 20.00

Total tax (p/lb) 10 10 1110 13,85 20,13) 25.10

Source: Tax calculations based on texts of various laws,

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in iuiproving the living conditions of their workers, particularly theirhousing, and to be also used to improve the companies' productivity byinvesting in fertilizers, irrigation or other improvements. Under Law 13,total Government receipts from sugar in 1975 are estimated at about RD$300million (including CEA's 60 percent contribution).

Prospects

115. If the sugar export taxes prescribed by Law 13 are fully enforcedin 1975, the Central Government current surplus may reach RD$387 million,allowing for a 20 percent expansion over 1974 in current outlays. It wouldbe prudent to keep capital expenditures at the high level reached in 1974(in real terms) to reduce inflationary pressures. In this case the overallsurplus could reach RD$125 million in 1975. These targets imply a firmcommitment by the authorities to control spending in 1975.

Table 15: CENTRAL GOVERNMENT CASH OPERATIONS, 1973-75(RD$ Millions)

1973 1974 1975(Actual) (Estimated) (Projected)

Current Revenues 360 474 711

(Non-sugar taxes) (285) (339) (356)(Non-tax revenues) ( 40) ( 45) ( 55)(Taxes on sugar) /a ( 35) ( 90) (300)

Current Expenditures 221 270 (324)

Current Surplus 139 204 387

Capital Expenditures 157 230 261

Overall Surplus (- : deficit) - 18 - 26 126

/a Includes 60 percent contribution from CEA, and income taxes on sugarprofits.

Source: Table 5.2 and Staff Estimates.

116. Tables 16 and 17 illustrate the possible structure and trends inGovernment finances by the end of the decade, taking into account the Govern-ment's intentions to improve the provision of social services and to revise

Table 16: PROJECTED CENTRAL G(VF-A{IM iT OPERATIONS, 1974-80(in millions HD$, wor3t;,at 1974 prices)

Value Composition Increase(% p.s. )19'_"k 1974 I 9 T 1974-80

Current Revenued 47!i 732 15.7 16.8 7.5

Current Expenditures 270 478 8.9 11.0 10.0

Current Surplus 201 254 6 .8 5.8 3.7

Capital Expenditure 230 336 7.6 7.7 6.5

Fixed Investment 164 223 5°4 5.1 5.3

Other 66 113 2.2 2,6 9.4

Overall Deficit 26 82 .8 1.9 21,0

Net External Financing 10 50 3 1.1 30.0

fNet Domestic Financing 16 32 .5 .8 12.0

Gross National Product 3018 4358 100.0 100l 0 6.3

Source: Staff Estimates and Table 5.2.

Table 17: STRUCTURE OF CENTRAL GOVERNMENT REVENUES, 1974-80

(in millions RD$, constant 1974 prices)

Value Composition ( as % of GNP) Rate ofjn se I197)4 1980 197)4 190L.74-0UO

Tax Revenues )426 643 14.1 14.8 7.1

Direct Taxes 126 323 4.2 7.4 17.0

Income Taxes 97 221 3.2 5,1 14.7

Property and Inheritance Taxes .12 76 0.4 1.7 36.0

Other 17 26 o.6 0.6 7.3

Indirect Taxes 300 320 9.9 7.3 1.1

Import Duties 169 117 5.6 2.7 -5.9

Export Duties 60 68 2.0 106 20o

Other 71 1lX 2.3 3.1 11.3

Non-Tax Revenues M8 88 106 2.0 10.7

Total Central GovernmentCurrent Revenues X 731 15.7 16.8 7.5

Gross National Product 3018 4358 100l0 100.0 6.3

Sources: Table 5.1 and Staff estimates.

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the tax structure. Government fixed investment is assumed to grow at asomewhat lower rate than GNP reversing recent trends. In real terms t,overn-ment fixed investment would grow at an annual rate of 5.3 percent. Othercapital expenditures -- largely credit programs -- would expand more rapidlythan fixed investment, in line with the changing Government priorities whichreflect the country's needs. The fast projected growth of current outlaysis also a reflection of the necessary changes in expenditure policies dis-cussed above (para. 80). The projected structure and level of Governmentrevenues take into account the recommendations of the May 1974 Symposium ontax reform (para. 112).

117. The projectionrs indicate that the size of the overall deficit maycome close to 2 percent of GNP by 1980, which is a manageable level. Based onexisting commitments and programs, official external lending could financeabout three-fifths of the total requirements. This projected increase inthe proportion of official foreign lending to total public investment willbe possible if the authorities continue to improve the preparation of pro-jects eligible for external financing. In the recent past domestic borrowingby the Central Government has not reached one percent of GDP. The projectedmodest increase of this percentage should not present a serious inflationarythreat if the Government, as projected, will be returning to the privatesector equivalent amounts in the form of credit programs. Although the DominicanRepublic could doubtless borrow from commercial foreign sources in order toreduce the extent of domestic borrowing, the projections have not allowed forsuch transactions in view of the long-run desirability to maintain the termsof foreign borrowing as long as possible.

IV. BALANCE OF PAYMENTS AND GROWTH PROSPECTS

A. Short-term Prospects and Credit Policy

118. The future economic growth of the Dominican Republic will continueto be closely linked to its balance-of-payments performance. The importanceof the foreign sector is a natural consequence of the small size of theeconomy and its relatively specialized resource base.

119. In recent years the Dominican Republic has made significant pro-gress in expanding non-sugar exports, particularly in tobacco, roastedcoffee, beef, ferronickel, manufacturing and tourism. Thus, the share ofsugar in exports and goods and non-factor services fell from 50 percent in1966 to 40 percent in 1973, in spite of rising sugar prices. However, eventhis lower degree of dependence on sugar implies great risks for an openeconomy, because cane crops are subject to wide fluctuations as a result ofthe weather and the international price of sugar is volatile. To reducethis dependence, the authorities have recently begun to intensify effortsto diversify foreign exchange earnings. But even if these efforts are suc-cesful and non-sugar exports expand at a fast pace, the present importanceof sugar is so great that it would take more than a decade before sugar

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exports became less than one-fourth of total foreign exchange earningsand the vulnerability of the external sector was significantly reduced.Meanwhile, it would be prudent to follow balance-of-payments, credit andfiscal policies aimed at increasing the levels of international reservesin periods of high sugar export earnings, and to draw on those reservesin lean years. 1/

120. With soaring sugar prices, and cane production reaching recordlevels, the short-term balance-of-payments situation is excellent. Sincethe Dominican Republic sells most of the sugar crop in the futures market,most of the 1974 crop was sold at prices prevailing in 1973, at an estimatedaverage price of 14.5 U.S. cents per pound. Therefore, the full benefits ofcurrent high prices will not be felt until 1975, when the average price,based on contracts already signed as of late 1974, is expected to reach33 U.S. cents per pound. Taking into account CEA's production plans andassuming a continuation of favorable weather, the volume of sugar exportsshould increase further from an estimated 1,015,700 tons in 1974 to 1,090,000tons in 1975, with a total value coming close to US$792 million, comparedto an estimated US$324 million in 1974 and US$187 million in 1973. In thesecircumstances it will be possible to generate in 1975 a current accountsurplus for the first time in a decade and an overall balance-of-paymentssurplus that may exceed US$250 million. As a result of this favorablesituation, the monetary authorities will face a new type of challenge in1975; the management of windfall gains.

121. The basic foreign exchange problem in 1975 -- and in the followingtwo or three years if the value of sugar exports remains above US$500 million-- will be how to ensure that the windfall earnings from exceptionally highsugar prices are saved and held as liquid reserves to be used in later,leaner years. To accomplish this objective it will be necessary to devisepolicies that will ensure that in 1975 the equivalent of about US$240million are accrued as international reserves by the Central Bank withouta corresponding increase in the monetization of the economy. If those re-serves were allowed to be monetized, the resulting increase in purchasingpower would lead to a great expansion in aggregate demand. This in turnwould create strong pressures to increase imports which, if released, wouldeventually use up the international reserves that the Republic must save forlater years. On the other hand, if those reserves were fully monetized butcontrols were maintained in order to restrain import growth to a level com-patible with the desired reserves accumulation -- i.e., imports of goods andnon-factor services of around US$975 million in current prices in 1975compared to an estimated US$872 million in 1974 and US$565 million in 1973 --then strong inflationary pressures would be bound to appear as a suddenexpansion in aggregate demand would doubtless strain an inelastic domesticproductive capacity. Therefore, to minimize loss of reserves and domestic

1/ Net international reserves of the Central Bank at year end 1974 wereUS$72 million, equivalent to one month's imports of goods and non-factor services.

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inflation in 1975, prudent financial management would require "sterilization'in the Central Bank of a volume of reserves of at least US$240 million.

122. This target sterilization of reserves could be accomplished throughthe strict enforcement of progressive taxes on sugar exports and the adoptionof credit policies to sterilize some of the windfall earnings thait willaccrue to the sugar sector.

123. The Central Government will be able to generate a sizeable overallsurplus in 1975 (para. 115). Under Law 13 it would be prudent to plan onan overall Central Government surplus of about RD$125 million (Table 15),which the authorities could easily prevent from entering the economy in1975, by depositing it in a special account in the Central Bank.

124. The remaining RD$100 million to be sterilized by the mcnetaryauthorities in 1975 will also originate in sugar exports. For this reason,it would not be advisable to adopt generalized tight credit policies thatmight penalize non-sugar economic sectors. A mechanism for the selectiveabsorption of excess liquidity in the sugar industry is clearly preferable.The admfilstration of such a mechanism should be easy, because there are.c-Ily three major sugar producers that would be affected and one of them isa state-owned enterprise. These three firms could be required to purchase~n 1975 -- and in later years, as long as the export price of sugar remainsAoove a level of around 20U/lb -- "Sugar Bonds" to be issued by the CentralBank. These bonds would yield a reasonable return -- possibly 7 to 8 per-cent -- and have a total maturity of around five years, including a graceperiod of about two years. The amount of Sugar Bonds to be purchased by£Le three firms would be a function of the export-price of sugar, thevolume of exports and the Central Bank's needs to sterilize reserves. Underthe foregoing assumptions, if the sugar companies were required to purchasebones for the equivalent of five cents per pound of sugar exports, in 1975,with a projected export volume of 1,090,000 tons, this would representabout .DRi125 million. The purchase of these bonds could be nmade at the timewhen export proceeds are surrendered to the Central Bank the same as theexport taxes, and be frozen by the Central Bank in another special account.

125. NIthough ' A is a state-owned firm, it should also be expected toinvest in S'igar Bonds accordinR to the same rules as the private companies.The full distributiorn of -FA's ,After-tax profits required by law should bebased on CEA's profit after bo-- ,p;1rchases. This would help CfA r:o increaseits assets to the extent of -ht.-n -';L,.r.-hases, and serve as collateral for theneeded investment ifn rationalizatioo (rara. 43).

126. CEA is required by law to distribute to their workers 4C percentof after-tax profits, Eor CEA this would represent in 1975 almost RD$20million, compared to an annual wage bill of a'bout RD$45 million. The actualcash payment of this bonus in 1975 woculd be inflationary. Oh alternativemore compatible with price stability would be to pay out up Lo one-fifthin 1975 and to deposit the remainder in special savings accounts.

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Table 18s TRENDS IN REAL EXCHANGE RATE

1970 = 100

Exchange Cost of Exchange Rate Export Price Real ExchangeRate Living Deflated Index a/ Rate

1966 1.0 94.7 1.06 91.0 0.96

1967 1.0 96.5 1.04 91.8 0.95

1968 1.0 98.2 1.02 92.4 0.94

1969 1.0 96.3 1.04 95.1 0.99

1970 1.0 100.0 1.00 100.0 1.00

1971 1.0 104.3 0.96 103.4 0.99

1972 1.0 112.5 0.89 110.2 0.98

1973 1.0 129.5 0.77 130.9 1.01

1974 (June) 1.0 149.4 0.67 176.6 1.18

a/ Weighted index of export prices of the Dominican Republic's major trad-ing partners, expressed in US$.

Source: Table 3.12

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127. Failure to implement taxation and liquidity absorption in the sugarsector in line with the preceding analysis would make it necessary for themonetary authorities, faced with strong inflationary pressures in 1975, tocontrol aggregate demand through a general tightening of credit. This ap-proach might bring about an undesirable change in the composition of effec-tive demand as a result of the switch in purchasing power from potentialinvestors and commerce to the sectors benefitting from the sugar windfall.

128. If the monetary authorities succeed in sterilizing reserves of

the order of RD$250 million as recommended here, they will wish to investthese funds in a way that will provide an adequate combination of yield,security and liquidity. From the viewpoint of liquidity, it would beprudent to invest in assets repayable over a period of three years, aftertwo years of grace, that is to say, a total maturity of five years. Theseterms would be consistent with the projected balance-of-payments needs inthe medium term, as discussed in the following section. 1/

129. Current economic conditions are ideal for the correction of certain

distortions in foreign exchange management that have appeared in recent years.The balance-of-payments, in the next two years at least, will be favorable.In addition, by having held internal inflation in 1974 at levels that com-pare favorably with those in the country's major trading partners, whenrecent exchange-rate realignments are taken into account, the competitiveposition of the country has improved as reflected in a strengthening of thepeso (Table 18). Therefore, this is a good time to rationalize the protec-tive system by lowering tariffs generally, and by removing quantitativerestrictions to imports. Although the immediate effect of these changeswould be to increase import levels, this could be offset by raising taxes onconsumption in equivalent amounts.

130. The existing foreign exchange system denies or restricts the avail-ability of foreign exchange from the Central Bank, at the official parity,for certain purposes such as travel abroad, payment of insurance premia and

1/ On February 27, 1975, legislation was adopted that (a) limits sales offoreign exchange by the Central Bank to US$800 million in 1975 andrequires that Central Bank foreign exchange earnings in excess of thatamount be set aside in a special account subject to Presidential control;(b) establishes that government revenues in excess of 1975 budgetedamounts (about RD$150 million) shall revert, on a monthly basis, toa special account in the Central Bank that may only be used by thePresidency for investment in agriculture; (c) requires the sugar companiesto deposit in separate bank accounts that part (about one-third or

RD$65 million) of their 1975 export taxes which they are allowed toretain for outlays to improve productivity or the living conditions oftheir workers and establishes that the companies may only make withdrawalsfrom those accounts for programs previously approved by the Presidency.

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other invisible payments, as well as for imports of about 80 items, mostlyfoods, beverages and automobiles. These transactions, however, are authorizedwithout restrictions when the necessary foreign exchange is acquired in thequasi-legal "parallel market". These restrictions have stimulated a demandfor foreign exchange from outside the banking system, at a premium thatfluctuates between 8 and 14 percent. This premium does not necessarily re-flect the fact that the official exchange rate is overvalued, because aslong as there are transactions that cannot be legally executed in the officialexchange market and are diverted to the parallel market, a certain premiumis bound to exist. As a result of this premium there is an incentive, forindividuals who earn foreign exchange, to sell it in the parallel marketrather than in the official banking system. This situation has stimulatedthe diversion of foreign exchange receipts from emigrants' remittances andtourist expenditures, as well as the over-invoicing of imports subject tolow import duties and the under-invoicing of non-traditional exports. Thisparallel market, which is not strictly illegal, has grown rapidly to anestimated annual volume of transactions of over US$100 million in 1973,equivalent to 18 percent of foreign exchange current earnings. Unless thepresent system is changed, volume is likely to continue to expand in linewith the expected growth in tourism and non-traditional exports. This impliesthat the monetary authorities would continue to have no control over theutilization of a large proportion of foreign earnings, when it may becomenecessary again to ration foreign exchange. One way to solve this situationis to unify the two markets. The unification can be accomplished, at a timeof high international reserves, by making foreign exchange available throughthe banking system for all legal transactions. Merchandise imports shouldeither be permitted, in which case the banks should provide foreign exchange,or prohibited and this prohibition be strictly enforced. This will reducedemand in the parallel market and tend to lower the premium. At the sametime, legislation could be enacted to require the surrender to the bankingsystem of all foreign exchange earnings. With these measures, it should bepossible to reduce the importance of the parallel market to marginal trans-actions.

B. Medium-term Prospects 1/

131. In the medium term, trends in sugar prices will be a key elementdetermining the growth rate of the economy. To illustrate the possiblepattern of future growth and its policy implications, the following projec-

I/ Thie projections discussed in this section are indicative of long-termtrends. For 1975 these projections are somewhat different than theshort-tern forecasts of sugar exports and reserves build-up analyzedIn the preceding sections (paras. 1 20 and 121).

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tions assume a quick drop in real terms in world sugar prices fromn theircurrent high levels. 1/

Table 19: PROJECTED SUGAR PRICES

(US cents per pound)

1974 1975 1976 1977 1978 1979 1980 1985(Actual)

Current prices 14.5 33 22 17 17 19 20 28

Constant 1974 prices 14.5 27 18 13 12 12 12 12

Source: Staff Estimates.

132. These price projections represent the actual average unit pricethat the Dominican Republic might receive, and are not necessarily identicalto the world prices in any year. Two major sources for differences are thefollowing. First, as indicated above, a large share of total sugar exports_s traditionally sold in the futures market, at prices prevailing in they&ar preceding the actual shipment and payment. Second, it has bezen assumedtnat if world prices were to drop sharply, the United States would reestablisha preferential market at higher prices, and the Dominican Republic: wouldcontinue to sell about three-quarters of its sugar exports in this preferen-tial miarket. (Tle Dominican U.S. quota in 1974 was 822,000 tons, comparedto total exports of 1,016,000 tons.)

133. The projections are also based on the assumption that the authori-ties continue to pursue policies leading toward growth and diversificationof exports. Sugar production by CEA could be expanded sufficiently to in-crease 1930 exports by about half a million tons (para. 43). Non-traditionalexports and gross tourism earnings could also increase at annual rates ofbetwe-en 15 and 25 percent, in real terms, from their low 1974 base (para. 78).

Table 20: ACTUAIL AND PROJECTED VOLUME OF SUGAR EXPORTS(Thousands of Metric Tons)

1966 1970 1975 1980 1985(Actual) (Actual)

548 764 1,090 1,500 1,900

1/ The main reason why world sugar prices are expected to decline from their1974 levels (US$0.60/lb in November 1974) is that sugar can be producedin many parts of the world at a much lower marginal cost (no more thanUS$0.10/lb). A prolonged period of high prices would induce productionin new areas and thus tend to lower prices. In addition, the productionof substitutes would be stimulated and the growth of consumption wouldtend to slow down.

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134. Other traditional comniodity exports (cocoa, coWfee, tobacco,ferronickel, bauxite) are expected to grow more slowl', at an average rateof 2 percent per annum owing to sipply and market constraints. Gold andsilver exports, which will start in 1975 at a value of ahout US$55 million,are conservatively assumed to remain at US$80 million per year in real termsover the next decade. This implies that it will be necessarv for non-traditional exports such as agro-industrial products, manufactures and tourismto become leaders of export growth. If the authorities act Promptly toredirect industrial incentives and to maintain the competitiveness of theeconomy by controlling inflation, it would be possible for manufacturedexports (including agro-industrial products and light manufactures) to growat an annual rate of about 18 percent in real terms. Gross tourism earningscould similarly expand at 15 percent per annum and other minor exports(beef, furfural, molasses, rum, etc.) at an average annual rate of 12 percent.If successful, this export diversification program would reduce the shareof sugar in total exports of goods and non-factor services from nearly 60percent in 1975 to 38 percent by 1979 and to under one-third by 1985.

135. In the recent past the creation of new jobs failed to expand at thesame rate as GDP. For the economy as a whole the ratio between GDP growthand growth in employment has been about 3:1 and in urban areas it has beenmore favorable, around 1.8:1. This imbalance has been the consequence of anindustrial incentive system and public expenditure policies that encouragedcapital-intensive activities. To reduce the magnitude of the unemploymentproblem it will be necessary to shift development policies in order to bringabout significant reductions in those ratios, in line with discussions inChapters II and III. With the national labor force growing at 3 percentper annum and the urban labor force at 6 percent per annum, the minimumrates of GDP growth required to maintain unemployment rates at presentlevels would be around 6.5 percent per annum overall and 7.2 percent in thecities, provided that employment-creating strategies are successfully im-plemented.

136. Parallel with action to diversify and expand exports, the attainmentof sustained 6.5 percent annual GDP growth without external debt problemswill require the adoption of measures to restrict the growth rate of importsto the same rate as GDP, 1/ namely, incentives to prodtuction of foodstuffs,a revamping of industrial effective protection to encourage greater use ofdomestic inputs, and a program to link tourism growth to domestic supplies.Although difficult to achtieve, the reduction ot tne imporr elasticity wouldbe possible if those measures were implemented in the context of prudentmonetary policies. The implied ratio of imports of goods and non-factorservices to GDP would be around 27 percent in 1975-80, compared to 23 to 24percent in 1970-72.

1/ Import elasticity was 1.08 percent over the twrJve-year periodcomprising 1960-64 and 196&-72.

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137. If future sugar prices behave as projected above, a rate growth ofGDP of about 6.5 percent per annum should be feasible. With the economy grow-ing at an annual rate of 6.5 percent, and sugar prices going down to 15 to 20cents/lb in 1976-80, overall balance-of-payments deficits would increasesteadily, reaching around US$290 million (in current prices) by 1980. There-fore it is of vital importance to ensure that a major part of the 1975 exportearnings be saved in the form of financial assets. If US$240 million can beset aside, it should be possible to finance the cumulative deficits lntil theend of the decade. In the early 1980's the structural weakness of theDominican foreign sector would again become a major constraint to growth. Inthe absence of a significant breakthrough in new exports, it might be neces-sary to slow GDP growth down to about 5 percent per annum to maintain balance-of-payments equilibrium. If prompt action is taken to' increase the employmentgenerating effects of future growth, and also to reduce population growth,a GDP growth rate of 5 percent in the 1980's may be compatible with stableunemployment.

138. In view of the pressing need to reduce the magnitude of the unem-ployment problem the authorities may want to pursue a high-growth strategymore in line with the country's recent experience. This might be feasibleif they succeed in creating the necessary incentives to attract large pri-vate capital inflows into productive, efficient activities such as tourismand agro-industrial exports. Steps should be taken to organize agriculturalproductive units to supply the new tourism centers. Public investment wouldhave to be equally selective, giving higher priority to the expansiort ofproductive capacity. However, the inadequate availability of foreigrL ex-change is likely to make this growth path difficult. Assuming an anrLualrate of GDP growth of 9 percent and the previously indicated sugar prices,the windfall gains of 1975 would be completely used up by 1978 and thlecumulative balance-of-payments deficit by 1980 would amount to US$550 toUS$600 million, on the basis of the existing programs of the major aid donors.In the 1980's this trend is likely to continue, unless there is a majorbreakthrough in the country's capacity to earn foreign exchange, such asthe discovery of new mineral deposits.

139. Given the structural weakness of the nation's foreign sector, itis necessary to continue to follow prudent debt-management policies borrow-ing on long maturities and only for projects with a high rate of return,and maintaining high international reserves. The indicative projectionsdescribed above assume a continuation of good weather throughout the 10-year span. Since sugarcane production is sensitive to dry weather, itwould be reasonable to expect that there will be years when sugar productionwill fall short of the targets. A 20 percent drop in production as a con-sequence of poor weather (as happened in the past in several years) couldrepresent a foreign exchange shortfall of US$80 million to US$160 million,depending on the price. This is an additional factor why, in spite of thepresent bonanza, the medium term balance-of-payments situation fully justi-fies a continuation of foreign assistance at long maturities.

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Table 21: CROWTH OF EXPORT EARNINGS, 1974-80(Million CurrentRD$)

% Annual Increase,1974 1980 1974-80

Raw Sugar 324 654 12.4

Other Agricultural 123 196 8.1

Minerals 111 269 15.9

Manufactures 76 282 24.3

Merchandise 634 1401 14.1

Non-factor Services 90 344 25.0

Total Goods and NFS 724 1745 15.7

(Total in 1974 Prices) 724 1193 8.7

Source: Table 3.16

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C. Creditworthiness

140. The prudent financial management of recent years is reflected ina relatively small and well-structured foreign public debt (para. 16). Totalexternal public and publicly guaranteed debt as of January 1, 1974 was US$430million, of which one-third had not yet been disbursed. Total debt wasequivalent to 17.5 percent of 1973 GDP, and only one-fourth of this debt hadbeen contracted on commercial terms (banks and suppliers' credits); the otherthree-fourths were loans and credits on official development assistance termsfrom international and bilateral (largely U.S.) aid agencies. Service pay-ments on this debt in 1973 were equivalent to about 4 percent of currentforeign exchange earnings, i.e., exports of goods and non-factor servicesplus transfer receipts.

141. The country's future creditworthiness depends largely on five kevvariables:

(a) trends in sugar export prices;

(b) success in expanding and diversifying exports;

(c) aiming at a rate of GDP growth consistent withprudent debt management;

(d) saving the windfall earnings from current highsugar prices to finance future development; and

(e) adopting policies aimed at maintaining a high rateof employment creation, even if GDP growth ratescannot be sustained at high levels.

Except for sugar prices, these variables can be greatly influenced by theauthorities, as this report has analyzed.

142. The projections discussed above (Section B), indicate the re-emergence of a resource gap after 1976. If the authorities are successfulin diversifying exports and restraining import growth, the resource gapwould peak in 1978 at 3.5 percent of GDP and decline gradually to 1.2 percentof GDP by 1985. The current account deficit (in current prices) wouldincrease until 1984, when it would reach US$370 million, and decline there-after. To finance the cumulative current account deficits, which would averageUS$295 million per year in 1977-85, the country could draw on net officialdevelopment loans and suppliers' credits to the tune of US$92 million peryear; if the favorable private investment climate continues, net directinvestment could average US$122 million annually and other capital movementUS$13 million. Thus, there would be an average annual residual of aboutUS$68 million. This residual could be financed through a combination offinancial credits and a drawdown of the reserves accumulated in 1975 (US$150million) and 1976 (US$176 million).

Tahle 22: BASIC MACROECONOMIC INDICATORS, 19714-80

(In Million RD$, Constant 1974 Prices)

Value Composition % Rate of increase X

1974 1980 1974 1980 197L-80 __

Gross Domestic Product (7actor Cost) 3085 L4456 100l 0 lOO0 6.3

Terms-of-Trade Adjustment - -137 -3 1 l

~"rucss Domestic Income 3085 4319 100,0 96.9 5.8

Imiports GNIFG 872 1195 28.3 26.8

Exnorts GNFS 724 1193 23.5 26,8

Resource Gap -148 -2 -4.U

Avail able Resources 3233 4 4,59 104.8 L00.0 3.5

Investment (5f6) (850) (19.0) (19,0) 6.)4

Consumpt.ion (2647) (3609) (85.8) (8_.0) 5.3

Gross Domestic Saving 438 710 14.2 15.9' 3

Source: 'Pabl]es 2.8

D-screpancies are. (1uei to rounUdng.

Table 23: ShlMlMARY BiALANJCE OF PAYMENTS, 1911I-60(millc)ion US$)

197h 19d0

Exports GNFS 72L 1,7451-iports GNFS 872 1,) 1

Resource Balance -11J8 -229

Factor Service Paymnents (Net) -6i -i62Current Transfers (Net) 58 1D3

Cu ':ent Account Balance -157 S2 3

!rivate Capital (Net) 3C 1L2Public Capital (Net) e 78

Di sburs ements (22) (iLl)Amorti zation (-1i) (33)

Residua] (Deficit:-) 103 98Cumulative (1974-80) 103 -102

Source; Table .§1

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143. The Dominican Republic has some untapped borr-owing capacity, asreflected in a debt service ratio of less than 4 percent. It would bepreferrable that this ratio should not be exceeded in view of the risksinherent to an open economy highly dependent on sugar exports. However, ifthe authorities are faced with the need to allow imports to grow at a some-what faster pace than was assumed above, the Government could contractadditional financial credits without bringing the debt service ratio tocritical levels. For example, assuming that the authorities borrowed fromcommercial banks, beginning in 1977, a net annual average of about US$140million, the total public debt service ratio by 1985 would be around 10percent. This ratio, however, should be considered on the high side,particularly taking into account that private profit remittances would beequivalent to an additional 7 percent of export earnings by 1985.

144. On balance, these projections suggest that the Dominican Republicwill continue to require substantial external assistance on long maturitiesand is creditworthy for moderate amounts of commercial borrowing. In viewof the crucial decisions that must be taken by the authorities in the nearfuture and the great uncertainty regarding future sugar prices, this assess-ment will require close monitoring.