republic of hondurasdocuments.worldbank.org/curated/en/765701468036880660/pdf/556… · honduras -...

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 65556-HN

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 55.1 MILLION

(US$86 MILLION EQUIVALENT)

TO THE

REPUBLIC OF HONDURAS

FOR A

FIRST PROGRAMMATIC REDUCING VULNERABILITIES FOR GROWTH

DEVELOPMENT POLICY CREDIT

November 3, 2011

Poverty Reduction and Economic Management

Central America Country Management Unit

Latin America and the Caribbean Region

This document is being made publicly available prior to Board consideration. This does not imply a presumed

outcome. This document may be updated following Board consideration and the updated document will be made

publicly available in accordance with the Association’s policy on Access to Information.

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Honduras - Government Fiscal Year

January 1 – December 31

Currency Equivalents

(Exchange rate effective as of October 28, 2011)

Currency unit = Lempiras (Ls.)

19.02 Ls. = US$1

Weights and Measures

Metric System

ABBREVIATIONS AND ACRONYMS

CABEI Central American Bank for Economic Integration (Banco Centroamericano de Integración

Económica)

CCT Conditional cash transfer

CIDA Canadian International Development Agency

CPAR Country Procurement Assessment Report

CPI Consumer Price Inflation

CPS Country Partnership Strategy

DEI Tax administration (Dirección Ejecutiva de Ingresos)

DPC Development policy credit

ENEE National Electricity Company (Empresa Nacional de Energía Eléctrica)

IDA International Development Association

IDB Inter-American Development Bank

IFRS International Financial Reporting Standards

IHSS Social Security Institute (Instituto de Seguridad Social de Honduras)

IMAE Monthly Index of Economic Activity (Índice Mensual de Actividad Económica)

INE National Institute of Statistics

IMF International Monetary Fund

INPREMA Teacher’s Pension Institute (Instituto Nacional de Previsión del Magisterio)

INJUPEMP Public Servant’s Pension Institute (Instituto Nacional de Jubilación y Pensiones de los

Empleados Públicos)

JICA Japan International Cooperation Agency

JSDF Japan Social Development Fund

KFW German International Development Agency

OAS Organization of American States

PER Public Expenditure Review

PETS Public Expenditure Tracking Survey

PRSC Poverty Reduction Support Credit

PROHECO Honduran Community Education Program (Programa Hondureño de Educación Comunitaria)

SBA Stand-by arrangement

SEFIN Ministry of Finance (Secretaría de Finanzas)

SIAFI Integrated Financial Management System (Sistema de Administración Financiera Integrada)

SIARH Integrated Human Resources Management System (Sistema Integrada de Administración de

Recursos Humanos)

SIGADE Debt Management System (Sistema de Gestión y Análisis de la Deuda)

UNDP United Nations Development Programme

USAID United States Agency for International Development

VAT Value Added Tax

Vice President: Pamela Cox

Country Director: C. Felipe Jaramillo

Sector Director: Rodrigo A. Chaves

Sector Manager: Auguste Tano Kouame

Lead Economist/Sector Leader Oscar Calvo-Gonzalez (acting)

Task Team Leaders: Christian Y. González & Rodrigo Serrano-

Berthet



TABLE OF CONTENTS

I. INTRODUCTION ............................................................................................................................................. 1

II. COUNTRY CONTEXT ................................................................................................................................... 2

Political Context ............................................................................................................................................. 2 Recent Economic Developments .................................................................................................................... 3 Macroeconomic Outlook and Debt Sustainability........................................................................................ 10 Crime and Violence, Citizen Security ........................................................................................................... 12 Poverty, Gender and Social Development .................................................................................................... 14

III. THE GOVERNMENT’S PROGRAM ........................................................................................................ 16

IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM .................................................................. 17

Link to Country Partnership Strategy .......................................................................................................... 17 Relationship to Other Bank Operations ....................................................................................................... 17 Collaboration with the IMF and Other Donors ........................................................................................... 17 Lessons Learned ........................................................................................................................................... 18 Analytical Underpinnings ............................................................................................................................ 19

V. THE PROPOSED OPERATION ................................................................................................................. 22

Operation Description.................................................................................................................................. 22 Policy Areas ................................................................................................................................................. 22

VI. OPERATION IMPLEMENTATION .......................................................................................................... 43

Poverty and Social Impact ........................................................................................................................... 43 Environmental Aspects ................................................................................................................................. 49 Consultation and Participation .................................................................................................................... 49 Implementation, Monitoring, and Evaluation .............................................................................................. 50 Fiduciary Arrangements .............................................................................................................................. 51 Disbursement and Audit ............................................................................................................................... 51 Risks and Risk Mitigation ............................................................................................................................. 52

ANNEXES ............................................................................................................................................................ 56

Annex 1: Letter of Development Policy ........................................................................................................ 56 Annex 2: Policy Matrix ................................................................................................................................ 70 Annex 3: Fund Relations Note...................................................................................................................... 75 Annex 4: Country at a Glance ...................................................................................................................... 76 Annex 5: Debt Sustainability Analysis ......................................................................................................... 79 Annex 6: Consultations and context for reforms in education sector and in citizen security ....................... 89 Annex 7: Institutional Framework of Honduras Integrated Citizen Security and Co-existence Policy ...... 92 Annex 8: Map of Honduras .......................................................................................................................... 97

This DPC was prepared by an IDA team led by Christian Y González (LCSPE) and Rodrigo Serrano-Berthet (LCSSO) and included

Cristian Aedo, Senior Education Economist (LCSHE); Juan Diego Alonso, Education Economist (LCSHE); Antonio Leonardo

Blasco, Senior Financial Management Specialist (LCSFM), Juan Buchenau, Senior Financial Sector Specialist (LCSPF); Valentina

Calderon, Consultant (LCSSO); Lorena Cohan, Social Development Specialist (LCSSO), Andrea Coppola, Country Economist

(LCSPE); Patricia de La Fuente Hoyes, Senior Finance Officer (CTRFC); Enrique Fanta, Senior Public Sector Specialist (LCSPS);

Ana Funes, Country Program Assistant (LCCHN); Jimena Garrote, Counsel (LEGLA); Silvia Gulino, Program Assistant (LCSPE);

Trina Haque, Country Operations Adviser (LCC2C); Patricia Holt, Program Assistant (LCSPE); Raul Junquera, Senior Public Sector

Specialist (PRMPS); Mariano Lafuente, Public Sector Specialist (LCSPS); Guillermo Lagarda, Research Analyst (LCSPE); Rogelio

Marchetti, Senior Financial Sector Specialist (LCSPF); Eduardo Melinsky, Consultant (LCSPE); Ezequiel Miranda, Consultant

(LCCHN); Pedro Olinto, Senior Economist (LCSPP); Margarita Puerto, Consultant (SDV); Carolina Rendon, Public Sector

Specialist (LCSPS); Jose Simon Rezk, Financial Management Specialist (LCSFM); Tirza Rivera-Ciro, Consultant (LCSPS); David

Varela, Senior Public Sector Specialist (LCSPS); and Giuseppe Zampaglione, Country Manager (LCCHN). The team is grateful for

the close collaboration of the Government of Honduras during the preparation of the credit. Oscar Calvo (LCSPE), Humberto Lopez

(AFTP2), and Jasmin Chakeri (LCSPE) provided internal quality oversight. The peer reviewers were Zeinab Partow, Senior

Economist (AFTP1); Pedro Rodriguez, Lead Economist (ECSP1); and Alexandre Marc, Lead Social Development Specialist (SDV)

i

CREDIT AND PROGRAM SUMMARY



Recipient Republic of Honduras

Implementing Agency Ministry of Finance

Financing Data IDA Credit Amount: SDR55.1 million (US$86 million equivalent).

Terms: Blend terms with 25 year maturity including a 5-year grace period. Service charge fee of

0.75 percent and a 1.25 percent interest charge.

Operation Type First in a series of two programmatic single tranche Development Policy Credits, to be disbursed

upon loan effectiveness.

Main Policy Areas This Development Policy Credit (DPC) is designed to support the Government’s efforts to reduce

vulnerabilities and foster growth by strengthening fiscal management and institutional mechanisms

and programs responsible for an integrated violence prevention strategy. Four complementary policy

areas are supported:

Tax administration reform

Pension reform

Civil service reform

Citizen security

Key Outcome Indicators

(2012)

Tax administration:

The number of large taxpayers filing electronically increases by at least 10 percent

(baseline 2010= 335 large taxpayers).

Pension reform:

100 percent of PROHECO teachers' pension contributions are flowing into INPREMA.

Civil service reform:

Central Government’s wage bill falls by at least 0.7 percent of GDP (baseline: 2010 = 11

percent of GDP).

Citizen Security

Average perception of insecurity improves in the municipalities from the center, northern,

and eastern regions where the ―Safer Municipalities‖ Program is being implemented

(Baseline 2010: 91 percent felt insecure (UNDP 2010): Target 2012: 80 percent felt

insecure).

Program Development

Objective(s) and

Contribution to CPS

The operation’s Development Objective is to assist the Government in strengthening fiscal

management and institutional mechanisms and programs responsible for an integrated violence

prevention strategy. The DPC operation supports progress towards the Country Partnership Strategy

objectives of Expanding Opportunities and Reducing Vulnerabilities and of Improving Citizen

Security.

Risks and Risk

Mitigation

The achievement of the development objective is subject to five main risks:

On the political side, the main risk derives from the Government’s ability to complete

implementation of the fiscal reform package. With a polarized society following the

political crisis of 2009, approval and implementation of the planned fiscal package could

be more difficult than anticipated, jeopardizing the needed fiscal adjustment. To reduce

this risk, the Government has been building consensus to implement the needed reforms to

return the country’s finances to a sustainable path. It will be important for the Government

to ensure an adequate communications strategy regarding the present DPC, highlighting

its positive distribution/poverty impact (as indicated in Table 6) in dealing with these

urgent reforms, and its potential to greatly contribute to the resolution of long-standing

issues in public administration in Honduras.

On the institutional side, the main risk is related to the weak capacity of Government

institutions to implement the fiscal consolidation program. To reduce this risk, the Bank is

working with other donors to support the Government’s fiscal consolidation efforts

through technical assistance and other means.

On the economic front, the main risk derives from the possibility that the global economy

(or some of Honduras’ key trading partners) might enter into another recession. The

implications of a global economic downturn as well as the main transmission channels are

likely to be the same as in the 2008 crisis: First, since the U.S. and the European Union

are Honduras’ largest export markets (about 60 percent of total trade value), exports

would fall significantly. Second, as workers’ remittances amount to about 16 percent of

GDP and 90 percent of them originate in the U.S., remittances could fall sharply in the

ii

event of a global economic downturn. Third, official development assistance might be

limited. The Government has been closely following the external economic conditions and

is currently preparing an action plan to mitigate the negative effects of a possible sharp

downturn of the world economy. In addition, the Bank and the Fund are maintaining an

on-going dialogue with the authorities on macroeconomic policy issues, which will help

detect potential threats to Honduras early.

On the environmental side, the main risk is the country's high exposure to natural

disasters. Honduras' major natural hazards are tropical storms and hurricanes that

frequently strike the country, generating extensive flooding along the north coast and

other regions. Hurricane Mitch in 1998 affected large portions of the country's population,

causing major economic damages estimated at US$3.5 billion. In 2005 Honduras was hit

by Hurricane Stan, which caused an estimated US$100 million in total economic damages.

The Government has taken important steps towards strengthening the country's disaster

risk management legal and institutional frameworks. In addition, the Bank is providing

key technical support to Honduras in terms of strengthening the institutional capacity to

engage in disaster risk management. If a disaster occurs, the Bank will revisit its planned

lending program and existing portfolio to ascertain how and where adjustments need to be

made.

On the citizen security component, there are institutional and indirect risks related to

strengthening institutional capacities to implement an integrated violence prevention

strategy. Institutional risks relate to weak capacity and financing requirements and are

being mitigated through (i) sound policy design (based on solid analytical work and

consultations), (ii) a gradual and sequenced implementation action plan, (iii) to be

coordinated by a multi-stakeholder National Citizen Security Council, (iv) developed with

the support from a coalition of development partners, and (v) funded partly through the

fiscal space created by a new security tax. Indirect risks relate to potential basic rights

abuses or corruption that might be associated with some of the actions supported by

programs that will be designed in the future as part of the law enforcement component of

the citizen security policy framework. Given that the law enforcement component is not

part of this DPC, the link with the prevention component as part of the overall citizen

security framework presents a low level of risk. Nonetheless it deserves mentioning and a

discussion of corresponding mitigation strategies. There are important risk mitigation

measures in place to reduce these risks, namely, (i) a strong rights-based approach

underpinning the design of the policy, (ii) an active coalition of development partners

supporting the design and implementation of the programs and actions that derive from

the policy, and (iii) the creation of multiple instances of oversight and accountability of

policy implementation such as the establishment of a Citizen Security Council (with

representatives from executive and judicial branches of government, and national and

local levels of government) and provisions for the participation of civil society and the

private sector at the national and local levels. The Bank will work with the Government to

strengthen even further mechanisms to engage civil society and private sectors in

monitoring policy implementation, particularly through grievance mechanisms. An

additional risk is that during political campaigns, candidates may take advantage of

voters’ perceptions of insecurity in order to justify repressive measures to combat crime

and violence. To mitigate this risk, the Government plans to carry out informational

campaigns based on the new integrated citizen security policy in order to emphasize the

importance of a comprehensive approach to tackle crime and violence. Such campaigns

include community mobilization and citizen engagement in a social dialogue on how to

respond to citizen security issues.

Operation ID P127331

1

IDA PROGRAM DOCUMENT FOR A

PROPOSED DEVELOPMENT POLICY CREDIT

TO THE REPUBLIC OF HONDURAS

I. INTRODUCTION

1. One of the Honduran administration’s top objectives is to foster high economic

growth. Putting the economy on a rapid and sustainable growth path will not be easy, but it is

feasible. Action will be required on five fronts. First and foremost, a more conducive

macroeconomic framework is necessary; in particular, redressing the large imbalances in

Central Government finances and unresolved structural weaknesses in public pension funds

and public sector enterprises. Second, an integrated citizen security strategy is necessary to

tackle the increasing levels of crime and violence that are undermining the country’s growth

potential and investment climate. Third, investments in infrastructures are needed to promote

the country’s regional development. Fourth, poor governance negatively affects return rates of

investment opportunities in Honduras. Finally, low levels of human capital are an important

growth constraint. This operation will focus on addressing the first two areas; the rest are

being supported by other Bank operations and activities.

2. The Government launched fiscal consolidation efforts in 2010 and has begun

tackling the remaining risks to macroeconomic stability and unresolved structural

weaknesses in public pension funds and public sector enterprises. To this end, the

Government has already introduced measures to close the actuarial deficits of the main public

pension institutes—Instituto Nacional de Previsión del Magisterio (INPREMA), which serves

the private sector and public sector teachers, and Instituto Nacional de Jubilación y Pensiones

de los Empleados Públicos (INJUPEMP), which covers Central Government civil servants.

Similarly, the Government has introduced measures to contain the wage bill and is

implementing a strategy to strengthen tax administration.

3. President Lobo’s administration has begun to make significant efforts to fight

crime and violence and promote citizen security; however, these efforts will require

substantial implementation support in order to be sustained and to have a robust

development impact over time. The Government has approved the National Citizen Security

and Co-existence Policy 2011-2022, which provides a comprehensive and long-term approach

to this challenge, with crime prevention as one of its main pillars. In addition, the Government

has mandated the Security, Defense, and Governance Cabinet (Gabinete de Seguridad,

Defensa y Gobernabilidad) to provide the intra-governmental coordination which is required

to implement the policy. Moreover, Congress has approved legal reforms to secure new

resources to finance activities to foster security, including those addressed in the citizen

security policy framework.

4. This document describes a proposed First Programmatic Reducing

Vulnerabilities For Growth Development Policy Credit (DPC) in the amount of SDR

55.1 million for the Republic of Honduras. The programmatic series, which includes one

subsequent loan, is designed to assist the Government in strengthening fiscal management and

in implementing an integrated citizen security policy. Specifically, the operation supports four

areas that are central to the reform program: (i) tax administration, focused on improving

taxpayer compliance; (ii) civil service reform, focused on the rationalization of the public

wage bill by delinking teachers’ salary adjustments from those reflected in the private sector’s

2

minimum wage; (iii) pension reform, designed to lessen contingent fiscal vulnerabilities by

reducing the public pension institutions’ actuarial deficits, and (iv) citizen security reform,

focused on strengthening institutional coordination mechanisms and programs needed for an

integrated violence prevention strategy . The reforms supported by this operation are expected

to have a positive impact on poverty and inequality (see section VI).

5. The proposed operation is envisaged in the new Country Partnership Strategy

covering the period FY2012-2014 (to be presented jointly with this operation to the

Board of Executive Directors) and is closely aligned with other Bank operations. For

example, the Improving Public Sector Performance Technical Assistance Loan (P110050,

currently under preparation and expected to accompany this operation) provides support to

strengthen public sector human resource management. In addition, a Japan Social

Development Fund (JSDF) for Employment Generation in Poor Urban Neighborhoods will

complement this operation.

II. COUNTRY CONTEXT

6. Honduras is a lower middle income country with per capita gross national

income of US$1,800.1 It is Central America’s second most populated country, with 7.5

million people, and the second largest in size, with an area of 112,088 square kilometers.

About half of the population is rural, and 80 percent of these people live in hillside areas,2

practicing subsistence agriculture. Honduras’ social indicators are among the worst in the

Latin America and Caribbean region but are comparable to other lower middle income

countries in other regions. At 82.4 homicides per 100,000 inhabitants, in 2010 Honduras had

the highest homicide rate in the world.

Political Context

7. On June 28, 2009, the Honduran Supreme Court ordered the removal of

President Zelaya following his decision to conduct a referendum that, if won, would

have allowed him to convene a National Constituent Assembly to rewrite the

Constitution and stand for re-election. An interim President was appointed by Congress the

following day, to remain in place until the November 2009 elections. Following these political

developments, Honduras was suspended from the Organization of American States (OAS)

and much of the international community put aid programs on hold, although a number of

donors continued implementing projects, particularly those focused on the poor.

8. President Porfirio Lobo from the National Party won the November 2009

elections with 55 percent of votes cast. International observers concluded that the elections

were free and fair. After President Lobo was inaugurated on January 27, 2010, the new

Government quickly set about a series of actions aimed at easing political tensions. Some of

the most important steps were naming a government of national reconciliation which included

some political rivals; establishment of a Truth and Reconciliation Commission; working with

Congress on important Constitutional reforms; restoring diplomatic relations with partner

countries; and prompt re-engagement with the international community and development

partners. The Government also faced a major challenge bringing the fiscal situation under

1 2009 Atlas GNI per capita. 2 Jansen et al. (2006a).

3

control (see below). In June 2011, Honduras’ membership in the Organization of American

States was restored, marking a milestone in the country’s efforts to normalize international

relations. Despite these advances, however, the widespread public sentiment appears to be

that change is not happening fast enough.

Recent Economic Developments

9. Shocks that hit Honduras in 2008 and 2009 negatively impacted the economy,

reducing the average growth rate to 1.6 percent in the 2008-2010 period. As the country

struggled to cope with rising food and fuel prices, a tropical depression struck on October 16,

2008. Honduras was then hit particularly hard by the global financial crisis because its

economy is relatively export driven, with high vulnerability to shifts in the global economy

and oil prices. The 2009 political crisis further compromised the nation’s fiscal situation, with

the combined public sector deficit increasing to 4.7 percent in 2009. As a result of these

crises, the economy contracted by 1.9 percent in 2009.

10. The Honduran economy staged a moderate recovery in 2010, with exports and

public investment being the key drivers of growth. On the supply side, financial

intermediation was the most dynamic sector, growing at 4.3 percent year over year, followed

by manufacturing at 4 percent. However, construction struggled for a second year, contracting

by 6.7 percent. On the demand side, public investment grew by 19.7 percent year over year,

followed by exports at 6 percent. Official figures show that GDP grew 2.8 percent in 2010,

reversing the decline of 1.9 percent in 2009. Economic growth was also supported by

increases in remittances from the US.

11. The recovery in 2010 was accompanied by a deterioration in the external balance

and an increase in inflation. The current account deficit increased from 3.6 percent of GDP

in 2009 to 6.2 percent in 2010. This reflects a jump in the merchandise trade deficit due to

higher oil prices. Inflation reached 6.5 percent in 2010, up from 3 percent in 2009. The surge

in the current account deficit was financed primarily by an increase in foreign direct

investment and long term public sector borrowing.

12. Fiscal consolidation efforts started in 2010. According to the Ministry of Finance,

preliminary fiscal information shows a Combined Public Sector deficit of 2.9 percent of GDP

in 2010, down from 4.7 percent in 2009 and well below the target of 3.7 percent under the

IMF program. This improvement is mainly explained by a surplus from the public entities, tax

reforms (which yielded an additional 1 percent of GDP), and measures to control public sector

wages. In addition, the Central Government deficit reached 4.8 percent of GDP in 2010, down

from 6.2 percent in 2009. The Bank supported the country’s fiscal consolidation efforts

through a Development Policy Credit (US$76.4 million) delivered in December 2010, along

with the IMF program and similar budget support operations from the IDB, European Union,

and the Central American Bank for Economic Integration.3

13. The Government is committed to continuing its fiscal consolidation efforts and

reducing public sector vulnerabilities. While the fight on crime may need additional

resources, the Government is taking the necessary measures to secure them. In June 2011,

3 The Government publishes in a timely manner on the Ministry of Finance’s website both the budget as approved by

Congress as well as the budget proposal. In September 2011, the Government published the 2012 Budget proposal in a timely

manner on the Ministry of Finance’s website: http://wwwsefin.gob.hn.

4

Congress approved the Efficiency of Revenues and Expenditures Law (Ley de Eficiencia en

los Ingresos y el Gasto Público), which eliminates some tax exemptions and enforces new

measures against tax evasion. In addition, Congress recently approved reforms of the

Population Security Law (Ley de Seguridad Poblacional), which creates new temporary taxes

to finance efforts to address security and social prevention issues. The new taxes include: (i) a

financial transactions tax on withdrawals from individual checking accounts and corporate

saving accounts with a minimum monthly average balance, (ii) a tax on the food and beverage

industry’s monthly gross income under special tax exemption regimes, (iii) a tax on the

mobile phone industry’s service monthly gross income, (iv) a tax on mining activities, and (v)

a tax on annual renewals of credit cards. The new taxes are estimated to raise government

revenues by about 0.3 percent of GDP on an annual basis for the next 5 years.4 In addition, the

Government will be reallocating resources from other areas of the budget and will be

receiving new grants from the donor community to finance the efforts in citizen security. The

fiscal consolidation efforts will come from reducing the wage bill, increasing tax revenues

through tax administration measures and by addressing the contingent liabilities in the

pension systems.

14. The rapid rise in the public sector wage bill has been halted. The 2007 Public

Expenditure Review (PER) identified rising public wages as a significant fiscal challenge and

has been a longstanding issue for Honduras. The proliferation of special pay regimes for civil

servants, notably teachers and health workers, has meant the Central Government could no

longer exert full control over the public wage bill. From 2000 to 2010, the public sector wage

bill increased from 7.5 percent to 11 percent of GDP—one of the highest levels in Latin

America (see Figure1). In particular, the largest jump in the wage bill was in 2009 when the

salaries increased by more than 20 percent. The wage bill represents about 75 percent of total

tax revenues and is more than three times the investment budget. To counter the trend, the

Government introduced several measures last year to freeze the wage bill at 11 percent of

GDP in 2010. The Government has recently introduced additional measures to reduce the

wage bill, which is expected to decline to about 10 percent of GDP by the end of 2011.

15. The public pension systems have important actuarial deficits, but the

Government is taking steps to reduce them. INPREMA has an actuarial deficit of about 79

billion Lempiras (US$4 billion) and reserves have started to deplete.5 The Government has

submitted a bill to Congress that would put the management of INPREMA in the hands of

technical and actuarial professionals to avoid the misuse of assets. In addition, the pension bill

makes several parametric adjustments, such as gradually increasing the retirement age from

50 to 65 and the minimum number of working years from 10 to 25 to be vested. Similarly,

INJUPEMP has an actuarial deficit of about 32 billion Lempiras (US$1.7 billion). The

authorities submitted a bill to reform INJUPEMP in April 2011. The legislation proposes

several parametric adjustments, such as gradually increasing the retirement age from 58 to 62

and the minimum number of working years from 10 to 15 to be vested. In the absence of the

reforms to the public pension systems, the Central Government will need to transfer to

INPREMA and INJUPEMP an additional 0.2 percent of GDP starting in 2014.6

4 The taxes under the Ley de Seguridad Poblacional are temporary and will expire after 5 years. 5 The difference between future Social Security obligations and the income rate of the Social Security Trust Fund as of

present. A pension system is said to be in actuarial deficit if the summarized income rate is less than the summarized cost rate

of Social Security for any given valuation period. 6 INPREMA’s net worth is sufficient to cover pension payments until 2019, however, many of its assets are not liquid and

therefore it will need transfers from the Central Government to cover its deficit in the medium term.

5

Figure 1. Central Government’s wage bill as a share of GDP (Selected Countries)

Source: IMF.

16. After weathering the crisis quite well, the domestic financial system is gradually

improving. Since the beginning of 2011, the Central Bank has reduced reserve requirements.

As a result, overall funding costs have decreased and stimulated credit demand, while a

growth in the banking system’s deposit base has helped maintain liquidity at adequate levels.

Asset quality has improved significantly since 2009. In June 2011, the banking system

reported a non-performing loans (NPL) ratio of 3.4 percent (4.7 percent in June 2009), which

is lower than the pre-crisis level, but still above the regional average. For the first time since

2007, the provisions of the system (3.8 percent of credit portfolio) fully covered the NPLs.

The system also reported an adequate capital adequacy ratio (CAR) of 14.7 percent, the same

as posted in the previous year, and all banks complied with the minimum capital requirements

of 10 percent of risk weighted assets. Supervision of the banking sector has also improved in

the last year, as the implementation of an ambitious plan to introduce risk-based supervision

and to strengthen the Banking and Insurance Commission's (CNBS) supervisory capacity

advances with support of the Bank’s Financial Sector Technical Assistance Credit and the

IDB.

0

2

4

6

8

10

12

Honduras Paraguay LAC El Salvador Costa Rica Nicaragua Panama Guatemala Dominican Republic

2008 2009 2010

6

Box 1. Global Uncertainty and Risks in the LAC Region

While LAC’s fundamentals remain robust and growth dynamics have been healthy to date, the region has become

increasingly aware of the rise in global uncertainties and risks. As the room for policy maneuvering to avert a

deeper crisis in the developed world is narrowing, risk aversion has risen across markets and so has the probability

of a worldwide economic downturn. There are two epicenters of uncertainty: the first and gravest one is Europe and

the second one is the United States.

This uncertainty gives rise to highly contrasting global scenarios, ranging from difficult but tolerable, to a severe

economic contraction. While real economic activity in LAC does not seem to have been much affected by the

recent turbulence in the developed world so far, downward revisions to growth forecasts for the region are likely to

happen in the short run, in line with the more pessimistic growth projections that are being produced for the U.S.

and Europe. The strong coupling of stocks across the world has tightened further in recent months. Sovereign

spreads for LAC have recently also picked up, but they have in general remained at low and stable levels compared

to those for several European countries.

In case of a new crisis, advanced economies may enter a recession followed by a prolonged low-growth path, as

happened in 2008. Unfortunately, the shock absorption capacity across countries within the region varies

considerably, implying that a bad global scenario could have crippling implications for some countries in the

region, especially those countries in Central America and the Caribbean that lack countercyclical macroeconomic

policy capacity and suitable social safety nets and those most tightly linked to the US and Europe, and least

benefitting from high commodity prices due to Chinese demand.

In Central America, the main transmission channels are likely to be the same as in the 2008 crisis:

o Trade: The United States and the European Union are Central America’s largest export markets, accounting

for 60 percent of agricultural exports.

o Remittances: Workers remittances from abroad amount to between 12 and 20 percent of GDP, except in

Costa Rica and Panama. In addition, 90 percent of remittances sent to Central American countries originate

in the United States.

o Capital markets: Accessing international capital markets may become more difficult if investor confidence

collapses. This could affect those countries with significant financing needs that cannot be met in the

domestic markets and/or through multilateral and bilateral loans.

o Official Development Assistance (ODA): After the 2008 economic crisis the donor resources were very

scarce. If a new severe contraction of the global economy occurs, financing through these sources will be

limited.

In light of these risks, authorities in Honduras have shifted to a much more cautious attitude, focusing on fiscal

structural reforms and a gradual tightening of fiscal policy to provide the room to act promptly in case an adverse

scenario materializes. The Central Bank is conscious of the need of continuing to enhance its capacity to deploy

counter-cyclical policy if needed. Honduras would face the challenge of a global recession with limited scope for

easing its fiscal stance given the need to buttress long-term fiscal sustainability. Monetary easing in Honduras

would need to remain in tune with the business cycles. In this regard, exchange rate flexibility is being considered

as part of the strategy to buffer the impact of a more pronounced slow down. Under a scenario of a double dip

recession in the world economy, Honduras’ GDP would grow by 2-3 percent in 2011 and would contract in 2012

by about 2 percent as exports and remittances flows slow down. However, the central government deficit would not

increase as much as in 2008 (6.2 percent of GDP) reaching about 4.5 percent of GDP. In addition, although in this

scenario exchange rate depreciation would increase the value of foreign debt, Honduras has a relatively low debt to

GDP ratio (27.8 percent of GDP) that could provide a cushion and would allow the country to access additional

financing from multilaterals and domestic creditors.

7

Figure 2: Honduras – Recent Economic Developments

Sources: Central Bank of Honduras, IMF, and WB staff calculations

-6

-4

-2

0

2

4

6

8

10

12

2007 2008 2009 2010 2011

IMAE-sa and GDP growth

(12 month percent change)

Real annual GDP

growth

IMAE-trend

Annual aver IMAE-

trend growth

Jul - 11

10.3%

-20

-15

-10

-5

0

5

10

15

20

Jan-07 Nov-07 Sep-08 Jul-09 May-10 Mar-11

Annual Cumulative Remittances


Exports

-60

-40

-20

0

20

40

60

80

Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10

Honduras Trade of Goods


Imports

0

5

10

15

20

25

30

35

40

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Real Interest Rate

Credit growth

Credit to Private Sector and Real Interest Rates

(In USD millions)

2719

3067

0

500

1,000

1,500

2,000

2,500

3,000

2006 2007 2008 2009 2010 2011

Net International Reserves

(In USD millions)

-30

-20

-10

-

10

20

30

40

50

60

70

Jan-04 Mar-05May-06 Jul-07 Sep-08 Nov-09 Jan-11

World Food Prices

Headline

Domestic Food Inflation

Inflation

(yoy percent change)

Although private sector credit remains subdued, lower interest rates will contribute to its recovery.

In addition, international reserves have increased significantly since 2009.

Following the sharp decline in 2009, GDP is recovering.

Exports are growing at a fast pace, but higher oil prices could worsen the current account deficit.

Although world food prices have been increasing, the impact on domestic prices have been mild.

Remittances are growing, and will continue to be a main source of income.

8

Figure 3: Honduras – Fiscal Developments

Sources: Central Bank of Honduras, IMF, and WB staff calculations.

In 2010, the fiscal deficit was reduced significantly,

Meanwhile, the wage bill has been stabilized,

...and capital spending declined.

financed primarly by external sources.

the public sector savings slightly recovered

annual % change

-7

-6

-5

-4

-3

-2

-1

0

2002 2003 2004 2005 2006 2007 2008 2009 2010

Combined Public Sector

Central Government

Fiscal Balance

(In percent of GDP)

-2

-1

0

1

2

3

4

5

6

2002 2003 2004 2005 2006 2007 2008 2009 2010

External Financing Domestic Financing

Fiscal Balance Financing Sources

(in US mns)

However, domestic debt remained the principal source to meet the financing needs.

0.0

2.0

4.0

6.0

8.0

10.0

12.0

0

10

20

30

40

50

60

70

80

90

2002 2003 2004 2005 2006 2007 2008 2009 2010

Wage/Tax Revenue (Percent, lhs)

Wage Bill (In percent of GDP, rhs)

(Central Government)

0

1

2

3

4

5

6

7

8

9

10

2004 2005 2006 2007 2008 2009 2010

Capital Expenditure

(In percent of GDP)

0

2

4

6

8

10

12

14

2004 2005 2006 2007 2008 2009 2010

Central Government Domestic Debt

(In percent of GDP)

-2

-1

-1

0

1

1

2

2

3

3

2006 2007 2008 2009 2010

Public Savings

(In percent of GDP)

9

Table 1: Honduras - Selected Economic Indicators

a/ Projections.

b/ Goods only.

p/ Preliminary.

Note: The projections assume that the reforms supported by the DPC are implemented.

Sources: Ministry of Finance; IMF, and Bank staff estimates.

2006 2007 2008 2009 2010 p/

2011 a/

2012 a/

2013 a/

2014 a/

Real GDP Growth 6.6 6.3 4.0 (1.9) 2.8 3.4 3.6 4.0 4.0

CPI Inflation 5.3 8.9 10.8 3.0 6.5 8.2 7.9 6.0 6.0

Public Sector Balance Components 2006 2007 2008 2009 2010 p/

2011 a/

2012 a/

2013 a/

2014 a/

Combined Public Sector Balance (1.3) (1.6) (1.7) (4.7) (2.9) (3.1) (2.5) (2.0) (2.0)

Central Government (1.1) (2.9) (2.4) (6.2) (4.8) (3.8) (3.1) (2.1) (2.1)

Other Public Sector (0.2) 1.3 0.7 1.6 1.9 0.7 0.6 0.1 0.1

o/w Pension Funds 0.7 1.1 2.0 1.7 2.3 1.9 1.6 1.3 1.2

Central Government 2006 2007 2008 2009 2010 p/

2011 a/

2012 a/

2013 a/

2014 a/

Central Government Total Revenues 18.2 19.2 19.9 17.5 17.4 17.2 17.5 17.6 17.6

Current Revenues 16.7 17.6 17.8 15.6 16.0 16.2 16.7 16.8 16.8

Tax Revenues 15.3 16.4 16.1 14.6 14.8 15.1 15.3 15.5 15.5

Non Tax Revenues 1.4 1.2 1.7 1.1 1.1 1.1 1.4 1.3 1.3

Other 1.5 1.6 2.1 1.9 1.4 1.0 0.8 0.8 0.8

Central Government Total Expenditures 19.3 22.1 22.4 23.8 22.2 21.0 20.6 19.7 19.7

Current Expenditures 16.1 18.1 17.5 19.2 18.4 17.1 16.7 16.6 16.6

o/w Wages & Salaries 8.3 9.2 9.3 11.2 11.0 9.9 9.7 9.5 9.3

Social Security Contributions 0.7 0.7 0.8 0.9 1.0 0.9 1.0 0.9 0.9

o/w Interest Payments 1.0 0.7 0.7 0.7 1.0 1.3 1.4 1.4 1.4

Capital Expenditures 3.4 4.1 4.8 4.6 3.7 3.9 3.9 3.1 3.1

o/w Budgetary Investment 1.7 2.2 2.4 2.8 1.7 2.3 2.1 2.1 2.1

o/w Other 1.7 1.9 2.4 1.8 2.0 1.6 1.8 0.9 0.9

Central Government Balance (1.1) (2.9) (2.4) (6.2) (4.8) (3.8) (3.1) (2.1) (2.1)

Total Public Sector Debt 31.7 19.7 20.2 23.7 26.3 27.8 28.0 27.8 27.6

2006 2007 2008 2009 2010 p/

2011 a/

2012 a/

2013 a/

2014 a/

Current Account (% of GDP) (3.7) (9.0) (15.3) (3.6) (6.2) (7.2) (6.3) (5.9) (5.7)

Foreign Direct Investment (% of GDP) 6.1 7.5 7.3 3.7 5.2 5.5 5.2 5.0 5.0

Exports (annual percentage change) b/ 6.7 8.1 8.3 (18.7) 17.1 22.5 9.6 7.7 5.0

Imports (annual percentage change) b/ 11.7 19.8 17.4 (28.1) 17.6 18.2 8.7 6.8 4.9

Gross International Reserves (US Million) 2824.0 2733.0 2,691.0 2,331.0 2,931.0 3,280.0 3,460.4 3,680.3 3,896.6

In months of imports 4.4 3.5 4.7 3.5 3.8 3.2 3.1 3.1 3.1

Net International Reserves (US Million) 2,531.0 2,409.0 2,460.0 2,116.0 2,719.0 3,067.0 3,246.4 3,466.3 3,682.6

Public Sector (percentage of GDP)

Output and Inflation (annual percentage change)

External Sector

10

Macroeconomic Outlook and Debt Sustainability

17. The Honduran economy is expected to grow by 3.4 percent in 2011, an

improvement from 2009-2010 but a low rate compared with those posted in the mid-

2000s. On the one hand, as the economies of Honduras’ major trade partners are slowing

down, maquila exports have stagnated.7 On the other hand, as commodity prices remain high,

the value of agriculture exports such as coffee and bananas have increased. In addition, the

economic slowdown in the US is expected to lead to a decline in remittances with respect to

2010. Total exports are expected to grow 22.5 percent while imports are projected to increase

18.2 percent. Foreign direct investment is expected to rise from 5.2 percent of GDP in 2010 to

5.5 percent of GDP in 2011.

18. Despite the global uncertainties, the growth outlook for Honduras remains

overall positive. Under a baseline scenario, world economic growth is expected to remain

sluggish through at least the first semester of the 2012. As a result, maquila exports are

expected to stagnate while agriculture exports will continue increasing due to relatively high

commodity prices. During the second half of 2012, the global economy is expected to slowly

recover. Maquila exports, spurred by growth in the US, are expected to drive industrial

production starting in the second half of 2012. As a result, the Honduran economy is expected

to grow at 3.6 percent in 2012, and at around 4 percent in 2013-2014.

19. Monetary policy is expected to remain vigilant as headline inflation picks up.

Headline inflation stood at 6.5 percent in July, and current projections suggest it will reach 8.2

percent by end-2011, which is well inside the Central Bank’s target range of 7-9 percent. The

Central Bank is committed to meeting its inflation target. To attain this goal, it will continue

to mop up excess liquidity through the placement of its own securities. In the near term, the

exchange rate will continue to serve as the main anchor for inflation expectations. In the

medium term, commodity and fuel prices are expected to decline and thus inflation is

projected to follow a similar trend and reach 6 percent in 2014.

20. The Government introduced a crawling exchange-rate band in late July 2011,

reverting to the policy it had pursued before 2005 and ensuring greater exchange rate

flexibility. The crawl rate will be equal to the expected differential between domestic and

foreign inflation and changes in the nominal effective exchange rate. The base rate will be

adjusted accordingly every week. As a transition measure, the exchange rate can appreciate to

its lower band in a single day, but depreciation cannot exceed 2 cents a day.

21. The current account deficit is expected to narrow in the medium term. Worker

remittances are expected to remain at about 16 percent of GDP in 2012-2014. Imports are

projected to grow on average close to 7 percent; combined with higher exports, this would

narrow the current account deficit from 7.2 percent of GDP in 2011 to 5.7 percent in 2014.

Foreign direct investment, mostly to the maquila sector, is projected to decrease from 5.2

percent of GDP in 2010 to about 5 percent in 2014.

7 Honduran 'twin plant' manufacturing program under which specialized production facilities can import components duty-

free for in-bond storage, assembly, and subsequent re-export. The Honduran maquila industry includes sectors such as

textiles and garments, among others.

11

22. The Government remains committed to reducing the combined public sector

deficit to 2 percent of GDP over the medium term.8 Throughout President Lobo’s term,

the Government will continue undertaking reforms to strengthen the finances of the public

pension funds and the Honduran Institute of Social Security, increase the efficiency of state

enterprises, and improve the targeting of social safety nets. Tax revenues are expected to

increase slightly over the medium term as a result of the implementation of reforms aimed to

strengthen the tax administration. Current expenditures are expected to decline as the wage

bill has been contained through several measures. The Government expects to rely on external

borrowing to finance its deficit and refinance domestic debt.9

23. A debt sustainability analysis suggests that Honduras’ public debt is on a

sustainable trajectory (see Annex 5). In the baseline scenario, the public-debt-to-GDP is

expected to increase from 26.3 percent of GDP in 2010 to 28 percent in 2012 and gradually

decline afterwards. The trajectory of public debt is projected to decline even under the most

pessimistic alternative scenarios considered in the analysis.

24. There is a risk that the global economy might enter into another recession at the

end of 2011. Our baseline scenario assumes that the global economy grows 2.8 percent in

2011 and 3.2 percent in 2012. Central America and Honduras are likely to be affected if the

developed countries enter into another recession. Although the magnitude of a new crisis

remains highly uncertain, a number of factors may make it more severe than in 2008. First,

the scope for monetary and fiscal policy in Europe and the US is limited at this point.

Second, if Chinese growth was affected, this would drag down commodity prices and

exacerbate the slump in global demand. In case the global economy falls into another crisis,

the Honduran economy may experience a contraction similar to the one in 2008 (about -2

percent).10

However, the fiscal impact may be less severe thanks to the recent structural

reforms undertaken in the fiscal sector (see Box 1 for more details). Also, the Government has

been closely following the external economic conditions and is currently preparing an action

plan to mitigate the negative effects of a possible sharp downturn on the world economy.

25. In sum, in light of the measures taken by the Honduran authorities and the

ongoing domestic economic recovery, the macroeconomic policy framework is deemed

adequate for this proposed Development Policy Credit.

8 In the long run, it is expected that the country will be able to run a proper countercyclical fiscal policy. Many of the

structural reforms supported by the program will contribute to this end. 9 Currently, domestic financing is more expensive than external financing and is relatively short term. The Government

wishes to refinance its domestic debt for a longer period and at a lower cost. However, the Government is also weighing

possible exchange rate and interest rate risks as well as the effects on domestic liquidity of not borrowing from local

investors. In addition, given investors’ perceptions of country risk, the interest cost of placing a bond in international markets

is uncertain. 10 If the global economy contracts, maquila exports are likely to decline significantly and overweighing the positive impact

of coffee and banana exports.

12

Crime and Violence, Citizen Security

26. The citizen security agenda has become increasingly significant in Honduras.

Weak governance, political instability, slow growth, and poor social outcomes have

contributed to an environment conducive to crime and violence. Between 2005 and 2010, the

country’s homicide rate doubled from 37 to 82.4 murders per 100,000 inhabitants, moving

Honduras from third to first place in Central America and indeed the world (Figure 4).11

Homicides are concentrated among males (94 percent), particularly those between 15 and 34

years of age. According to the Violence Observatory, 70 percent of all homicides are in urban

areas, although they are significant and on the rise in rural areas as well (30 percent of

homicides).

27. In the past five years, violence against women has also increased by 125 percent;

women’s homicide rates have increase from 4.8 murders per 100,000 inhabitants in 2005 to

10.8 murders per 100,000 inhabitants in 2010. It is the second highest cause of death for

women in Honduras. According to the 2005 National Demographic and Health Survey

(ENESF), 12

15 percent of women were victims of some form of violence at least once in the

previous 12 months. Rates were slightly higher for women in urban areas compared to women

living in rural areas (17 percent versus 12 percent).

Figure 4. Homicide Rates in Central American Countries per 100,000 inhabitants

(2005-2010)

Source: WB (2011), UNDP (2011), SICA (2011)

28. Crime and violence are making Honduras poorer and have become a major

development challenge. Deteriorating citizen security is undermining Honduras’ growth

potential and investment climate, its social and human development progress, and its

prospects for improving governance. The annual economic costs of crime and violence have

been estimated at near 10 percent of Honduras’ GDP (nearly US$900 million).13

A recent

11 Violence is concentrated in urban areas. Among cities with more than 100,000 people, the most violent are La Ceiba (158

homicides per 100,000 inhabitants), San Pedro Sula (148), Juticalpa (129), Puerto Cortes (109), Comayagua (104), and

Tegucigalpa and Comayaguela (93). 12 Encuesta Nacional de Epidemiologia y Salud Familiar (ENESF) 13 World Bank (2011). Crime and Violence in Central America. A Development Challenge.

0

10

20

30

40

50

60

70

80

90

2005 2006 2007 2008 2009 2010

Costa Rica

El Salvador

Guatemala

Honduras

Nicaragua

Panama

13

Bank study estimates that reducing homicide rates by 10 percent could boost annual economic

growth by 0.7 percent.14 Not surprisingly, citizens perceive violent crime as one of the major

threats to their welfare, and the failure to curb this epidemic continues to undermine the

legitimacy of government and the rule of law.

29. The World Development Report 2011 on Conflict, Security, and Development

provides a solid framework to understand the dynamics of crime and violence in

Honduras. The WDR argues that the risk of major violence is greatest when high levels of

internal and external stress combine with weak national institutions. Societies are vulnerable

when their institutions are unable to protect citizens from abusers, or to provide equitable

access to justice and economic opportunity. These vulnerabilities are exacerbated in countries

with high levels of internal stress (high youth unemployment, growing income inequality, and

perceptible injustice). Externally driven events such as the presence of trafficking networks or

economic shocks add to the stresses that can provoke violence.

30. In the case of Honduras, the escalating levels of crime and violence are partly the

result of external phenomena. Drug trafficking has become the main factor in increasing

violence levels in Honduras in recent years, as a result of the shift of drug-trafficking routes

between South America and North America from the Caribbean to the Central America-

Mexico corridor.15 There is a correlation between homicide rates and the parts of the country

with high intensity of drug trafficking, such as the Atlantic coast and areas bordering

Guatemala.

31. Like other countries of Central America’s northern triangle, Honduras has seen

a proliferation of youth gangs from the deportation of transnational gang members from

US prisons since the mid-1990s.16 It is estimated that approximately 112 gangs, or maras,

17

with 36,000 members, are now operating in the country, and that 15 percent of homicides are

gang-related.18 While the role of youth gangs has been exaggerated, its close links with

different forms of organized crime has made them a growing threat for citizen security.

32. The impact of these external stresses has been exacerbated by the prevalence of

many risk factors that make individuals and communities vulnerable to violence. Studies

show that violence does not result from a single factor but from the accumulation of

disadvantages and risks. Violent individuals tend to experience disadvantages at the

individual level (e.g., low education, poor employability skills) and in their families (domestic

violence, lack of parental monitoring), relationships (friends who are gang members),

communities (living in violence hotspots with high presence of guns, drugs, alcohol), and

society at large (culture of violence, stigmatization of poor youth as criminals, repressive and

corrupt police).19 Honduras shows a prevalence of many of these risks. In at least the past two

14 Ibid. 15 Drug trafficking and violence in Central America and beyond. Gabriel Demombynes. Background Case Study. World

Development Report 2011. 16 Ibid. 17 When referring to gangs in Central America, a distinction is sometimes made between maras and pandillas, with the term

maras being used to refer to the MS-13 and 18th Street gangs, while the term pandillas is used for localized, home-grown

gangs. 18 Casa Alianza, 2006. http://www.casa-alianza.org/docs/2006/2006-12-12-26-hond-ejec.pdf 19 Territorial ―hotspots‖ of crime and violence tend to coincide with enclaves of urban inequality suffering from multiple

forms of risk and disadvantage (high levels of poverty, low social capital, lack of public services, high exposure to natural

disasters, urban decay, etc.).

14

decades, the country has had high levels of outmigration in search of work, leaving

dysfunctional family structures where young children and youths often do not have sufficient

parental supervision, rendering them prey to the guidance and structure offered by the youth

gangs or maras. Another risk factor is the high levels of firearms due to weak enforcement of

regulations. In 2010, 151,003 firearms were registered but the estimated total was close to

800,000.20

Firearms are used in most murders reported during 2010.21

High levels of

inequality and a lack of opportunities are also a contributing factor (see next section).

33. Weakened by (among other factors) the corrupting influence of organized crime,

the criminal justice system has been ineffective in its preventive, deterrent, and punitive

roles, undermining good governance and the rule of law. As the state’s ill-equipped justice

and security sectors struggle and often fail to combat organized crime, Honduran citizens’

trust in the rule of law declines. Institutional weakness often contributes to maintain situations

of impunity. In 2006, 63,537 criminal complaints were filed, 49,198 of which were referred

for investigation and only 1,015 ended in a conviction due in part to deficiencies of the

criminal investigation process. Overall trust in criminal justice institutions and the police have

declined significantly in the last few years, from 51 percent in 2004 to 41 percent in 2008, and

from 57 percent in 2004 to 44 percent in 2008 respectively. 22 Despite low confidence of

citizens’ in the security and justice sector, the number of legal complaints has doubled in the

last years. The weak social sector performance and the lack of a comprehensive social policy

on violence prevention activities weaken society at the same time that poor educational

prospects and limited job opportunities make crime an attractive option.

Poverty, Gender and Social Development

34. Honduras remains one of the poorest and most unequal countries in Latin

America. The country was severely affected by the economic crisis. Preliminary estimates

indicate that as result of the economic contraction in 2009 associated with the international

economic crisis, poverty in Honduras may have risen by approximately 2 percentage points

between 2008 and 2009. Consumption-based figures for 2009 indicate that 44.5 percent of the

population lived in poverty and 20.1 percent lived in extreme poverty (Figure 5).23

These rates

are expected to fall gradually as growth recovers. According to the Honduras Poverty

Assessment (2006), indigenous peoples and other non-Mestizo/Ladino groups account for 6.5

percent of the population, and 71 percent live below the poverty line. According to official

figures, the Gini coefficient that measures inequality in income distribution for 2007 stood at

0.57. These figures are among the highest in Latin America.

35. The decline in wage remittances observed in 2009 constituted an important

transmission mechanism for poverty. A quarter of the poorest 20 percent of the population

receive remittances, and this contributes around a quarter of their total incomes. Since more

than half of all migrants come from urban areas, the urban poor are more vulnerable to the

decline in remittances. Recent Bank analysis indicates that the majority of workers are

20 Informe sobre Desarrollo Humano para América Central 2009-2010, PNUD. 21 Annual Report National Observatory of Violence, 2010. 22 The Americas Barometer by the Latin American Public Opinion Project (LAPOP), Political Culture, Governance and

Democracy in Honduras, 2008. 23 Honduras official figures may differ from these because they are based on household income and use a different

methodology in the calculation.

15

employed in low skilled and low paying jobs in agriculture and related sectors. In Honduras,

agriculture seems to be the residual absorber of labor—not retail services, as in other Central

American countries. During the 2008-2009 crisis, Honduran urban unemployment rose

rapidly due to job losses in maquilas and construction.

36. To offset the potential negative impact of the fiscal consolidation efforts on the

most vulnerable the Government recently launched a new Conditional Cash Transfer

Program (Bono 10,000). By end-2011, the Program is expected to cover about 300,000

families living in extreme poverty. The program, which was launched in 2010, not only aims

to mitigate the impact of the economic and fiscal crisis on the poor in the short run, but also

contributes to the long-term objective of reducing poverty as outlined in the National Plan.

The program, which is supported by the Bank's Social Protection Project, subsumes some of

the earlier cash transfer programs and will improve coverage, benefits and accumulation of

human capital for eligible families living in extreme poverty. The earlier cash transfers Bono

Solidario and Bono Escolar have been discontinued as separate transfers and integrated

within the Bono 10,000. The eligible population for this Program ultimately comprises the

approximately 600,000 extremely poor families with children aged 0 to 59 months, children in

primary school (grades 1 to 6), and pregnant mothers. These families represent about 87

percent of all extremely poor families. The program aims to provide more adequate benefits to

these households conditional on investments in human capital accumulation through regular

use of health and/or education services. Moreover, a large share of households currently

benefiting from the program has indigenous background.

Figure 5: Poverty and Extreme Poverty in Honduras

(2002-07 and projections through 2012)

Source: Own simulations based on LSMS survey data from INE.

37. Gender and age-related issues have led to risky behaviors that may contribute to

violence as a major development challenge. High teenage pregnancy rates, especially

among poor women leads not only to a large proportion of households headed by women—35

percent in 2006, the highest for Central America—but also to higher dropout rates, which

makes it harder for young women to obtain quality employment. Nevertheless, on average,

women now have more schooling than men which results in an inverse gender gap in

education (female to male ratio in: primary enrollment 99.78; secondary enrollment 123.94;

tertiary enrollment 151.48 in 2008). In contrast, participation of women in the labor force has

increased slowly over the last two decades. At only 40.1 percent in 2009, it continues to be

0

10

20

30

40

50

60

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

Poverty

Extreme Poverty

16

one of the lowest rates of female labor force participation in Latin America (LAC average: 56

percent in 2009).

38. Among boys, dropping out of school, compounded by the lack of employment

opportunities, may lead to their involvement in gangs and acts of violence as well as in

crime and drug trafficking. For both girls and boys, the poor quality of education may also

contribute to dropping out of school and result in the risky behaviors just described. Over the

past two decades, Honduras has devoted an increasing share of public spending to the

education sector. Public sector education expenditures increased from 5 percent to 8.6 percent

of GDP between 1990 and 2007. Despite this increase, however, Honduras has not been able

to increase the level of education outcomes of its students, due in part to serious teacher

absenteeism and opposition to reforms by strong teachers’ unions. The weak performance of

the education system also has serious implications in terms of violence, given that dropping

out of school is one of the primary risk factors for the involvement of children and youth in

criminal and violent behavior.

III. THE GOVERNMENT’S PROGRAM

39. Early in 2010, the Honduran Congress approved the Government’s proposed

Country Vision 2010-2038 and National Plan 2010-2022. The overarching long-term

objectives of the Country Vision are: (i) a Honduras without extreme poverty, educated and

healthy with consolidated provision of social services; (ii) a Honduras with a developing

democracy, with security and without violence; (iii) a productive Honduras generating

opportunities for dignified employment while making sustainable use of resources and

reducing environmental vulnerability; and (iv) a modern, transparent, responsible, efficient,

and competitive state. The Lobo Administration’s priorities and challenges are derived from

these objectives and include:

40. Strengthening macroeconomic and fiscal management. Achieving GDP growth at

rates above population increases remains a key challenge for the Government. Among the

principal issues to tackle are: strengthening public finances, building the private financial

sector, diversifying exports, increasing access to credit, providing added value to export

products, and increasing adoption technology for key engines of growth. The proposed

operation supports key elements of the government’s strategy. These include: (i) reforming

the country’s tax system to raise collections, improve tax administration, and fight tax

evasion; (ii) bringing the public wage bill under control in key sectors, with a focus on

education; and (iii) reducing the actuarial deficit of public pension and health institutions.

41. Ensuring the rule of law and controlling crime and violence. Developing an

integrated citizen security policy, fomenting credibility of justice enforcers, enhancing the

performance of public institutions responsible for preventing crime and violence and

enforcing the rule of law, and strengthening public and private sector performance against

organized crime remain key issues identified by the Lobo administration. The proposed

operation supports the violence prevention strategy and inter-institutional coordination

mechanism of the Government’s integrated citizen security policy (Política Integral de

Seguridad y Convivencia Ciudadana 2011-2022).

17

IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM

Link to Country Partnership Strategy

42. The proposed operation supports progress toward the strategic objectives of

expanding opportunities through reducing vulnerabilities, and improving citizen

security included in the new Country Program Strategy (CPS, Report No. 63370-HN).

The CPS aims to support: (i) consolidation of macroeconomic stability and fiscal

management; (ii) poverty reduction and higher employment as the basis for social stability;

(iii) efforts to improve governance; (iv) improved citizen security; and (v) the continued

implementation of the current portfolio in support of the CAS pillars. The proposed DPC is

the first programmatic lending operation envisaged in the CPS and would contribute to the

objectives of macro stability and fiscal management as well as improved citizen security.

Relationship to Other Bank Operations

43. The proposed DPC is linked to the Improving Public Sector Performance

Technical Assistance Project (P110050) geared to address human resource management

issues, among other areas (US$18 million). The Government is committed to consolidating

a sustainable wage bill, with growth limited to 10.1 percent of GDP in 2011 and 10 percent of

GDP in 2012. In the area of human resources management, the new public sector operation

will provide technical assistance to the Government to support its efforts to control personnel

expenditures and improve civil service professionalization in selected institutions. The project

will contribute strengthening control of personnel expenditures through the implementation of

the following payroll audits: (i) transactions-based payroll audit for the Health Secretariat

focusing on contracted personnel and for the Public Works Secretariat focusing on temporary

personnel on wages (jornales), both groups with payrolls parallel to the Government’s

integrated financial management system (SIAFI); and (ii) process-based payroll audit for

central administration institutions. Given the political sensitivity of these issues, the project

will also finance a communications strategy to advise the government on the political

economy aspects of the process.

44. The Bank will also consider how its portfolio, even those projects that do not

directly address these issues, can play a role in reducing crime and violence. These

include the Financial Sector Technical Assistance Project with its focus on payment systems,

the Quality of Education Project aimed at preparing graduates for the workforce, and the

Nutrition and Social Protection Project that supports skills development and placement

services for youth at risk. Moreover, the Barrio Ciudad operation which combines the

delivery of basic services via urban upgrading, combined with social prevention interventions

in poor urban neighborhoods, the JSDF grant for Employment Generation in Poor Urban

Neighborhoods accompanying the Barrio Ciudad operation, should all be seen as part of this

package of interventions with potential to contribute to enhancing citizen security and

addressing crime and violence in Honduras.

Collaboration with the IMF and Other Donors

45. The complexity of the Honduran economy calls for the coordinated engagement

of key donors. The proposed operation has been prepared in close consultation with the IMF

18

and IDB as part of a coordinated multilateral effort to support the Government’s agenda to

consolidate fiscal sustainability and macroeconomic stability. The IDB is preparing a similar

operation supporting civil service and pension reform.24

In 2010, the IMF Board approved a

blended 18-month arrangements supported under the Stand-By Credit Facility and the Stand-

By Arrangement with a total access of 100 percent of quota (about US$202 million).

According to the IMF, all the quantitative performance criteria for end-June 2011 were fully

met after the second review.

46. The IMF program covers five reform areas. First, the program foresees strict

control of current spending and government employment, aiming at a public sector deficit no

greater than 3.1 percent of GDP for 2011. Second, it calls for an improvement in the financial

situation of public sector enterprises. Third, it establishes a ceiling for new non-concessional

debt. Fourth, it foresees a reduction of the actuarial deficits of the public pension systems.

Finally, it seeks to strengthen the financial position of the Central Bank. In addition, the IMF

is providing technical assistance on multi-annual budgeting, revenue projection, resolution of

arrears and tax administration.

47. In addition, the Bank is working on the security agenda in collaboration with the

G-16 donor group on justice and security in Honduras. This group consists of the

European Union, UNDP, the Spanish Cooperation, USAID, the US State Department, JICA,

IDB, and CIDA. A matrix on projects and technical assistance to be funded by the

international cooperation has been prepared by the donor group. In addition, the Bank will

work with the Friends of Central America, a multi donor coordination group created in 2010

to coordinate citizen security initiatives in Central America. The Bank is also working in close

collaboration with UNDP, which has been advising the Ministry of Security on the national

citizen security policy and the Safer Municipalities program (Municipios mas seguros), which

defines a strategy at the local level. The Bank will continue to promote partnerships with key

donors working on violence prevention in Honduras, such as USAID and KFW. The Bank

will continue to promote partnerships with key donors such as the European Commission and

the IDB that are designing large citizen security operations in the country. IDB has also

expressed interest in coordinating with the Bank the provision of technical assistance related

to the design of an action for the citizen security and co-existence integral policy. The Bank is

also discussing with the European Commission opportunities for joint analytical work and

collaborative interventions on violence prevention.

Lessons Learned

48. Four main lessons from the Poverty Reduction Support Credit (FY05), and the

First Programmatic Financial Sector Development Policy Credit (FY05) have been

incorporated into the design of this DPC. Both operations were rated moderately

satisfactory. In addition, emerging lessons from the Fiscal Emergency Recovery Development

Policy Credit (FY10) were taken into account. The lessons include:

Ownership of reforms is critical for a successful outcome. The satisfactory outcome of

previous lending operations is to a large extent a consequence of exclusively supporting

24 Both the Bank and the IDB support the same reforms through the budget support operations in pensions and civil service.

The technical assistance activities provided by both institutions are complementary, as the IDB’s support focuses on the legal

aspects while the Bank’s support has been in the technical aspects of the reforms.

19

government-led initiatives. A continued technical and policy dialogue with the authorities

and their technical team was important to maintaining the authorities’ ownership and

commitment.

Strong analytical underpinnings and links to Bank investment lending provides the

foundation for a well-designed development policy operation. The key pieces of

Economic and Sector Work (ESW) and the Country Financial Accountability and

Procurement Assessment Report (CFAA/CPAR) not only contributed to the design of the

previous lending operation, but also helped inform the reform efforts of the Government

and supported a fruitful policy dialogue.

Effective donor coordination during project preparation is important. To avoid

conflicting policy advice and have a stronger voice in the policy dialogue with the

Government, it was important to coordinate with the IDB, IMF, EU, and other donors

during program preparation.

Policy lending should support reforms under implementation. The PRSC relied on the

future approval of legislative instruments to advance many of the key reforms, which was

not very effective. In the case of the proposed operation, an intensive policy dialogue and

technical assistance helped the Government complete most of the prior actions during the

preparation phase of the credit, including legislative approval of necessary laws and

decrees. In line with the lessons learned from the PRSC, however, the majority of

measures are administrative in nature and do not require approval by Congress.

Analytical Underpinnings

49. The design of the proposed operation is backed up by solid analytical work

conducted by the Bank, IDB, and IMF. The substantial body of analytical work has

provided the basis for an in-depth dialogue with the Government and has supported the design

of the DPC. Table 2 shows the links between the components included in the DPC and the

recommendations provided by recent analytical work.

20

Table 2: Links between the DPC and Prior Analytical Work

Analytical Reports – Findings and Recommendations

Links to

DPC

Prior

Actions

I. TAX REFORM

Fiscal Emergency Non-

Lending Technical Assistance

(WB 2010)

Taxes should be filed and paid electronically because this is one of the best

ways to improve tax collections as well as to improve the processing of

returns.

1.2

II. PENSION REFORM

Public Expenditure Review

(WB 2007)

Adjustments needed in contributions and/or benefits on INPREMA,

INJUPEMP and IHSS to avoid the Central Government having to cover

cash-flow deficits. A shortfall in the break-even contribution rate signals an

actuarial imbalance that will eventually lead to financial and fiscal distress.

This situation would require significant parameter adjustments to maintain

the system’s solvency in the long term.

2.1

Technical Assistance Report on

Pension System (WB 2011)

The pension system in Honduras is facing financial problems due to

structural and design problems. An aging population, early retirement age,

and low contribution ratios in most of the system’s institutions have resulted

in cash-flow structures that cannot ensure the benefit payments in the long

term. The report recommends parametric reforms to ensure sustainability in

the long run.

2.1

III. CIVIL SERVICE REFORM

Honduras Institutional

Governance Review

―Strengthening Performance

Accountability‖ (WB, 2009)

The report recommends applying a set of universal principles to all public-

sector employees, particularly in the area of salaries and pay policy, thus

contributing to fiscal sustainability.

3.1

―Public Expenditure Tracking

and Service Delivery Survey-

Education and Health in

Honduras‖ (PETS, WB 2010)

The report recommends improving the teachers’ database and harmonizing

different contracting regimes for staff in the public sector. 3.1

―Honduras’Country Governance

and Anti-Corruption Experience:

Opportunities and Challenges

(WB, 2011)

The report emphasizes the need for a stronger focus on performance for

improved efficiency in public spending and in service delivery going

forward and flags that the quality of education is lower than in the

neighboring countries despite a high increase in spending in the period

2007-2009. The discrepancy is partly to be found in the teachers’ salaries

(highest in the region), a result of relatively strong teachers’ unions.

3.1

IV. CITIZEN SECURITY

Crime and Violence in Central

America, A Development

Challenge

(WB, 2011)

Crime and violence are key development challenges for Central American

countries.

The economic costs of crime and violence in Honduras have been estimated

at nearly 10 percent of Honduras’ GDP (approximately US$900 million a

year). It is estimated that reducing homicide rates by 10 percent could boost

annual economic growth by 0.7 percent.

Successful citizen security strategies require action along multiple fronts

that combine prevention and criminal justice reform in combination with

regional approaches in the area of drug trafficking and firearms.

Interventions should be evidence-based, starting with a clear understanding

4.1

21

of the risk factors involved and ending with a careful evaluation of how

planned actions affect future options.

Opening Spaces to Citizen

Security and Human

Development.

Human Development Report

for Central America

(UNDP, 2009)

Ensuring citizen security is essential to sustainable development. Security is

not conceived as an isolated matter, but as part and parcel of countries’

economic and social development.

The iron fist (mano dura) and soft fist (mano blanda) approaches have

failed and must evolve toward a smart hand (mano inteligente) strategy of

citizen security based on a comprehensive strategy that includes preventive

and coercive actions, congruence with the justice system, and respect for the

values of civility.

4.1

Honduras, Criminal justice and

Human Rights (Draft)

WB (2011)

Increases in crime and violence in Honduras have exacerbated existing

institutional weaknesses and the lack of inter-institutional coordination

among criminal justice institutions.

A coordinated effort is needed among the executive, judiciary, and

legislative branches to develop a national security and criminal policy with a

human rights perspective and a strategic plan to implement it. To date a

number of legal reforms aimed at strengthening judicial independence have

had poor and limited results.

In Honduras, criminal procedure reforms have been a first step in a long

process that still needs significant improvement. In this regard, it is critical

to create modern management systems for the various entities responsible

for the new procedures. A coordinated effort is needed among the executive,

judiciary, and legislative branches to develop a comprehensive security and

criminal policy with a human rights perspective and a strategic plan to

implement it. The study also recommends that a national integrated

intelligence platform be created. Such a platform would be designed to

facilitate criminal investigations of organized crime and would integrate a

database with information from different sources.

4.1

Institutional Governance

Review. Strengthening

Performance Accountability in

Honduras. The World Bank,

2010.

Honduras has undertaken important reforms since the early 1980s to

strengthen the justice sector as a key element in good governance, and its

role in improving public security. These reforms include the adoption of

legal changes, the creation or expansion of key organizations, and the

allocation of additional human, financial, and material resources. In spite of

the reforms, Hondurans are still demanding general improvements to the

justice system, particularly with regard to security.

Compared to regional and international standards, the productivity of all

sector institutions is very low. In a country with one of the highest crime

rates in the region, the performance of all actors in the criminal justice chain

is disappointingly poor.

The police seem to be the weakest link in the criminal justice chain and

perhaps a key element to achieving improvement in overall performance.

New programs to finance equipment and infrastructure and a series of

outreach initiatives aimed at bringing the police closer to the community

and fostering citizen cooperation hold some promise. However, what is

needed most is organizational restructuring, efforts to improve the quality of

existing staff and to attract more qualified recruits, a more efficient control

of performance (including information systems, which are significantly

underdeveloped), better coordination among all parties, and the formulation

of policies for the overall sector.

4.1

22

V. THE PROPOSED OPERATION

Operation Description

50. The proposed operation supports the Government’s efforts to launch a number

of structural reforms that will help to consolidate the foundations for growth by

achieving fiscal sustainability and reducing crime and violence. More specifically, the

operation’s development objective is to assist the Government in strengthening fiscal

management and the institutional mechanisms and programs responsible for an integrated

violence prevention strategy. To achieve these objectives, the operation supports key

structural reforms in four components: (i) tax administration; (ii) pension reform; (iii) civil

service reform; and (iv) citizen security.

Policy Areas

Component 1: Tax Administration

Background

51. Tax collections increased slightly in 2010 but remain below pre-crisis levels. In

part as a result of the recently approved tax reforms, revenue as a share of GDP increased

from 14.6 percent in 2009 to 14.8 percent in 2010. Direct tax revenues rose from 4.8 percent

in 2009 to 4.9 percent of GDP in 2010, indirect taxes increased from 9 percent to 9.1 percent

of GDP and tariffs increased from 0.8 percent of GDP in 2009 to 0.9 percent of GDP in 2010

(Table 3).

52. Tax collections have not met expectations partly because of weaknesses in tax

administration. The 0.2 percent of GDP increase in overall tax revenues in 2010 reflects the

combined effect of new tax measures with an expected yield of 0.8 percent of GDP and

implicit revenue losses of about 0.6 percent of GDP, partly attributable to weak tax

administration. The Dirección Ejecutiva de Ingresos (DEI) identified important operational

capacity constraints that explained the underperformance of tax collection units. In particular,

the Large Taxpayer Unit (LTU), responsible for collecting close to 80 percent of Central

Government revenues, had important operational deficiencies. In addition, DEI recognized the

importance of applying measures to facilitate tax administration and reduce tax exemptions.25

25 Estimated by IMF Staff. Published in IMF Country Report 11/101 May 2011.

23

Table 3: Central Government Current Revenues (Percent of GDP)

Source: SEFIN

Government Actions

53. The Government is committed to ensuring full implementation of the tax

administration reforms by focusing on substantial improvements of the operational

capacity of the large taxpayer unit in the course of the year. Modern tax administrations

develop strategies for administering different categories of taxpayers, recognizing the

different risks, requirements, and their contribution to the overall tax revenues. By segmenting

taxpayers into groups that share similar characteristics, modern tax administrations can better

understand the compliance risks each segment possesses and better customize enforcement

and service strategies to deal more effectively with these risks. A frequent approach to

taxpayer segmentation is to distinguish taxpayer by their size, usually by dividing taxpayer

base into three market segments, that is, large, medium, and small taxpayer. However, this

approach takes into account not only their contribution to revenue but also their behavior and

characteristics. In fact, a common feature in almost every country is that a small group of

large taxpayers (the largest 1-2 percent of taxpayers) account for the bulk of tax revenue

(between 70-80 percent of total revenue collection). These large taxpayers share some other

distinct characteristics apart from their significant contribution to revenue collection. These

entities are typically legal entities and are often corporate groups with overseas branches, they

are often involved in complex international transactions, and they have access to advice from

accounting and legal professionals. Also, new IT developments, including tax registry, e-

filing and taxpayer services are tested in a small portion of taxpayers, like LTU, and then

extended to the whole taxpayer base. Similar strategies are being used for control and

enforcement. Other actions include to achieve this goal include the approval of the anti-

evasion law that strengthens tax administration and the upcoming assessment of tax

exemptions. The Government recognized that the approval of the anti-evasion law was crucial

to ensure that the full benefits of the tax reforms are realized.

54. Tax administration represents a key pillar of the Government’s fiscal

consolidation strategy. The DEI executive board has approved its project plan to strengthen

the Large Taxpayers Unit.26

As a first step, the DEI approved and implemented the large

26 Strengthening the large taxpayer unit with a specific focus on tax audit is one of the most critical aspects of the tax

administration reform in Honduras. In effect, less than 1 percent of taxpayers (621 taxpayers are assigned to the LTU)

accounts for almost 80 percent of tax revenue. DEI’s strategy is aligned with international good practices and hinges on three

2002 2003 2004 2005 2006 2007 2008 2009 2010

Total Current Revenues 18.3 15.6 16.3 16.3 16.7 17.6 17.8 15.6 16.0

o/w Tax Revenues 16.0 13.7 14.5 14.5 15.3 16.4 16.1 14.6 14.8

Direct Taxes 3.7 3.2 3.9 4.2 4.7 5.3 5.2 4.8 4.9

Income Taxes 3.5 3.0 3.5 3.8 4.2 4.7 4.6 4.3 4.4

Other Direct Taxes 0.2 0.3 0.4 0.4 0.5 0.6 0.6 0.5 0.5

Indirect Taxes 10.3 9.2 9.4 9.2 9.5 9.9 9.8 9.0 9.1

Excise 1.2 1.1 0.9 0.8 0.8 0.9 0.8 0.7 0.7

Sales 5.5 5.0 5.1 5.2 5.6 6.1 6.3 5.4 5.5

Other Indirect Taxes 0.8 0.6 0.6 0.5 0.5 0.6 0.6 0.6 0.7

Fuel Tax 2.7 2.5 2.8 2.7 2.5 2.4 2.1 2.3 2.2

Tariffs 2.0 1.3 1.2 1.2 1.1 1.2 1.1 0.8 0.9

Imports 2.0 1.3 1.2 1.2 1.1 1.2 1.1 0.8 0.9

24

taxpayer inclusion criteria and carried out a census of large taxpayers, resulting in a total of

621 taxpayers who account for about 80 percent of revenues. Other measures are already

underway and include: (i) signing agreements to file tax returns electronically; (ii) including

taxpayers in the reporting system and electronic tax payments; and (iii) selecting and training

of LTU auditors according to international best practices.

Box 2. Project Plan of the Large Taxpayer Unit

Short term (through December 2011) • Establish an organizational structure for the Large Taxpayers Unit (LTU).

• Strengthen the San Pedro Sula LTU in terms of personnel and equipment.

• Establish an inventory of existing tax exemptions and special regimes.

• Implement selective control for credit notes.

• Approve the regulations of Decree 17/2010 on electronic billing.

• Start regular controls and reduce the number of noncompliant large taxpayers to less than 3 percent by the end

of the year.

• Increase the number of taxpayers who register to file on-line to at least 80 percent by the end of the year and

increase the number of e-filing returns to at least 50 percent for the Value Added Tax (VAT) and 30 percent for

the Corporate Income Tax (CIT).

• Increase the percentage of electronic payments of the VAT, income tax, and withholdings.

• Create an Information Technology Commission to determine development priorities for different areas.

• Prepare an action plan to turn contract workers into permanent staff for IT personnel.

• Create a unit in charge of developing audit technical guidelines for the different economic sectors.

• Develop the audit guidelines for the mining sector or other strategic economic sector.

• Strengthen training in the development of audit guidelines and auditing.

Medium term (2012) • Centralize planning in the LTU.

• Establish a registry of special regimes and exemptions.

• Develop a control system for the authorization of returns and exempt purchases.

• Swap credit letters to facilitate the control of existing stock and prevent fraudulent use.

• Develop an electronic invoice system.

• Develop audit manuals for each economic sector and establish a medium-term training plan.

Expected Results

55. Tax administration and policy reforms will contribute to higher Central

Government tax collection by tapping into a larger tax base and ensuring greater

compliance. It is expected that the number of large taxpayers filing electronically will

increase by at least 10 percent by December 2012. Improved control, combined with the

effect of the recent tax policy reforms, is expected to result in an increase in the tax-to-GDP

ratio from 14.8 percent in 2010 to about 15.3 percent in 2012.

pillars: use of risk-based criteria to select taxpayers for audit, sectors specialization, and targeted training programs to

increase auditors' skills. In addition, it is expected that the LTU will be used as a pilot with a view to replicating revamped

business processes in other units.

25

Government’s medium-term reform agenda

56. The Government is committed to further strengthening tax administration as

evidenced by the implementation of the project plan of the LTU and the reduction in the

number of incompliant large taxpayers by 2.5 percent by December 2012. Among the

measures to be implemented are: a) to elaborate a report at the end of the day of those who

have not filed their returns, b) to implement a system for sending reminders and c) to make a

telephone follow-up plan for incompliant tax-payers. These measures are considered crucial

to sustaining an increase in the tax-to-GDP ratio over time. The Government has hired a

consultant to assist with the implementation of these reforms.

57. A number of medium-term measures are planned to make customs and tax

administration more effective. These include the adoption of legislation on transfer pricing

and a tax procedural code, the creation of the office of control of tax exemptions, and

improvements in the application of rules of origin in customs.27

The adoption of transfer

pricing rules is a trigger for the next operation.

27 Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related parties for

goods, services, or use of property (including intangible property). Transfer prices among components of an enterprise may

be used to reflect allocation of resources among such components, or for other purposes. OECD Transfer Pricing Guidelines

state, ―Transfer prices are significant for both taxpayers and tax administrations because they determine in large part the

income and expenses, and therefore taxable profits, of associated enterprises in different tax jurisdictions.‖

Many governments have adopted transfer pricing rules that apply in determining or adjusting income taxes of domestic and

multinational taxpayers. The OECD has adopted guidelines followed, in whole or in part, by many of its member countries in

adopting rules. The rules of nearly all countries permit related parties to set prices in any manner, but permit the tax

authorities to adjust those prices where the prices charged are outside an arm's length range. Rules are generally provided for

determining what constitutes such arm's length prices, and how any analysis should proceed. Prices actually charged are

compared to prices or measures of profitability for unrelated transactions and parties. The rules generally require that market

level, functions, risks, and terms of sale of unrelated party transactions or activities be reasonably comparable to such items

with respect to the related party transactions or profitability being tested.

Most systems allow use of multiple methods, where appropriate and supported by reliable data, to test related party prices.

Among the commonly used methods are comparable uncontrolled prices, cost plus, resale price or markup, and profitability

based methods. Many systems differentiate methods of testing goods from those for services or use of property due to

inherent differences in business aspects of such broad types of transactions. Some systems provide mechanisms for sharing or

allocation of costs of acquiring assets (including intangible assets) among related parties in a manner designed to reduce tax

controversy.

Most tax treaties and many tax systems provide mechanisms for resolving disputes among taxpayers and governments in a

manner designed to reduce the potential for double taxation. Many systems also permit advance agreement between taxpayers

and one or more governments regarding mechanisms for setting related party prices.

Many systems impose penalties where the tax authority has adjusted related party prices. Some tax systems provide that

taxpayers may avoid such penalties by preparing documentation in advance regarding prices charged between the taxpayer

and related parties. Some systems require that such documentation be prepared in advance in all cases.

Box 3: Prior Actions – Tax Reform Improve tax administration

To improve taxpayer compliance, the Government has: (i) approved a plan to strengthen the large taxpayer unit

within DEI, as evidenced by Agreement DEI SG 118-2011, dated May 16, 2011, and published in the

Recipient’s Official Gazette on October 25, 2011; and (ii) approved a registry of large taxpayers, as evidenced by

Agreement DEI SG 043-2011, dated March 18, 2011, and published in the Recipient’s Official Gazette on June

25, 2011.

26

Component 2: Pension Reform

Background

58. The Honduran mandatory pay-as-you-go (PAYGO) system is implemented by

five institutions covering 645,833 contributing members. The system reaches 21 percent of

the working age population ages 20 to 60 and 10 percent of the population over 60 years old

(48,903 beneficiaries) (Table 4). Contributions in 2010 were L$6,155 million (2.1 percent of

GDP), and benefits and expenses amounted to L$4,938 million (1.7 percent of GDP). The

system had a combined net worth of L$52,410 million (17.8 percent of GDP) at the end of

December 2010.

Table 4. Honduras pension system, 2010

Source : World Bank estimates based on institutes financial statements

59. The system is facing financial problems due to structural design issues. An aging

population, early retirement ages, and low contribution ratios in most of the system’s

institutions have resulted in cash-flow situations that cannot ensure benefit payments in the

long term. In addition, in the case of INPREMA it has been affected by poor management.

60. INPREMA and INJUPEMP28

have reached critical actuarial situations, as cash

payments have exceeded, or will shortly exceed, cash inflows. These institutions jointly

account for 19 percent of contributors and 48 percent of retirees. To ensure continuity of

operations, they need to introduce parametric changes in their operational rules. Due to their

legal structures, the changes need to be introduced by law.

61. INPREMA is already facing an operational deficit: contributions are not

sufficient to cover the payment of benefits and expenses. During the first five months of

28 INPREMA (Instituto Nacional de Previsión del Magisterio) serves the private sector and public sector teachers, and

INJUPEMP (Instituto Nacional de Jubilación y Pensiones de los Empleados Públicos) covers Central Government civil

servants.

TOTAL IHSS INPREMA INPREUNAH (4) INJUPEMP IPM

No. of Contributors 645,833 496,000 70,906 6,519 51,663 20,745

No. of Retirees 48,903 22,000 13,987 589 9,617 2,710

Total Contribution 2010 -mill Lps.- 6,155 852 2,344 270 2,078 611

Total Benefits and Expenses 2010 -mill Lps.- 4,938 377 2,218 258 1,659 426

Net Operating Result-mill Lps.- 1,217 475 126 12 419 185

Net Worth -mill Lps.- 52,410 10,595 18,132 2,219 15,208 6,256

Retirement Age - mínimum 65 m./60 f. (yrs) 50 yrs 58 yrs 58 yrs 50/58 (1)

Mínimum Contribution Period 180 mo. 120 mo 25 yrs 10 yrs 25 yrs

Contribution Rate (% of base salary) of which: 3.5% 19% (2) 19.0% 18.0% 25.0%

Mean monthly salary for Pension calculationlast 180 last 36 last 36 last 36 last 60

Replacement Rate per year of service 40%+ l% p.y in

exc of 5 ys

3% p.y 2.75% p.y 2.75% p.y 65% + 3% p.y

over 25

No. of Contributions per year 12 12 13 12 13

No. of Benefits paid per year 14 14 14 14 14

Pensión Indexed to Inflation? Yes Yes(3) Yes(3) Yes(3) Yes(3)

Notes:

(1) 50 for risk activities personnel (army, police, firefighters), 58 for civilian personnel

(2) Private sector 18%

(3)Yes; subject to actuarial reports and approval of the CNBS and SEFIN

(4) INPREUNAH according to data as of june-2011

27

2011, the institution has accumulated an operational deficit of approximately L$35 million.

The actuarial deficit of L$78,271 million (equivalent to about 25 percent of GDP) is four

times bigger than INPREMA’s net worth. There are approximately 10,400 active participants

who have reached retirement age. Considering the present mean pension of L$10,966 a

month, the additional annual pension payments these participants would require under current

rules—if they were to retire now—is equivalent to approximately L$1,600 million.29

This

amount would make the cash flow situation unsustainable and put pension payments at risk.

62. INJUPEMP has an operational surplus but the actuarial deficit30

of L$32,250

million (equivalent to about 11 percent of GDP) is approximately two times bigger than

the institute’s net worth of L$15,208 million. By 2014, it is expected that benefits and

operational expenses will surpass contributions. If nothing is done, cash-flow actuarial

projections indicate the net worth will be consumed by 2030.

63. The Instituto de Seguridad Social de Honduras (IHSS) faces financial problems

stemming from both its health and pensions obligations. The IHSS manages private sector

and municipal employee’s pensions, and medical and workers’ insurance. The premium

charged to provide medical coverage—8 percent on capped salaries—has been insufficient to

pay operational expenses. This situation has prompted IHSS management to transfer (―lend‖)

money from the pension area to cover the shortfall in the health area. Continuing to do this

will jeopardize future pension payments. IHSS net worth of L$10,595 million represents

approximately 28 times the amount of annual pensions and operational expenses in 2010

(L$376 million). However, the average age profile of its participants is low. In addition, they

have displayed significant job turnover, so many of them do not reach the minimum

requirements for a pension. Existing rules allow participants who do not qualify for a pension

to withdraw their personal contributions. However, the same rules dictate that employers’

contributions remain in the pool of IHSS assets. This situation provides a windfall increase in

assets that could partly cover remaining participants’ future payments. However, this

mechanism to cover future needs is not in the spirit of an equitable social contract.

64. Cash flow for the Instituto Nacional de Previsión de la Universidad Autónoma de

Honduras (INPREUNAH) is suffering from an irregular pattern of employer’s

contributions from the Universidad Autónoma de Honduras (UNAH). The institute started

operations with actuarial liabilities from existing participants as well as from already retired

university personnel. This actuarial liability was not compensated and, when combined with

the irregular employer contributions, complicates the payment of present benefits. An

actuarial study was done in 2009, but it needs to be revised to be consistent with the criteria

used by Comision Nacional de Bancos y Seguros (CNBS, National Commission of Banks and

Insurance Agencies) for other pension institutes.

65. In December 2006, the Government reformed the Instituto de Previsión Militar (IPM), which covers active members of the armed forces and civilian personnel. The

reform included an increase in the population of contributors. Police and firefighters (almost

24,000 participants) were transferred from INJUPEMP to increase the low base of

contributors (4,000). Parametric reforms were also introduced—including a higher retirement

age, longer contribution periods and elevated contributions.

29 Based on 14 monthly payments. 30 Estimated in 2009.

28

Government Actions

66. The IHSS’s cash flow has been improved by the increase in the maximum

contributory salary to L$7,000. As of June 2011 the previous cap on contributing salaries

(L$4,800) was increased by 46 percent. This increase is significant because a higher portion

of participant's salary will be used to calculate the contribution to the IHSS. However, the

new cap is slightly over the minimum salary and further increases might be needed.

67. In 2011, the government drafted and sent to Congress new laws for INPREMA

and INJUPEMP, substantially modifying rules and regulations to improve their

actuarial situations. The most important changes for both include: income from the 13th and

14th monthly paychecks will be subject to pension contributions; the number of months to

compute the final mean salary (on which benefits are based) will increase gradually from 36

to 180 months; use of International Accounting Standards (IAS 19 & 26) and Guidelines from

the International Actuarial Association will be mandatory to prepare Financial Statements

(including the actuarial valuation as notes); and governance will be improved (selection of

Board Members based on merit, CNBS as Regulator and Supervisor). Additional changes

include increases in minimum retirement age, contribution rates, and the minimum years of

services needed to achieve a full pension (Table 5).

Table 5: Specific actions for INPREMA and INJUPEMP

Action INPREMA INJUPEMP

Increase in minimum

retirement age.

Mandatory retirement age is 65 years. Existing contributors from 58 years, to 62

in steps; new entrants from 58 to 65 years.

Increase in

contribution rates.

Employer from 11 to 15 percent in steps (private),

and to 12 percent (public); employee from 7 percent

to 9.5 percent in steps.

Employer 11 percent (no change);

employee from 7 to 8 percent.

Years of service for

full pension.

Existing contributors increased from 10 to 20 years

stepwise; new entrants from 10 to 25 years.

Existing contributors increased from 10 to

15 years in steps; new entrants from 10 to

15 years.

68. The new INPREMA law has a mandatory retirement age of 65 years; however,

existing contributors could retire earlier. Table 6 shows the requirements to submit a

retirement application if the retiree is 56 years or older. These retirement applications will be

prioritized according to a formula based on applicant’s age and years of service. To ensure a

stable financial situation over a projected period of 20 years, the projection of the new

pension payments, including the payments for these retirees that qualify for early retirement,

during that period should be consistent with a projected net worth that is not diminished in

real terms.

Table 6. INPREMA’s requirements to submit retirement application Year in which the teacher submits its

retirement application

Minimum Age

required to submit

the application

Years of Contributions

2011-2014 56 14

2015-2017 57 16

2018-2019 58 18

2020 and on 59 20

29

69. The Government regularized the situation of teachers from the Honduran

Program for Community Education known as PROHECO (Programa Hondureño de

Educación Comunitaria). The PROHECO program was created in early 1999 as a policy

action to help improve the coverage, quality and accountability of education in the most

relegated areas of the country. PROHECO teachers faced criticism from their public school

counterparts on the basis of the lack of qualifications that these new teachers had, on average,

compared to their peers in regular public schools. Since the dispute had legal grounds, a new

set of regulations for the appointment of educational staff with no formal teacher training had

to be issued to validate these teachers as public servants.31

Ever since the creation of the

PROHECO program, though, these teachers started earning salaries and began sending

personal and employer contributions to INPREMA. Yet, they were never formally registered

in INPREMA and, after six years of full contribution (1999-2005), INPREMA stopped

receiving any of their contributions. The situation then turned into one where: a) original

contributions were never returned back to the PROHECO program; b) PROHECO teachers

were left without contributions and without the access to any social security benefits for the

ensuing years (2005-2011). The situation changed, finally, in June 2010, when INPREMA

issued the Resolution N°4364-1515-2010, by which it was decided that the PROHECO

teachers had to be affiliated with INPREMA. In August 2011, a Tripartite Commission

(INPREMA, SEFIN, and SEDUC) was formed to prepare a Tripartite Agreement for

Affiliating the PROHECO teachers retroactively to March 1999, when the Program first

started, and to settle on the obligations of the parties in regards to the floating debt for pension

contributions since the year 2005, when INPREMA stopped receiving any such related

transfers on behalf of PROHECO teachers. The Tripartite Commission also worked on a

complementary Agreement, to be signed between SEFIN and INPREMA, laying out a

repayment schedule for the aforementioned debt. Both Agreements have been finalized. As a

result, authorities committed to registering the amount of pending contributions to the

teachers’ pension plan as floating debt in the SIAFI and SIGADE, and the Ministry of

Finance, Ministry of Education, and INPREMA created a Tripartite Commission to lay out a

repayment schedule for the outstanding debt and for incorporating the PROHECO teachers

into the INPREMA.32

Expected Results

70. The pension system’s financial condition will improve as result of the measures. The combined introduction of the parametric reforms will reduce the INPREMA’s actuarial

deficit by 43 percent and by 51 percent in the case of the INJUPEMP. The parametric changes

introduced in the laws will provide a solid base and cash flow consolidation which in turn will

substantially reduce the actuarial deficit for both institutions. Improved governance will set

the stage for adequate administrative, and investment performance. In the case of INPREMA,

the increase of the retirement age to 65 together with prioritization of future pension payments

will stabilize its net worth in real terms for the next 20 years. The Government’s long-term

agenda includes the reform of the IHSS separating the Pension from Health.

31 This was accomplished by the issuance of the Executive Agreement N°369-01 signed on July 13, 2001. 32 This will be operationalized through the production of three instruments: a) a Tripartite Agreement formalizing the

Incorporation of the PROHECO teachers into INPREMA; b) a Tripartite Agreement formalizing the scheme for the

repayment of the floating debt of PROHECO teachers with INPREMA in a period of 5 years starting in 2012; c) the inclusion

of an article in the Special Clauses of the National Budget 2012 securing the resources to honor the payment of the first

installment of the floating debt in 2012.

30

71. Increasing the base of IPM contributors will improve the institute’s actuarial

prospects. Additional contributions will bring immediate resources to cover present

payments, balancing the cash flow and allowing for the building of reserves for the near

future. However, detailed actuarial projections will be needed to validate the institute’s long-

term stability.

72. PROHECO teachers will have their situation regularized. The commitments and

agreements reached bring to an end the uncertainty over which institution should pay the

pensions of these teachers. Having been signed, the teachers now have the same pension

coverage as the teachers participating in INPREMA.

Government’s Medium-Term Reform Agenda

73. The Government is working on a long-term plan to tackle remaining issues. They

include portability of contributions and developing an action plan to resolve issues IHSS faces

both in pensions and health.

74. A new provision (Ley de transferencia de valores actuariales) will address

portability. Signing and implementing agreements mandated by the law will allow

participants to accumulate enough years of service and qualify for a proportional pension

from the institutes to which the participant has contributed.

75. The increase in the IHSS’s maximum contributory salary is the continuation of a

healthy trend toward bringing more resources to the institute. In relative terms, however,

L$7,000 is low—almost equivalent to the minimum legal salary. The pension contribution

rate of 3.5 percent of the salary is very low compared with other Central American countries.

The cash flow situation of the IHSS health segment will require further intervention. In the

coming months, the Government will draft a new law to reform IHSS that separates the health

and pensions management, which is a trigger for the next DPC.

Box 4: Prior Actions – Pension Reform

Reform the public pension systems

To reduce the actuarial deficits of the public pension systems, the Government has: (i) submitted to Congress, for

approval thereof, a bill of law to reform INPREMA’s pension system, as evidenced by acknowledgement

(Constancia), dated October 26, 2011 signed by the first secretary of Congress; and (ii) submitted to Congress,

for approval thereof, a bill of law to reform INJUPEMP’s pension system, as evidenced by acknowledgement

(Constancia) signed by the first secretary of Congress, dated April 26, 2011.

To regularize the pension regime for the PROHECO teachers, the Government has formalized the incorporation

of the PROHECO teachers to the INPREMA pension system as of the date each said teacher was appointed, as

evidenced by: (i) agreement signed among SEFIN, SE and INPREMA (Convenio de Afiliación), dated October

27, 2011; and (ii) agreement signed by SEFIN with INPREMA to cancel the Recipient’s debt to INPREMA with

respect to teachers’ and employers’ contributions (Convenio de Cancelación de Deuda), dated October 27, 2011.

To strengthen the financial situation of IHSS, the Government has increased the maximum salary subject to

contribution to IHSS, as evidenced by Resolution SOJD No. 02-29-03-2011, and published in the Official

Gazette on June 17, 2011.

31

Component 3: Civil Service Reform

Background

76. Achieving a fiscally sustainable wage bill remains a crucial challenge for

Honduras’ public administration. Steady increases in teachers’ pay and benefits in 2006-

2009, combined with ineffective controls over the creation of new posts and payroll

management, pushed personnel expenditures from 8.3 percent to 11 percent of GDP, or about

75 percent of tax revenues. In particular, the largest jump in the wage bill was in 2009 when

the salaries increased by more than 20 percent. Teachers’ pay accounted for 53 percent of the

Government’s wage bill in 2010; teachers were approximately 57 percent of the public

sector’s workforce. The teachers’ salaries in Honduras are among the highest in Latin

America (See Section IV) and are about 7 times higher than the private sector minimum

wage.

77. Since 2010, the Government has made significant efforts to contain personnel

expenditures, particularly in the education sector, but these changes will need to be

sustained over time. A teachers’ payroll audit in 2010 has allowed the Government to

eliminate ghost workers and stop payment of incorrect allowances. Better controls over

payroll information systems by SEFIN have strengthened the Government’s capacity to

contain the number of teacher positions. The new controls align the actual positions with

those authorized by the budget and prevent potential mistakes when calculating and

processing payments. The Government has frozen the teachers’ pay per class hour between

2010 and October 2011 by temporarily delinking base pay from the private sector’s minimum

wage and not adjusting for inflation.33

The audit and elimination of anomalies were mostly

one-time efforts. However, the Government will need to continually enhance controls in the

next years and seek a more sustainable and at the same time politically viable solution.

78. Control over the creation of new positions and pay negotiation are areas of

particular concern. SEFIN and the Civil Service Agency lack legal or management control

instruments over the creation of new positions, particularly in the education sector and the

decentralized administration. In addition, negotiations with trade unions have been

fragmented due to the existence of more than eight different employment regimes.34

Different

provisions apply to different staff groups, which have sought to leap-frog each other to

preserve their benefit differentials. Legislative Decree 220/2003 (Ley de Reordenamiento del

Sistema Retributivo del Gobierno Central) regulates pay negotiations, basing them on

expected inflation. It provides a ceiling for the public sector’s consolidated wage bill as a

percentage of GDP, but the regulations and the limit were bypassed by the pay increases

granted to teachers during the Zelaya administration.

33 The Teachers’ Statute indexes pay adjustments to increases in the average private sector minimum wage. See Legislative

Decree No. 136-1997, articles 46, 48 and 49. Legislative Decree No. 224-2010 suspended any pay measures established in

the statutes of special regimes during the period October 28, 2010 to October 27, 2011. 34 These eight groups include the seven professional statutes (teachers, doctors, pharmaceutical chemists, dentists, social

workers, microbiologists and professional nurses) and the regular civil service. Military personnel and the police also

negotiate pay increases separately.

32

Government Actions

79. The Government has sent a bill to Congress for containing wage bill growth by

anchoring pay negotiation for all public servants, including all special regimes, on the

previous year’s inflation level. By applying the same pay adjustment methodology for all

public servants, the draft bill, submitted to Congress in October 2011, would delink

permanently the teacher’s salary adjustments from the private sector minimum wage. The use

of the previous year’s inflation, as determined by the Central Bank, as the basis for pay

negotiation for all public servants, will enhance equity of pay increases while maintaining

purchasing power of public servants. The pay increase being negotiated between the

Government and the public sector trade unions following the approval of the proposed new

law is expected to end the wage freeze for teachers established since January 2010. The draft

bill aims to provide predictability for personnel expenditures growth and contribute to achieve

a fiscally sustainable wage bill in the medium term.

80. The Government has also implemented stronger controls over payroll. Executive

Decree PCM-006-2011 created and implemented a Payroll Monitoring and Control Unit at

SEFIN to monitor overall payroll with an initial focus on teachers and the health sector. The

Government has also included teachers in the centralized database for payroll management

that links SIAFI and SIARH, increasing coverage from 23 percent to about 83 percent of all

central administration permanent staff. Finally, the Government has approved Executive

Decree PCM-032-2011, regulating the procedures for any measures that have a financial

impact on the education wage bill, including the authorizing mechanisms for processing the

education sector payroll. The Executive Decree will provide stronger controls to SEFIN by

linking authorized positions in the budget to the payroll, allowing online monitoring of

payments, and the introduction of automated controls in SIAFI to prevent payments without

available resources, among other control mechanisms.

Expected Results

81. Anchoring pay negotiation with the previous year’s inflation level as determined

by the Central Bank of Honduras for all public servants, including all special regimes, is

fundamental to the Government’s objective of achieving a fiscally sustainable wage bill.

The proposed law provides predictability and control over the wage bill and would avoid the

scenario of fully applying the methodology established in the teachers’ statute (see Box 6).

Increased management controls are also expected to contribute to the same goal. The Central

Government’s wage bill is expected to be 9.9 percent of GDP in 2011, and then slowly

decrease in the following three years (Figure 6). Enhanced controls over the payroll will limit

the creation of new positions to those authorized in the budget and reduce potential mistakes

in calculating base pay and allowances.

33

Figure 6. Evolution of Honduras Central Government’s Wage Bill 2006-2010 and

Projection for 2011-2014 following the proposed law to establish a uniform pay

adjustment methodology and stronger controls

(As percent of GDP)

Source: SEFIN

0

2

4

6

8

10

12

2008 2009 2010 2011 2012 2013 2014

Box 5: Prior Actions – Civil Service Reform

Achieve a fiscally sustainable wage bill

To ensure equity of salary increases for all public servants, the Government has submitted to its Congress, for

approval thereof, a bill of law to establish a uniform pay adjustment methodology for all said public servants, as

evidenced by acknowledgement (Constancia) signed by the first secretary of Congress, dated October 28, 2011.

To strengthen the monitoring of the teacher's payroll, the Government has:

(i) Established a single database (SIARH-SIAFI) which accounts for over 80 percent of the Government's public

servants and includes all teachers, as evidenced by a letter from the Minister of SEFIN, dated October 27, 2011;

(ii) created a payroll management and control unit within SEFIN, as evidenced by Executive Decree PCM-006-

2011, dated February 8, 2011, and published in the Official Gazette on March 22, 2011; and

(iii) approved a consolidated set of norms regulating human resource management processes in the education

sector (Normas Unificadas Aplicables a la Gestión de Recursos Humanos Docentes), as evidenced by Executive

Agreement No 032-2011, date October 25, 2011, and published in the Official Gazette on October 25, 2011.

34

Box 6. Potential fiscal impact of the proposed law suspending pay adjustment methodologies for

special regimes

Unlike all the other public sector employment regimes, teachers' pay adjustments are based on the private sector

minimum wage rather than on inflation levels. Article 46 of the Teachers’ Statute establishes that the class-hour

value for calculating teachers’ base pay will be based on a calculation using the average current minimum wage.

All teacher allowances, such as seniority and academic degrees, are in turn, determined following the class-hour

value. According to the 2011 Minimum Wage Agreement (No. STSS-223-2011), the applicable average

minimum wage would value the class-hour at L$ 129.94, compared to the current value of L$ 57.5 (or a 126

percent increase).

If the Teacher’s statue were to be applied in October 2011 by using the current minimum wage, personnel

expenditures in the education sector would skyrocket from L$ 17 billion in 2011 to more than L$46.5 billion in

2012, taking the overall Central Government’s wage bill from 10 percent of GDP to over 18 percent of GDP.

While the government has maintained a wage freeze on teachers since January 2010, this has been politically

difficult to sustain due to inflation levels. The proposed new law, supported by this DPC, applies a uniform pay

adjustment methodology to all public servants including special regimes, ends the wage freeze for teachers by

determining that pay increases will be based on the previous year’s inflation, and provides predictability and

control over public sector personnel expenditures. Thanks to this proposed law, the Central Government wage

bill is expected to reach 9.9 percent of GDP in 2011 and later stabilize below 10 percent during the period 2012-

2014.

Government’s Medium-Term Reform Agenda

82. The Government is committed to achieving a fiscally sustainable wage bill by

having the proposed law approved by Congress and by strengthening controls over

payroll in other key sectors. In the meantime, 2012 Budget Law, expected to be approved in

December 2011 and which in Honduras is primary law, is expected to determine pay increases

for all public servants based on the previous year inflation level according to Central Bank

figures, as mandated by Legislative Decree 220/2003 (Ley de Reordenamiento del Sistema

Retributivo del Gobierno Central). The SEFIN-managed human resources database for

teachers, which is used for payroll management, is expected to be audited on a regular basis

and its equipment will be upgraded with support from a World Bank loan on human resource

management in education. A payroll audit exercise will ensure adequate controls are in place

in all central government institutions in each step of the payroll process to reduce the floating

debt related to personnel expenditures. Transactions-based payroll audits to check accuracy

of individual payments are planned in the Secretariats of Health and Public Works, where a

high number of contracted personnel are paid following manual processes parallel to SIAFI.

The transactions-based payroll audits in these two secretariats and the approval of the

proposed law suspending pay adjustment methodologies for special regimes are triggers for

the next DPC.

83. Finally, the Government also plans to work towards achieving other key human

resource management objectives, such as improving the attraction and retention of

qualified personnel and the professionalization of the civil service. The Government is

already working on institutions such as the Department of Revenues and Customs and the

Banks and Insurance Commission to improve attraction and retention through the creation of

a differentiated pay scale and career structure and plans to introduce externally validated

merit-based selection and recruitment processes for selected positions in pilot institutions.

35

Component 4: Citizen Security

Background

84. Honduras has lacked a comprehensive and integrated citizen security policy. The

systemic multi-sectoral/multi-causal nature of crime and violence has become one of the most

important obstacles to good governance, growth, human development, and economic

development in Honduras. Over the past decade, the Government has been unable to develop

a comprehensive and integrated policy that can meet this challenge. Efforts to prevent

violence by addressing its multiple causes have been marginal, underfunded, and sporadic. A

few innovative experiences at the municipal level have shown the importance of the local

level to coordinate actions that increase safety and peaceful co-existence.

85. The dominant approach has been mostly reactive and focused on repression. In

the first half of the 2000s, the Government adopted an ―iron fist‖ (mano dura) approach,

framing citizen security as an objective that could be reached only through more repression.

Some of the key measures included: modifying the criminal code 10 times between 2003 and

2006 to define new crimes and harden penalties, passing an anti-maras law that made it a

crime to belong to a gang, and modifying the children's code in 2005 to allow for the

detention of juvenile criminals in high-security prisons and lower the age of legal

responsibility to 14 years.

86. The previous administration began to develop a comprehensive policy on citizen

security. Based on executive decree No 095-2006, the Secretariat of Security drafted the

guidelines for an integrated citizen security policy (Bases de la Política Integral de Seguridad

Publica y Ciudadana. Lineamientos para el Plan Quinquenal 2008-2015). The Security

Secretariat has the mandate to develop strategies, plans, and programs on security related to

the public order, peaceful coexistence, violence prevention, criminal investigation, and citizen

safety. It also regulates issues related to migration and security, detention centers, and the

management and administration of the national police among other functions. The draft

guidelines for the citizen security policy addressed four key areas: (i) violence prevention, (ii)

reaction or coercion, (iii) rehabilitation, and (iv) reintegration. The guidelines were prepared

with the participation of a broad range of Government institutions and the active participation

of civil society organizations working on human rights and security issues, including the

Center of Investigation and Promotion of Human Rights (CIPRODEH) and the Women

Rights Center (CDM) among others. Government delays and the political crisis in 2009

hindered the guidelines’ approval by the Council of Ministers. Nevertheless, it has been an

important precedent and input for the National Citizen Security Policy recently approved by

the current administration. For instance, several recommendations included in the draft

guidelines for the public policy on citizen security have been included in the recently

approved integrated policy, such as the creation of a sub-secretariat of coexistence and

community participation, promotion of private sector participation in violence prevention

activities, and the creation of a National System of Citizen Security.35

35 Guidelines for an integrated public policy on citizen security in Honduras. Consultation Process with Civil Society

Organizations. Center of Investigation and Promotion of Human Rights (CIPRODEH). April, 2008

36

87. Measures to prevent crime and violence have been marginal thus far and

fragmented. In 2001, a national program for the prevention, rehabilitation, and social

reinsertion of mara members and gangs was created. However, it was not until 2005 that the

program actually started with a very small budget. Its approach goes beyond the issue of

gangs by addressing the risk factors that generate youth violence and exclusion. Recently the

program has received additional funds to carry out a public policy and national campaign on

violence prevention at the national and municipal levels. Programs on crime and violence

prevention are dispersed across government agencies without coordination or interaction with

each other (e.g., National Institute of Youth, National Institute of Women, Family and

Childhood Institute, etc). Nevertheless, some projects appear to be delivering positive results,

such as the World Bank funded Barrio Ciudad Program implemented by FHIS which

promotes community-based initiatives for violence prevention in 10 municipalities. In

addition, a new law, which creates a national council on coordination and the definition of the

social policy (Consejo Nacional de Coordinación y Articulación de Politicas Sociales

[CONCAPS]) has been approved by Congress. This council has the potential to be an

important platform for enhancing collaboration on violence prevention interventions among

government and civil society organizations working on the issue (e.g. FHIS, National Institute

of Youth, National Institute of Women, etc).

88. While there has been progress in terms of strengthening inter-agency

coordination, there is room for improvement on the policy side. The Government has been

convening more regularly its Security, National Defense, and Governance Cabinet (Gabinete

de Seguridad, Defensa Nacional y Gobernabilidad) to achieve greater inter-ministerial

coordination within the executive branch.36

What has been missing is a mechanism for

coordination across branches of government (particularly between executive and judiciary)

and between national and local levels of government (see next section on establishment of

Citizen Security Council to address this). In addition, a key challenge for the Honduran

criminal justice institutions is to ensure that effective coordination mechanisms are in place,

and that the decisions of senior management are effectively implemented at the intermediate

and lower levels of each organization. More effective and simpler coordination instruments

are needed. An action plan to improve inter-institutional coordination among the agencies

involved in criminal justice and security is essential to ensuring effective implementation of

the citizen security and co-existence integral policy. (See Annex 7 for a description of key

institutions in security and justice sectors).

89. Honduras has relatively weak information systems. The country lacks an integrated

information system capable of collecting, producing, and analyzing crime statistics. The

national police, the Attorney General’s Office, the judicial and health systems use different

definitions, methods, and practices to register and report crimes. Furthermore, the national

police lack unified instruments to collect data produced by different departments such as the

preventive, criminal investigation, special services, and traffic police. Therefore, information

on crime and criminal justice is contradictory, unreliable, and fragmented In this regard, the

National Violence Observatory, which is operating in the National University of Honduras,

has been created in Honduras as a mechanism to register, process, and analyze information on

36 The Cabinet is comprised of the Secretariat of the Presidency, the Secretariat of Justice and Human Rights, the Secretariat

of the Interior and Population, the Secretariat of Security, the Secretariat of Defense, and the Secretariat of Planning and

International Cooperation. Its mandate is to ensure that the activities of the key actors involved in citizen security and justice

in the executive branch are in line with the main presidential priorities established in the Nation’s Plan.

37

crime and violence; however, it currently lacks the equipment and human resources needed

for an optimal performance. Municipal observatories have also been established in addition to

specific modules on violence against women and children.

90. Local governments have been at the forefront of the innovations in citizen

security. Some municipalities, such as Puerto Cortes, have developed successful mechanisms

to raise security taxes and manage them transparently through a trust fund monitored by local

authorities, the private sector, and civil society organizations. In addition to the Bank financed

Barrio Ciudad program, UNDP has supported a program to increase local governments'

capacities to develop citizen security plans. The program is being carried out in coordination

with the Secretariat of Security in cities such as La Ceiba, Choloma, Juticalpa, Comayagua,

Choluteca, and Islas de la Bahia. IDB (with its project in the Sula Valley), the Spanish

cooperation, and USAID have also funded initiatives at the municipal level. Despite the

progress achieved so far, these efforts are isolated and lack evaluations to measure their

effectiveness.

Government Actions

91. In early October 2011, the Government approved a comprehensive and

integrated National Citizen Security and Co-existence Policy for 2011-2022. This is the

first time the Government has adopted a policy that combines the traditional emphasis on

crime control with a strong emphasis on preventing crime and violence. This integrated policy

reflects the key principles and programs recommended by the guidelines for an integrated

citizen security policy in Honduras developed by the previous administration in consultation

with civil society organizations. It is the product of a long process of analysis, discussion, and

negotiations related to a comprehensive public policy on citizen security in the country. The

policy defines citizen security as the effective protection of a wide range of human rights,

specifically the right to life, the right to physical and emotional integrity and other rights

related to personal safety (security of one's home, freedom of movement, the right to personal

property), in addition to collective rights such as the freedom to access public spaces. The

strategy’s three pillars include: (i) strengthening national and local management of citizen

security policy, (ii) implementing programs on crime and violence prevention and social

cohesion with a human rights approach, and (iii) strengthening the infrastructure for security,

alternative justice, and the penitentiary system. The policy aims to address the main risk

factors (such as guns, drugs, gangs, lack of family and community cohesion) and protective

factors (such as a culture of prevention, availability of conflict resolution mechanism) that

influence crime and violence (Figure 7). The new policy acknowledges that sound decision-

making should be based on accurate and updated information, and thus envisions the

strengthening of criminal justice information systems, and the Universidad Nacional

Autonoma de Honduras’ Violence Observatory. The policy is being supported by a broad

coalition of international partners, including IDB, EU, USAID, CIDA, Spanish Cooperation,

GIZ, UNDP, and the Bank.

38

Figure 7: 2011- 2022 National Citizen Security and Co-existence Policy

Strengthening national and local management of citizen security

and coexistence policy

Creation of the National System of Citizen Security

and Coexistence

Creation of the National Citizen Security Council

Institutional strengthening of the Security Secretariat

Implementation of the national program "Safer

municipalities" (municipios mas seguros)

Promoting inter-sectorial interventions in

municipalities with high concentration of violence and

crime

Establishment of the violence and crime information system

Strengthening of the observatory of violence

Promotion of citizen and private sector participation

Coexistence and crime and violence prevention programs with a human rights approach

Promoting changes in citizen behavior

Promoting a culture of citizenship

Supporting the control of arms and explosives

Supporting the control of psychoactive substances

Strengthening departments of municipal justice, units of conciliation and mediation,

and the creation of integrated justice centers

Implementing programs for youth at risk

Formulation of the policy for road safety

Strengthening of infrastructure for security, alternative justice, and detention centers to address

crime and violence

Master plan for equipment for the police and prisons

-Strengthening human resources (training)

-Improving administrative and operational offices of the police and prisons

-Modernization of communication resources

-Modernization of logistical equipment (cars, bikes,)

Strengthening criminal investigation and intelligence

Improving international cooperation in the fight against drug trafficking

Prevention Crime Control

39

92. In terms of institutional development, a critical reform introduced by the policy is

the creation of the National Citizen Security Council. The Citizen Security Council will

report directly to the president and will be given responsibility for the elaboration of the

policy’s action plan and its oversight mechanisms. The Council’s multi-stakeholder

composition will ensure that the National Citizen Security and Co-existence Policy is

implemented in a way that represents the views not only of the national Government through

the Security Cabinet, but also of the judiciary, local authorities, civil society, and the private

sector. This council is comprised of the President of the Republic, the Security Secretariat

(which will act as the technical secretary), the Secretariat of Interior and Population, the

Secretariat of Justice and Human Rights, the Office of the Attorney General, the national

police, the Supreme Court, line ministries and institutions working on crime and violence

prevention.37

93. In terms of policy content, the innovation of this policy lies in its call for a

paradigmatic shift in the Government’s approach to citizen security. This shift can be

characterized as moving away from the traditional exclusive focus on law enforcement

measures towards one that complements it with a new emphasis on the social prevention of

crime and violence as evidenced by the inclusion of programs aimed at:

Protecting youth and children at-risk of violence through a set of interventions that,

among other things, strengthen parenting skills within dysfunctional families, establish

social bonds between alienated youth and their communities, and prevent addiction to

alcohol and drugs.

Scaling up alternative dispute resolution mechanisms as a way to prevent that minor

conflicts escalate into violent altercations by strengthening municipal justice offices

and conflict mediation units, creating integrated justice centers, strengthening

municipal counseling offices for women, and reforming legislation (see below).

Building citizenship and culture of peace through programs that enable proper and

safe use and enjoyment of public spaces, promote social and economic inclusion of

vulnerable populations by building their life and work skills, civic competences, and

their disposition to become agents of social change.

Promoting road safety through the formulation of a national road safety policy,

mainstreaming road safety principles in the construction of road infrastructure and

promoting behavioral changes among all road users through education and awareness

campaigns.

94. The recent passage of the population security law (Ley de Seguridad Poblacional),

creating new taxes to finance security and social prevention programs, increases the

chances that these institutional and policy innovations will deliver concrete results (see

Box 7). Addressing the escalation of violence in a sustainable manner requires the

mobilization of additional resources. Following the example of successful countries like

Colombia in creating new specific taxes to finance additional security programs, on

September 13, 2011 Congress approved a security tax law.38

Revenues from the new law

should help boost the share of the budget allocated to security in Honduras, which is

37 In addition, the National Council of Interior Security (Consejo Nacional de Seguridad Interior or CONASIN) was created

in 2008 as a body through which civil society and private sector could advice the Security Secretariat in policy design and

implementation. The performance of CONASIN has yielded mixed results and the Government is reviewing its role. 38 Congress approved in June 2011 an initial version of the Population Security Law but was modified significantly in

September 2011.

40

approximately 10 percent of the total budget, lower than El Salvador (19 percent of the total

budget), Guatemala (13 percent of the total budget) and Nicaragua (12 percent of the total

budget). From 2006 to 2010, security expenditures in Honduras have increased about 76

percent, while total crime and homicides have also increased during this time frame

(homicides increased from 46 per 100,000 inhabitants in 2006 to 77.5 per 100,000 inhabitants

in 2010). A thorough review of the security and justice sectors budgets will shed light on

challenges and opportunities for improving budget allocation within citizen security.39

Box 7. Taxes created by the Population Security Law (Ley de Seguridad Poblacional)

Recognizing the importance of collecting additional revenues for security programs and following the example

of Colombia and other countries that have needed to resort to novel taxes for this purpose, the Honduran

congress created the following new taxes which are expected to yield revenues of about 0.3 percent of GDP

annually:

A 0.2 percent financial transactions tax on withdrawals from individual checking accounts and corporate

saving accounts with a monthly average balance greater than 120,000 lempiras. Remittances and

transactions from the public sector among others are exempted.

A tax on annual renewals of credit cards. The tax ranges from 500 to 1000 lempiras and depends upon the

credit’s card limit.

A 2 percent tax on FOB exports from mining companies.

A 1 percent tax on the mobile phone industry’s service monthly gross income.

A 0.5 percent tax on the food and beverage industry’s monthly gross income under special tax exemption

regimes.

Expected results

95. The creation of the Citizen Security Council and the social prevention emphasis

of the Citizen Security and Co-existence Policy are expected to deliver a diverse set of

results in the short, medium, and long term. On the institutional side, greater coordination

across sectors and levels of government should result in more comprehensive and integrated

municipal security plans, which in turn should help reduce the sense of insecurity and fear of

crime and violence as well as the opportunities for crime through situational prevention

interventions. Increased access to alternative conflict resolution mechanisms and campaigns

aimed at promoting a culture of peace should reduce the levels of conflict and violent crime.

Increased economic, educational, and leisure opportunities for at-risk youth could reduce the

number of youth joining criminal gangs. Finally, improved collaboration and strengthening of

the security and criminal justice sectors may lower impunity rates, and lead to overall

improvements in the efficiency and effectiveness of sector expenditures.

39 The distribution of the budget has remained almost constant, with the largest share allocated to operational expenses (79.4

percent in 2009 and 77.3 percent in 2010). Most notably, from 2009 to 2010 almost 10 percent of the budget in security

shifted from crime prevention to institutional building. The budget allocated to prevention declined from 11.4 percent to 2.7

percent from 2009 to 2010, while the budget allocated to institutional building increased from 5.3 percent in 2009 to 15.2

percent in 2010. While these trends are not very different from the distribution of the budget in other countries in the region,

it is noticeable that there is a relatively lower share of the budget allocated to prevention in Honduras when compared with

other countries in Central America.

41

Box 8. Prior actions- Citizen Security

Improve citizen security

To support the prevention of crime and violence and achieve the Government's development and poverty

reduction objectives, the Government has: (a) adopted a violence prevention strategy of proposed programs

focused on: youth at risk, alternative conflict resolution, road safety, and citizenship building, as evidenced by

Decree No. PCM 057-2011, dated September 6, 2011, published in the Official Gazette on October 1, 2011; and

(b) created the National Citizen Security Council, as evidenced by Decree No. 003-2011, dated October 18,

2011, published in the Official Gazette on October 20, 2011.

Government Medium-Term Agenda

96. The Government will develop an Action Plan to ensure an effective

implementation of its National Citizen Security and Co-existence Policy. The Security

Secretariat, supported by the Security Cabinet and the National Citizen Security Council, will

coordinate this policy through a plan establishing goals, milestones, operational rules, and

funding mechanisms for its various programs and components by March 2012. The policy

also proposes to strengthen the National Violence Observatory which will facilitate useful

information for planning and designing crime and violence prevention programs. With the

introduction of the security tax, the Government is committed to ensuring the necessary

resources to implement its policy, and managing them in a transparent, accountable, and

results-oriented manner. Funding and technical assistance for the implementation of the action

plan will come from the Security, Justice and Human Rights Donors Group. In addition,

specific grievance mechanisms can be included in the policy’s action plan at the national and

local levels. These mechanisms could be developed in close collaboration with the Secretariat

of Justice and Human Rights, the Office of the Human Rights Prosecutor, and civil society

organizations working on human rights issues.

97. An important element of this Action Plan will be the operationalization of the

Government’s flagship Safer Municipalities Program, which places municipalities at the

center in the development of integrated citizen security strategies. The program aims to

improve citizen security across municipalities by strengthening: (a) coordination between

national government agencies, police, judiciary, and local governments, and (b) partnerships

between the local government, citizens, private sector, and community organizations. The

model outlined in the Safer Municipalities Program is based on integrated municipal citizen

security plans designed by multi-stakeholder citizen security councils led by the mayor.

Among other activities, the municipal plans include the mapping of violence and conflict in

communities through participatory assessments, the strengthening of local crime information

systems, improving public-private partnerships, and developing alternative mechanisms for

conflict resolution at the local level. In this regard, addressing citizen security at the municipal

level has showed successful results in dropping interpersonal crime rates and promoting

citizen coexistence in cities such as Bogota, Medellin and Quito, as well as in Honduras itself

through the Bank-financed Barrio Ciudad Project. The Government plans to pilot the Safer

Municipalities Program in at least 10 municipalities with the highest levels of crime and

violence in the country. As a key element of the citizen security policy, the Safer

Municipalities Program has been launched and discussed among local governments, judicial

42

operators, and civil society organizations in Tegucigalpa as well as in various regions of the

country.

98. The Government is designing a violence prevention program at the municipal

level called “National Campaign for Violence Prevention.” It will coordinate prevention

activities among schools, health posts, community organizations, and municipal offices of

women, youth, and conflict resolution. The initial emphasis will be on creating opportunities

for youth at risk, and will start in 50 municipalities. While in the beginning it will be managed

by an office that reports directly to the president, it is envisioned that it could be absorbed by

the Ministry of Social Development, tasked with the role of coordinating social policies. This

national program should help operationalize the prevention pillar of the Citizen Security

Policy at the national level, and the prevention component of the Safer Municipalities

program at the municipal level.

99. The Government is also planning to promote a more active role of local

governments in terms of alternative conflict resolution mechanisms. To achieve this

objective, the Security Secretariat and the Secretary of the Interior plan to reform the

arbitration and conciliation law (Ley de Arbitraje y Conciliación) to expand the authority of

municipal governments regarding alternative conflict resolution mechanisms. Expanding

alternative conflict resolution mechanisms is a critical service to promote a culture of peace

and respect for basic rights at the local level, and to reduce the excessive workload of the

judicial system. The Bank is proposing to make the approval of the Ley de Arbitraje y

Conciliación an indicative policy action for the second operation of this DPC series.

100. The Government is developing a policy to improve inter-institutional

coordination among the National Supreme Court, the Attorney’s General Office and the

Security Secretariat. Effective coordination among agencies involved in criminal justice

and security is essential to complement the security and violence prevention focus of the

citizen security and co-existence policy. This policy will provide guidelines related to legal

harmonization, crime prevention, modernization of the criminal justice and police systems,

and inter-institutional coordination among judicial operators. It will also include a human

rights perspective to criminal justice issues. The EU has conditioned its second operation in

the security sector (for 30 million euros) on the approval of this policy and is mobilizing

substantial technical assistance resources to support its design. The Bank is proposing to make

the approval of this policy an indicative trigger for the second operation of this DPC series. In

addition, the Bank will conduct a Public Expenditure and Institutional Review of the

justice and security sectors.

Overall Operation’s Design and Conditionality Principles

101. The operation’s design takes into account good practice principles on

conditionality. These include strong country ownership through close cooperation and

technical assistance, close coordination with other development partners (especially the IDB

and the IMF), alignment of the operation with the Government’s reform timetable, and

selection of critical structural reforms that will yield medium- to long-term benefits (Box 9).

43

Box 9: Good Practice Principles on Conditionality

Principle 1: Reinforce Country Ownership.

• The operation is closely aligned with the Government’s National Plan and the pension reform package, which

was submitted to Congress this year.

• It is accompanied by a program of technical assistance, supporting the Government in the design and

implementation of the reforms.

Principle 2: Agree upfront with the Government and other financing partners on a clear division of labor.

• The operation’s policy matrix was developed in close cooperation with the Government, and jointly agreed

upon with other key development partners, especially the IDB and the IMF.

• All donors involved in budget support meet regularly and closely coordinate their support.

Principle 3: Customize the components and structure of the operation to country circumstances.

• The timing of the operation is aligned with the Government’s reform timetable and financing needs.

• Potentially controversial reforms were designed so that the impact on poorer groups is mitigated by other

measures (such as the CCT program).

Principle 4: Choose only actions critical for achieving results as conditions for disbursement.

• Four prior actions were selected based on their structural nature and criticality for re-establishing fiscal

sustainability. In addition, two prior actions were selected to tackle citizen security.

Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based

financial support.

• In response to the Government’s request, the operation’s timetable would allow for disbursement in CY2011

to help meet the Government’s financing needs.

• The operation’s outcome indicators will be jointly monitored by the Government and the Bank.

VI. OPERATION IMPLEMENTATION

Poverty and Social Impact

102. The policy actions supported by this operation are likely to have short, medium,

and long-run impacts on welfare and its distribution. For instance, in the short run,

teachers and contributors to IHSS, INPREMA and INJUPEM will be affected by: (i) the

increase in the salary ceiling for contribution to IHSS from LPS 4,700 to LPS 7,000, (ii)

delinking of teachers’ salaries from the private sector minimum wage, (iii) the increase in the

employees contribution rates from 7 to 9.5 percent of salaries for INPREMA participants, and

(iv) the increase in the employees’ contribution rates from 7 percent to 8 percent for

INJUPEMP participants. Also in the short run, the increase in private school employers’

INPREMA contribution from 11 percent to 15 percent is likely to negatively affect the

welfare of those sending their children to private schools because demand for private

education is likely inelastic and additional costs would be completely transferred to

consumers. The increase in public school employers’ INPREMA contribution from 12 percent

to 15 percent is likely to affect welfare only indirectly via additional fiscal deficits.

Nevertheless, these impacts are likely to be small in the short run.

103. While in the short run, the increase in the salary ceiling for contributions to the

IHSS are likely to affect mostly the non-poor, only a small share of households are likely

to be pushed below the poverty line. As seen in Figure 8, approximately 85 percent of the

IHSS participants that earn more than Lps 4,700 belong to the upper two quintiles and are

unlikely to become poor because of the reforms. Approximately 3.6 percent belong to the

44

bottom two quintiles, and while they may be pushed deeper into poverty, the expansion of the

CCT program Bono 10,000, which is targeted to the extremely poor, is likely to mitigate some

of this negative impact. The estimates also suggest that approximately half of those belonging

to the third quintile (6 percent of IHSS participants) are likely to be pushed below the

moderate poverty line. For those, the expansion of CCT program is unlikely to be a mitigating

factor, however.40

Figure 8. Distribution of IHSS Participants that will be affected by the Reforms

by Income Quintile

Source: World Bank Staff Calculations with data from 2007

Encuesta Permanente de Hogares de Propósitos Múltiples, Instituto

Nacional de Estatistica, Honduras.

104. In terms of their distribution, the short-run impacts of the policy actions related

to INPREMA are unlikely to hurt the poor. Almost 93 percent of teachers who contribute

to INPREMA belong to the upper two quintiles of the income distribution (Figure 9). In

particular, more than 78 percent belong to the top quintile. Thus, the delinking of teachers’

salaries from the private sector minimum wage and the increase in employees’ contribution to

INPREMA are unlikely to have negative poverty impacts. Moreover, in the long run, the

reforms should help the country in allocating more fiscal resources to more effective anti-

poverty programs by reducing the likelihood that the country would have to allocate general

fiscal resources to cover INPREMA deficits. Also, families who send their children to private

schools, who are likely to be impacted in the short run by the increase in the employers’

INPREMA contribution, tend to be the richest in Honduras.

40 The CCT program is targeted to the extreme poor.

0.4%3.2%

11.8%

26.2%

58.5%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

1 2 3 4 5

45

Figure 9. Distribution of INPREMA Participants by Income Quintile

Source: World Bank Staff Calculations with data from 2007

Encuesta Permanente de Hogares de Propósitos Múltiples,

Instituto Nacional de Estatistica, Honduras.

105. In the short run, the increase in the employees’ INJUPEMP contribution from 7

percent to 8 percent of salaries is unlikely to affect poverty and equity negatively. As in

the case of INPREMA, more than 92 percent of INJUPEMP participants belong to the upper

two quintiles of the income distribution, and approximately three-quarters of them belong to

the top quintile (Figure 10).

Figure 10. Distribution of INJUPEMP Participants by Income Quintile.

Source: World Bank Staff Calculations with data from

2007 Encuesta Permanente de Hogares de Propósitos

Múltiples, Instituto Nacional de Estadistica,

Honduras.

106. Teachers’ real wages are likely to maintain current levels due to their pay

increase based on inflation, but will be lower compared to the pay adjustment

methodology mandated by the Teachers’ Statute because of the de-linking of their

salaries from the private sector minimum wage. Nevertheless, this is unlikely to affect the

poor as most teachers belong to the upper two quintiles of the income distribution. Moreover,

the new Law for Education is expected to partially countervail these negative wage effects. It

will ensure a minimum education threshold for individuals to become teachers (university

education) and will allow and encourage teachers to obtain graduate degrees in education.

These extra credentials are expected to lead to a new salary scale for the teaching profession,

allowing for more flexibility in salary increases within the current teacher wage grids. Also,

1.3 0.85.2

14.5

78.2

0

10

20

30

40

50

60

70

80

1 2 3 4 5

0.8 1.15.9

19.3

72.9

0

10

20

30

40

50

60

70

80

1 2 3 4 5

46

the creation of the National System for Teacher Training will provide an important boost for

the teaching profession formalizing (and institutionalizing) a long overdue demand from

teachers for permanent and relevant capacity building across the teacher corps, all of which

also has important salary implications for teachers. The combined effect of the reforms in the

education sector is likely to be higher quality of teaching in public schools, which will benefit

especially poorer households.

107. Teachers in Honduras receive relatively high salaries when compared to other

countries in LAC and Central America, and alleviating the fiscal burden associated with

the large teachers’ payroll will allow the country to invest more in reducing poverty and

inequality in the medium and long-run. As shown in Table 6, at 6.6 percent of GDP,

Honduras spends 60 percent more in public education than the LAC average. It spends, on

average, almost 32 percent more than Costa Rica, a country known for its high investments

and positive results in public education. On average, educational spending in Honduras is

highly inefficient. World Bank (2007, p.29) shows that the efficiency of education spending

(dollars invested per unit of educational outcome attained) is, on average, lower in Honduras

than elsewhere in the region. 41

The bulk of this spending goes to the salaries of teachers, who

are relatively better off than comparable professions. In fact, as indicated by the labor market

analysis presented in the Public Expenditure Review (PER, World Bank, 2007), Honduran

teachers are remunerated 16 to 25 percent more than similarly qualified counterparts outside

the education sector, especially in the 35-to-50 age group.42

Therefore, a gradual decrease in

teachers’ pay is not only likely to reduce income inequality, but it is also likely to free up

fiscal space to expand access to education to a growing school-age population.

Table 6. Education Outcomes in Central and Latin America

Source: UNESCO and World Bank EdStats.

* Central Government Expenditures in Education

108. While there are no “victimization” data linked to income or expenditure surveys

in Honduras, it is likely that the poor, especially the urban poor, are the ones that suffer

the most with crime and violence. Rich households are more able to defend themselves by

investing in private security and demanding police protection. The urban poor often live in

communities controlled by gangs and are more exposed to murders, extortion, and robberies.

Corrupted police forces, while often ensuring the safety of the rich, frequently victimize the

poor as well. In the medium run, therefore, policies enacted to combat crime and violence are

likely to be progressive because the poor have more to gain in terms of welfare than the rich.

41 Out of 22 countries ordered in descending order of efficiency, Honduras ranks close to the bottom in terms of this

indicator. See ―Project Appraisal Document on a Proposed Credit in the Amount of SDR9.8 million (US$15.37 million

equivalent) to the Republic of Honduras for an Education Quality, Governance and Institutional Strengthening Project‖,

Report N°40514-HN; Washington, DC: The World Bank. 42 Note that such comparison does not take into account the fact that the teaching profession tends to have lower working

hours and larger vacation periods than non-teacher professions of equally educated counterparts. See World Bank

(forthcoming), ―Teachers in the LAC Region: Honduras Country Note‖.

Honduras Costa Rica El Salvador Guatemala Nicaragua LAC

Adult Literacy Rate (age 15+), 2004-2009 , % 83.6 96.1 84.1 74.5 78.0 90.5

Primary Completion Rate, 2004-2010, % 84.1 89.6 85.9 76.9 93.8 93.8

Net Primary Enrollment, 2004-2010, % 96.6 88.3 94.0 95.1 92.6 92.6

Net Secondary Enrollment, 2004-2010, % 36.1 40.8 55.0 39.9 70.2 70.2

Public Edu.Spending, 2000-2009, % GDP 6.6 5.0 2.9 3.1 3.4 4.1

47

109. In the medium run, welfare and equity are likely to be positively affected by: (i)

the increased efficiency of tax collection, (ii) the fiscal savings resulting from the

delinking of teacher salaries from the private-sector minimum wage, and (iii) the

reduction in crime and violence. Increased revenue collection due to the tax administration

reform and the delinking of teachers’ salaries are likely to expand the Government’s fiscal

envelope, allowing it to invest more on its social programs. For instance, additional revenues

could be allocated to expanding the national conditional cash transfer program (CCT) Bono

10,000. According to the poverty and distributional analysis carried for the Honduras Fiscal

Emergency Recovery DPC (Report number 55656-HN), the CCT’s well-designed targeting

system is very progressive and likely to be effective in reducing poverty and improving the

country’s income distribution in the medium and long runs.

110. The combined impacts of the policies supported by this operation are likely to be

pro-poor in the long run. First, all of them are likely to induce faster economic growth, a

necessary condition for long-term poverty reduction. For instance, increasing the efficiency of

revenue collection is likely to enhance growth by reducing economic inefficiencies linked to

the dead-weight losses of taxes. In addition, crime reduction seems likely to boost economic

growth. Moreover, ensuring the sustainability of pay-as-you-go pension systems in the

country reduce the likelihood that general taxes will be needed to cover future deficits,

another factor likely to help boost growth.

111. Finally, parametric pension reforms that will affect future generations of retirees,

are likely to be progressive and improve the distribution of income in the long run. The

benefit/contribution ratio is likely to fall for all future retirees due to the delay in retirement

age, increase in the contribution rates, and the extension of the time horizon upon which

average retirement benefits are computed. The improved sustainability of the overall system

will reduce the need for additional general fiscal resources in the future. Since the VAT,

which is the main source of revenues in Honduras, is mostly regressive, policies that

minimize the future need for fiscal resources to fund pension deficits out of general taxation

are likely to improve income distribution in the long-run. Moreover, most participants in the

pay-as-you-go systems affected by the reforms belong to the upper quintiles of the income

distribution, which means that the poor are unlikely to be negatively impacted currently and in

the future.

48

Table 7: Likely distributional and poverty impact of measures supported by DPC

Prior Actions Groups Likely to be most

affected

Welfare Impact on

Affected Group* Likely Equity

Impact*

1. Improve taxpayer administration

The Government completed a registry of large

taxpayers and approved an action plan for the

Large Taxpayers Unit.

Incompliant large

taxpayers

-

+

2.1. Reduce the actuarial deficit of INPREMA pension systems

The Government has submitted to Congress a

Law that reforms INPREMA’s pension system. Public sector teachers

-

+

2.2. Reduce the actuarial deficit of INJUPEMP pension system

The Government has submitted to Congress a

Law that reforms INJUPEMP’s pension

system. Public sector employees

-

-

2.3 Formalize the legal situation of the PROHECO teachers

The Government has signed an agreement to

reincorporate PROHECO teachers into

INPREMA. PROHECO teachers

+

+

2.4 Stabilize the IHHS financial situation

The Government has passed a Law that

increases the maximum contributory salary. All private sector

employees

-

-

3.1. Achieve a fiscally sustainable wage bill

The Government has submitted to its Congress,

for approval thereby, a bill of law to establish a

uniform pay adjustment methodology for all

said public servants.

Public sector teachers

-

+

3.2. Strengthen the control of the teacher’s payroll

The Government has started paying teachers’

salaries through SIAFI.

Public sector teachers

-

+

4.1. Improve the citizen security,

The Government has created the National

Citizen Security Council.

All households

+

+

The Government has adopted a violence

prevention strategy of proposed programs

focused on: youth at risk, alternative conflict

resolution, road safety, and citizenship building

All households

+

+

*+ denotes positive impact; - denotes negative impact; = denotes neutral impact.

49

Environmental Aspects

112. The policy actions supported by the proposed operation are not likely to produce

significant impacts on the environment, forests, or other natural resources. The tax

administration reforms supported are not pertinent to environmental regulations. The same

applies to the prior actions related to civil service reforms that pertain to the wage bill control

of the education sector. The prior actions related to pension reform are not likely to have

significant positive or negative effects on the environment.

Consultation and Participation

113. While generating broad-based policy dialogue around national development

strategies within the framework of the Country Vision and National Plan has proven

difficult in the post-crisis context, Government efforts in this regard have been focused

on some of the most pressing, volatile, and politically sensitive issues in the national

public sphere. The policy measures prioritized in the current DPC have been part of this

urgent reform agenda, all of which have also received ample media attention and debate:

Tax administration: Consultation with non-governmental actors has been limited

mostly to business and banking sectors. However, this is a permanent issue in national

media and debate, with widespread support particularly with respect to focusing on tax

evasion and exonerations among large contributors.

Efficiency in public administration, particularly with respect to the wage bill: The

debate has largely focused on education as a sector that represents one of the country’s

largest public wage bills and public budget allocations. At the same time, the

education sector has been plagued by an inefficient administration, corruption at

various levels, poor performance levels, and ineffective mechanisms for accountability

and local oversight/participation. During the past year and a half, the Government has

held consultations on this issue, with ample participation on the part of civil society,

parents associations, teachers’ unions, local governments, and legislators. Most

recently, Congress approved a law to incentivize local participation and oversight in

education. In addition, the Lobo administration and the National Congress have

recently conducted an open multi-sector dialogue process aimed at consensus-building

for a completely new General Law on Education. The leadership of the teachers'

unions is also actively participating in this dialogue, albeit with some periodic flashes

of opposition; nonetheless, there is broad public support for reform, including among

teachers (see Annex 6 for a more detailed discussion).

Pension system reform: This is linked to the previous issue because of the number of

teachers enrolled in the pension system. Although there is widespread recognition of

the urgent need for reforms, debate continues regarding how to best ensure their

sustainability, transparency, and improved fairness in the distribution of benefits (see

Annex 6 for a more detailed discussion).

Citizen security (crime and violence): As perhaps the most pressing development

challenge, there is widespread recognition of the urgent need for action and a

perception that the country still has time to implement measures to combat crime. The

citizen security policy was approved by the current Government administration,

building upon processes of ample consultation with civil society working on citizen

security and violence prevention. The new policy has been consulted among local

50

governments and civil society actors in Tegucigalpa, as well as in various regions of

the country, with particular emphasis on the Safer Municipalities Program.

Nevertheless, some civil society organizations have raised issues of limited

participation in the design of the citizen security policy. Civil society organizations,

particularly those working on human rights issues, have also expressed the need for

increased coordination among crime/justice/security sectors, with a view towards

combating corruption and an adequate focus on prevention, social programs, and

cooperation with local actors in development (see Annex 6 for a more detailed

discussion).

114. Other priority issues at the center of national dialogue during the first half of the Lobo

Administration include:

National reconciliation: Healing the divisions among the population has been a top

priority for the Unity Government message of the Lobo Administration as well as part

of international agreements linked to the 2009 crisis.

Anti-corruption plan: The focus has been on the executive branch. A more complete,

integral plan, with elements within the judicial and legislative branches, as well as

improved coordination among public agencies and effective linkage to citizen-led

initiatives, is needed.

Development of “charter cities”:43

A dialogue has been prioritized among government

officials, members of Congress, and the business sectors. There is enthusiasm in the

country with respect to their potential, but at the same time concern that a rapid

process for approval might not allow for sufficient dialogue to ensure more favorable

conditions for the Honduran population.

115. As noted in the Fiscal Emergency DPC of 2010, ensuring quality multi-

stakeholder dialogue and consultation processes will be key in generating a greater

awareness and consensus around the Government’s reform program as well as

increased public ownership of the overall development strategy. The effort requires active

citizen participation and representation of social sectors from and within the various regions

of the country. One of the most novel aspects of the Country Vision and National Plan is the

new framework for policy dialogue at the national and regional/local levels. However,

progress in this regard has been slow, and the effort has in some cases been discredited by

political interference. In particular, civil society organizations note that there should be

stronger social monitoring of the use of budget support resources. This is a key element that

the Government should not put aside because it represents a great potential for creating

broader awareness and consensus around urgent reforms and broader development strategies.

Implementation, Monitoring, and Evaluation

116. The Ministry of Finance (SEFIN) is responsible for the implementation of the

operation as well as for coordinating the actions among the concerned agencies,

including the Central Bank of Honduras, the Ministry of Education, the Ministry of

Planning, and the Ministry of Security. Together with SEFIN and the National Institute of

Statistics (INE), these institutions collect the necessary data for the identified monitoring

43 A charter city is a city-scale special reform zone that can take many forms. The common elements are: a) An uninhabited

piece of city-sized land, provided voluntarily by a host government; b). A charter that specifies the rules that will govern the

new city; and c) The freedom for would-be charter city residents, investors, and employers to move in or out.

51

indicators. SEFIN and the Bank have agreed to monitor the progress in the program supported

by the DPC, and its evaluation will shape preparation of a new Country Partnership Strategy.

Fiduciary Arrangements

117. The recipient is the Republic of Honduras. The credit is for an amount of 55.1

million SDR, on standard IDA terms to be disbursed in a single tranche. The closing date for

the credit is November 15, 2012.

118. The Public Expenditure and Financial Accountability (PEFA, 2009) report

identified a number of strengths and weaknesses of Honduras’ financial management

systems. The report concludes that a notable modernization of the Public Financial

Management (PFM) system has been implemented in Honduras, but some challenges remain.

SEFIN’s modernization is progressing well, and the main challenges for the administration

are to address the uneven institutional capacity of some key PFM regulatory agencies. In

addition, it will be important to consolidate the advances made in PFM, especially those

affecting consolidation of the procurement system (HONDUCOMPRAS), formulation of

strategic sectorial planning, strengthening the medium-term expenditure framework (MTEF),

and implementation of the human resources module.

Disbursement and Audit

119. The Bank would make the single loan disbursement to a dedicated account that

forms part of the country's official foreign exchange reserves at the Central Bank of

Honduras. The disbursement would be made upon Bank's assessment of satisfactory

compliance of prior actions agreed. Disbursement will not be linked to any specific purchases

and no procurement requirements would be needed. Once the credit is approved by the Board,

the recipient would open and maintain a dedicated deposit account in US dollars for the

recipient’s use. IDA will disburse the proceeds of the credit into the deposit account. If the

proceeds or any part thereof are used for ineligible purposes, as defined in the Financing

Agreement, IDA will require the recipient to either return the amount to the deposit account

for use for eligible purposes or refund the amount directly to IDA. The deposit account in US

dollars would be maintained in the Central Bank and its transactions and balances fully

incorporated into the recipient’s accounting records and financial statements via the integrated

financial management system (SIAFI). The legal agreement will include a clause requiring

written confirmation that the amount of the loan has been credited to an account available to

finance budgeted expenditures. It will also contain a clause for an audit at the Bank’s request

of financial transactions from the receipt of the loan proceeds by the Central Bank to the

transfer of the local currency equivalent into a treasury account designated for budget

expenditures.

120. The Central Bank is the financial agent of the Government. The latest IMF

Safeguards Assessment available for review was performed in 2008. The Central Bank

published its Annual Financial Statements for 2010 with a clean opinion by external auditors,

but the audit report notes a deviation from the IFRS that could result in material adjustments

if IFRS are fully adopted. However, a review of the financial statements, project external

audit reports, and the experience with segregated accounts for investment lending brought

nothing to the Bank’s attention of that would indicate that the banking control environment

52

into which the loan proceeds will flow is other than adequate under the proposed

arrangements. The fiduciary arrangements are in place to mitigate identified risks.

Risks and Risk Mitigation

121. The DPC is subject to five main risks: political, institutional, economic and

environmental. In addition, the innovative and sensitive nature of the citizen security

component adds a fifth risk that combines reputational and development impact elements.

122. On the political side, the main risk is related to the Government's ability to

complete the implementation of the fiscal reform package. With a polarized society

following the political crisis of 2009, approval and implementation of the planned fiscal

package could be more difficult than anticipated, which could jeopardize the needed fiscal

adjustment. To reduce this risk, the Government has been building consensus to implement

the needed reforms to bring the country's finances back to a sustainable path. It will be

important for the Government to ensure an adequate communications strategy regarding the

present DPC, highlighting its positive distribution/poverty impact (as indicated in Table 6) in

dealing with these urgent reforms, and its potential to greatly contribute to the resolution of

long-standing issues in public administration in Honduras.

123. On the institutional side, the main risk is related to the weak capacity of

Government institutions to implement the fiscal consolidation program. To reduce this

risk, the Bank is working with other donors to support the Government's fiscal consolidation

efforts, including programs to provide technical assistance.

124. On the economic front, the main risk derives from the possibility that the global

economy might enter into another recession. Under this scenario, the country’s shock

absorption capacity could face important limitations, in particular to apply effective

countercyclical macroeconomic policies and suitable social safety nets. In Honduras, the main

transmission channels are likely to be the same as in the 2008 crisis: First, since the U.S and

the European Union are Honduras’ largest trade markets (about 60 percent of total trade

value), exports would fell significantly. Second, workers’ remittances from abroad amount

about 16 percent of GDP and 90 percent of them are originated in the United States. Third,

official development assistance would be limited. To reduce this risk, the Government has

shifted to a much more cautious attitude, focusing on fiscal structural reforms and a gradual

tightening of fiscal policy. In addition, the Government has been closely following the

external economic conditions and is currently preparing an action plan to mitigate the

negative effects of a possible sharp downturn on the world economy. Also, the Honduran

Central Bank is continuing to enhance its capacity to deploy counter-cyclical policy if needed.

125. On the environmental side, the main risk is the country’s high exposure to

natural hazards. Honduras’ major natural hazards are tropical storms and hurricanes that

frequently strike the country, generating extensive flooding along the north coast and other

regions. Hurricane Mitch in 1998 affected large portions of the country's population, causing

major economic damages estimated at US$3.5 billion. In 2005 Honduras was hit by Hurricane

Stan, which caused an estimated US$100 million in total economic damages. The

Government has taken important steps towards strengthening the country's disaster risk

management legal and institutional frameworks. In addition, the Bank is providing key

53

technical support to Honduras in terms of strengthening the institutional capacity to engage in

disaster risk management. If a disaster occurs, the Bank will revisit its planned lending

program and existing portfolio to ascertain how and where adjustments need to be made.

126. On the citizen security component, the main risks are related to supporting

institutional reforms for the implementation of the integrated citizen security policy,

which includes both violence prevention and law enforcement/crime control objectives.

There are two main types of risks involved— institutional and indirect. The former relates to

the weak institutional capacity of the Government and the challenges involved in

implementing a security policy that requires strong multi-sectoral and intergovernmental

coordination, and tackling complex problems. There is a risk that the policy will not be

implemented, or be implemented partially because of lack of funding, weak capacity, or

insufficient political will to coordinate. Indirect risks relate to potential basic rights abuses,

abuse of authority, or corruption that might be associated with some of the actions supported

by programs that will be designed in the future as part of the law enforcement component of

the policy (in areas such as police equipment, prison infrastructure and management, gun

control). Even though the law enforcement component is not part of this DPC, the link with

the prevention component as part of the overall citizen security policy presents a low level of

risk that deserves mentioning and a discussion of corresponding mitigation strategies.

Institutional risks are being mitigated through five strategies:

a. The citizen security policy follows good international practice, is based on consultations

and incorporates solid analytical work. The diagnosis underpinning the policy includes a

national victimization survey, information from the National Violence Observatory, as

well as wide consultations with multiple stakeholders (see below). The core objectives and

strategies of the policy are also aligned with recent analytical work done by the Bank in

Central America and Honduras (see analytical underpinnings section).

b. The decision to implement the policy in a gradual and sequenced manner over the next

decade, and to prioritize actions through an Action Plan for the remaining period of this

administration. A parallel effort is being done (with support from EU) to develop a

criminal justice and security policy that will be coordinated with the citizen security

policy.

c. The creation and strengthening of coordination and oversight mechanisms to implement

the policy, including: (i) a Security Cabinet for inter-ministerial coordination within the

Executive power, and under the leadership of the Secretariat of the Presidency, and (ii) a

National Citizen Security Council that brings the relevant security, judicial, human rights,

and line ministries together with the Supreme Court, Prosecutors Office and local

governments to support the implementation of the policy.

d. A coalition of international development partners that strongly support an integrated

approach. There are more than ten partners organized in a Security, Justice, and Human

Rights Round Table that will provide technical assistance and financing to design and

implement the policy’s Action Plan. Each agency (e.g. IDB, EU, USAID, UNDP) will

focus on technical engagement in areas where it has a comparative advantage. Some of

the main players include IDB preparing an operation around criminal justice investigation

for 20 million dollars and EU with 40 million euros.

54

e. Mobilizing national resources through a new security tax that will help finance activities

included in the action plan for the citizen security policy.

Indirect risks are being mitigated through some of the strategies mentioned above (such

as the broad coalition of partners supporting the implementation of the action plan) as

well as through three additional strategies:

a. The Government of Honduras has included a strong rights-based approach to its citizen

security policy. The Government has created the Ministry of Justice and Human Rights,

which is part of the Cabinet and Council. One of the functions of the Citizen Security

Council will be to formulate recommendations to preserve human rights and fulfill civic

duties for peaceful coexistence. The policy document stresses that all programs need to be

designed within a rights-based framework. In addition, the government is developing

education and sensibilization campaigns to promote a change in mentality among citizens

away from repression and iron fist approaches and more towards prevention and a culture

of legality and peaceful coexistence.

b. The policy provides for measures to include civil society and private sector participation

in the design and implementation of the policy at the national and local levels. The policy

is based on a draft prepared in 2008 by the previous administration which held wide-

ranging consultations with civil society organizations. Informal consultations held by the

Government and by the Bank confirm that the content of the policy addresses many of the

concerns of civil society organizations (such as the need for a greater focus on community

participation in violence prevention activities and inter-institutional coordination). The

objective of flagship programs such as Safer Municipalities was discussed at the

grassroots level with mayors and key local stakeholders at department-level meetings,

which provided ample opportunity to gather inputs for program design. The strategy has

been launched by the Security, National Defense, and Governance Cabinet with broad

participation of government institutions, NGOs, donors, and the media, among others. In

addition, a link to the citizen security policy will be posted on the websites of the

Secretariat of the Presidency and the Secretariat of Security. The Bank will work with

Government to strengthen even further mechanisms to engage civil society and private

sectors in monitoring policy implementation, particularly through grievance mechanisms.

c. The citizen security policy itself incorporates international standards and good practices

in its different components to mitigate some of the potential risks. For instance, among

other provisions, the modernization of detention centers initiative includes internal

conduct codes based on international disciplinary standards as well as measures intended

to professionalize the police. With regard to institutional strengthening of the police force,

the policy supports the development of internal control systems to enhance transparency

and accountability of police officers, as well as increased effectiveness of the preventive

policing, and education of the police force as public servants and community members.

127. An additional risk is that during political campaigns, candidates may take

advantage of voters’ perceptions of insecurity in order to justify repressive measures to

combat crime and violence. To mitigate this risk, the Government plans to carry out

informational campaigns based on the new integrated citizen security policy in order to

emphasize the importance of a comprehensive approach to tackle crime and violence. Such

55

campaigns include community mobilization and citizen engagement in a social dialogue on

how to respond to security issues.

128. Overall, the level of risk of this component is low (given its focus on institutional

coordination and in social prevention) and it is far outweighed by the much higher risk

of inaction. While the proposed mitigation measures provide a robust risk management

strategy, it is clear that some level of risk will always remain. The economic, social and

human costs imposed by the current levels of crime and violence mean that ordinary citizens’

most basic and fundamental rights are under attack and as such, the risk of inaction far

outweighs the remaining level of risk. Strengthening institutions and social prevention

initiatives are critical steps of an integrated response to what has become the most

fundamental challenge to the development and welfare of Honduras citizens.

56

ANNEXES

Annex 1: Letter of Development Policy

64

Translation of Letter of Development Policy

70

Annex 2: Policy Matrix

Objective Key Issues Prior Actions for Board

Approval First Programmatic

Loan

Intermediate Outcome

Indicator

(December 2012)

Indicative Triggers

for Second

Programmatic Loan

Indicative Medium-

Term Outcome

Indicators

1. Improve tax

administration.

Lack of enforcement

and control by the

Revenue

Administration (DEI)

has led to weak

taxpayer compliance.

To improve taxpayer

compliance, the Government

has: (i) approved a plan to

strengthen the large taxpayer

unit within DEI, as evidenced by

Agreement DEI SG 118-2011,

dated May 16, 2011, and

published in the Recipient’s

Official Gazette on October 25,

2011; and (ii) approved a

registry of large taxpayers, as

evidenced by Agreement DEI

SG 043-2011, dated March 18,

2011, and published in the

Recipient’s Official Gazette on

June 25, 2011.

Status: Complete

The number of large

taxpayers filling

electronically increases

by at least 10 percent

(Baseline 2010=335

large taxpayers).

The Government has

adopted transfer

pricing rules.

The Government has

reduced the number of

incompliant large

taxpayers by keeping

them below 2.5 percent

of the total (Baseline:

2011= 2.77 percent).

71



Loan


Indicator

(December 2012)

Indicative Triggers

for Second

Programmatic Loan

Indicative Medium-

Term Outcome

Indicators

2. Reform the

pension

systems.

2.1. Achieve

sustainable

actuarial and

financial

balances in

INPREMA and

INJUPEMP.

2.2.

PROHECO

teachers’

pension plan

incorporated

into

INPREMA.

Both INPREMA and

INJUPEMP show

actuarial deficits due to

structural problems in

plan design.

PROHECO teachers’

legal situation is not

clearly defined.

To reduce the actuarial deficits

of the public pension systems,

the Government has: (i)

submitted to Congress, for

approval thereof, a bill of law to

reform INPREMA’s pension

system, as evidenced by

acknowledgement (Constancia)

signed by the first secretary of

Congress, dated October 26,

2011; and (ii) submitted to

Congress, for approval thereof, a

bill of law to reform

INJUPEMP’s pension system, as

evidenced by acknowledgement

(Constancia) signed by the first

secretary of Congress, dated

April 26, 2011.

Status: Complete.

To regularize the pension regime

for the PROHECO teachers, the

Government has formalized the

incorporation of the PROHECO

teachers to the INPREMA

pension system as of the date

each said teacher was appointed,

as evidenced by: (i) agreement

signed among SEFIN, SE and

INPREMA (Convenio de

Afiliación), dated October 27,

2011; and (ii) agreement signed

by SEFIN with INPREMA to

cancel the Recipient’s debt to

INPREMA with respect to

teachers’ and employers’

contributions (Convenio de

100 percent of

PROHECO teachers’

pension contributions

are flowing into

INPREMA.

The Government has

adopted the regulations

to the INPREMA and

INJUPEMP pension

reforms.

PROHECO teacher’s

contribution history

has been incorporated

in INPREMA’s data

base.

INPREMA maintains

constant net worth of at

least L$18,000 million

in real terms.

INJUPEMP maintains

constant net worth (not

including provisions) of

at least L$15,000

million in real terms.

100 percent of the

PROHECO teachers are

legally eligible to

receive pension

payments from

INPREMA (Baseline

2010=0).

72



Loan


Indicator

(December 2012)

Indicative Triggers

for Second

Programmatic Loan

Indicative Medium-

Term Outcome

Indicators

2.3. Stabilize

IHSS long-

term financial

situation.

Low contribution rate,

commingling of

pension funds with

health area.

Cancelación de Deuda), dated

October 27, 2011.

Status: Complete

To strengthen the financial

situation of IHSS, the

Government has increased the

maximum salary subject to

contribution to IHSS, as

evidenced by Resolution SOJD

No. 02-29-03-2011, and

published in the Official Gazette

on June 17, 2011.

Status: Complete.

The Government has

drafted a new law to

reform IHSS which

separates the health

and pensions

management.

Transfers from IHSS

pension are to health

area have been

eliminated (baseline:

September 2011= L$

1,200 million).

3. Achieve a

fiscally

sustainable

wage bill.

Teachers’ statute

indexes salary

adjustments to the

private sector’s

average minimum

wage, with no

reference to the state’s

fiscal capacity to pay,

and teachers are paid

through a parallel

financial management

system, with limited

control from SEFIN.

To ensure equity of salary

increases for all public servants,

the Government has submitted to

its Congress, for approval

thereof, a bill of law to establish

a uniform pay adjustment

methodology for all said public

servants, as evidenced by

acknowledgement (Constancia)

signed by the first secretary of

Congress, dated October 28,

2011.

Status: Complete.

To strengthen the monitoring of

the teacher's payroll, the

Recipient has:

(i) Established a single database

(SIARH-SIAFI) which accounts

for over 80 percent of the

Government's public servants

Central Government’s

wage bill falls by at

least 0.7 percent of GDP

(baseline: 2010 = 11.0

percent).

The Government has

adopted the regulations

to the new pay

adjustment

methodology.

The Government

carried out transactions

based payroll audits in

Secretariats of Health

and Public Works.

Central Government’s

wage bill is below 9.8

percent of GDP

(Baseline: 2010 = 11.0

percent).

73



Loan


Indicator

(December 2012)

Indicative Triggers

for Second

Programmatic Loan

Indicative Medium-

Term Outcome

Indicators

and includes all teachers, as

evidenced by a letter from the

Minister of SEFIN, dated

October 27, 2011;

(ii) created a payroll

management and control unit

within SEFIN, as evidenced by

Executive Decree PCM-006-

2011, dated February 8, 2011,

and published in the Official

Gazette on March 22, 2011; and

(iii) approved a consolidated set

of norms regulating human

resource management processes

in the education sector (Normas

Unificadas Aplicables a la

Gestión de Recursos Humanos

Docentes), as evidenced by

Executive Agreement No 032-

2011, date October 25, 2011,

and published in the Official

Gazette on October 25, 2011.

Status: Complete.

74



Loan


Indicator

(December 2012)

Indicative Triggers

for Second

Programmatic Loan

Indicative Medium-

Term Outcome

Indicators

4. To improve

citizen

security.

The Government lacks

a comprehensive and

integrated approach to

citizen security that

combines crime control

with violence

prevention and

coordinates the actions

of key ministries,

levels of government,

and non-state actors.

To support the prevention of

crime and violence and achieve

the Government's development

and poverty reduction

objectives, the Government has:

(a) adopted a violence

prevention strategy of proposed

programs focused on: youth at

risk, alternative conflict

resolution, road safety, and

citizenship building, as

evidenced by Decree No. PCM

057-2011, dated September 6,

2011, published in the Official

Gazette on October 1, 2011; and

(b) created the National Citizen

Security Council, as evidenced

by Decree No. 003-2011, dated

October 18, 2011, published in

the Official Gazette on October

20, 2011.

Status:Complete.

Average perception of

insecurity has improved

in the municipalities

from the center,

northern, and eastern

regions where the "Safer

Municipalities" Program

is being implemented

(Baseline 2010: 91

percent felt insecure

(UNDP 2010): Target

2012: 80 percent felt

insecure).

Arbitration and

Conciliation Law (Ley

de Arbitraje y

Conciliacion) is

reformed to expand the

authority of municipal

governments regarding

alternative conflict

resolution mechanisms.

National policy is

approved to improve

inter-institutional

coordination between

Security and Justice

Sectors.

Reduction of gun-

related homicides at the

national level (baseline

2010:83 percent; target

2013: 75 percent;

source: Violence

Observatory).

75

Annex 3: Fund Relations Note

IMF Completes Second Review under Stand-By Arrangement and Standby Credit

Facility for Honduras

Press Release No. 11/298

July 29, 2011

The Executive Board of the International Monetary Fund (IMF) has completed the second

review of Honduras’s economic performance under a program supported by an 18-month

Stand-By Arrangement and a Standby Credit Facility. The arrangements were first approved

on October 1, 2010 in the amount of SDR 129.5 million (about $207.1 million), equivalent to

100 percent of the country’s quota in the IMF (see Press Release No. 10/374). Completion of

the review would make SDR 71.225 million (about $113.9 million) of that total available to

the authorities. The Honduran authorities, however, intend to continue treating the financing

as precautionary. The Board decision was taken on a lapse of time basis (a process where the

Board agrees that a proposal can be approved without convening formal discussions) on July

29, 2011.

Higher domestic investment spending and growing demand for Honduras’ exports are

contributing to output growth. However, high international commodity prices are putting

pressures on inflation and the external current account deficit. The policy responses to these

shocks, consistent with the authorities’ economic program for 2011, should include

reassessing public expenditure priorities to help mitigate the effect of the shocks on the poor

and a monetary policy stance that keeps domestic demand in check. The main goals of the

Fund-supported economic program continue to be consolidating the public finances,

increasing the share of investment and social spending in public expenditure, strengthening

the international reserves position, and upgrading the monetary and exchange rate policy

frameworks.

Note: The review was completed on a lapse of time (LOT) basis. Reviews would be proposed for consideration

on an LOT basis if all of the following conditions are met:

1. The relevant arrangement does not involve exceptional access;

2. The most recent program review under the relevant arrangement was not concluded on a lapse of time basis;

3. The review to be completed does not raise general policy issues requiring Board discussion;

4. All prior actions for the review have been met;

5.The review does not introduce major changes in the objectives or design of the program, including but not

limited to, an augmentation of access, major changes in conditionality for future reviews, the combination of

future reviews envisaged under the arrangement, or the rephasing of disbursements; and

6. Performance under the member’s program does not raise concerns as to whether the review should be

completed, in particular as a result of deviations, other than minor deviations, from the quantitative performance

criteria and structural benchmarks.

http://www.imf.org/external/np/sec/pr/2010/pr10374.htm

76

Annex 4: Country at a Glance

Honduras at a glance 8/18/11

Latin Lower

Key D evelo pment Indicato rs America middle

Honduras & Carib. income

(2010)

Population, mid-year (millions) 7.6 572 3,811

Surface area (thousand sq. km) 112 20,394 31,898

Population growth (%) 1.8 1.1 1.2

Urban population (% of to tal population) 48 79 41

GNI (Atlas method, US$ billions) 14.2 4,011 8,846

GNI per capita (Atlas method, US$) 1,870 7,007 2,321

GNI per capita (PPP, international $) 3,710 10,286 4,784

GDP growth (%) 2.8 -1.9 7.1

GDP per capita growth (%) 1.0 -3.0 5.9

(mo st recent est imate, 2004–2010)

Poverty headcount ratio at $1.25 a day (PPP, %) 23 8 ..

Poverty headcount ratio at $2.00 a day (PPP, %) 35 17 ..

Life expectancy at birth (years) 72 74 68

Infant mortality (per 1,000 live births) 26 19 43

Child malnutrition (% of children under 5) 9 4 24

Adult literacy, male (% of ages 15 and o lder) 84 92 87

Adult literacy, female (% of ages 15 and o lder) 83 90 74

Gross primary enro llment, male (% of age group) 116 118 109

Gross primary enro llment, female (% of age group) 116 114 105

Access to an improved water source (% of population) 84 93 86

Access to improved sanitation facilities (% of population) 66 79 50

N et A id F lo ws 1980 1990 2000 2010 a

(US$ millions)

Net ODA and official aid 102 448 448 457

Top 3 donors (in 2008):

United States 19 215 110 129

Spain 0 6 35 58

Japan 7 85 50 42

Aid (% of GNI) 4.2 16.0 6.5 3.4

Aid per capita (US$) 28 92 72 61

Lo ng-T erm Eco no mic T rends

Consumer prices (annual % change) .. 23.3 10.1 6.5

GDP implicit deflator (annual % change) 13.2 21.2 30.8 5.7

Exchange rate (annual average, local per US$) 2.0 4.1 15.0 18.9

Terms of trade index (2000 = 100) .. 129 100 77

1980–90 1990–2000 2000–10

Population, mid-year (millions) 3.6 4.9 6.2 7.6 3.0 2.4 2.0

GDP (US$ millions) 2,566 3,049 7,106 15,400 2.7 3.2 4.6

Agriculture 23.7 22.4 15.9 12.5 2.7 2.2 3.2

Industry 24.3 26.4 32.5 26.5 3.3 3.6 3.7

M anufacturing 15.0 16.3 22.7 18.4 3.7 4.0 4.1

Services 52.0 51.2 51.7 60.9 2.5 3.8 6.4

Household final consumption expenditure 69.4 66.8 70.8 79.6 2.6 3.0 4.6

General gov't final consumption expenditure 12.7 12.9 13.4 18.0 3.3 2.0 6.1

Gross capital formation 24.8 23.0 28.3 23.0 3.0 6.9 2.3

Exports o f goods and services 37.2 37.2 54.0 43.9 1.1 1.6 4.1

Imports of goods and services 44.1 39.9 66.4 64.6 1.2 3.8 3.8

Gross savings .. .. .. 16.2

Note: Figures in italics are for years other than those specified. 2010 data are preliminary. Group data are for 2009. .. indicates data are not available.

a. A id data are for 2009.

Development Economics, Development Data Group (DECDG).

(average annual growth %)

(% of GDP)

10 5 0 5 10

0-4

15-19

30-34

45-49

60-64

75-79

percent of total population

Age distribution, 2009

Male Female

0

10

20

30

40

50

60

1990 1995 2000 2009

Honduras Latin America & the Caribbean

Under-5 mortality rate (per 1,000)

-6

-4

-2

0

2

4

6

8

95 05

GDP GDP per capita

Growth of GDP and GDP per capita (%)

77

Honduras

B alance o f P ayments and T rade 2000 2010

(US$ millions)

Total merchandise exports (fob) 1,297 2,749

Total merchandise imports (cif) 2,863 6,897

Net trade in goods and services -831 -3,117

Current account balance -508 -955

as a % of GDP -7.2 -6.2

Workers' remittances and

compensation of employees (receipts) 484 2,520

Reserves, including gold 1,319 2,931

C entral Go vernment F inance

(% of GDP)

Current revenue (including grants) 15.1 24.6

Tax revenue 13.8 15.5

Current expenditure 14.8 22.6

T echno lo gy and Infrastructure 2000 2009

Overall surplus/deficit -5.2 -2.9

Paved roads (% of to tal) 20.4 ..

Highest marginal tax rate (%) Fixed line and mobile phone

Individual .. .. subscribers (per 100 people) 7 114

Corporate 25 30 High technology exports

(% of manufactured exports) 0.3 0.8

External D ebt and R eso urce F lo ws

Enviro nment

(US$ millions)

Total debt outstanding and disbursed 5,402 4,917 Agricultural land (% of land area) 26 28

Total debt service 392 286 Forest area (% of land area) 48.5 38.7

Debt relief (HIPC, M DRI) 816 1,893 Terrestrial protected areas (% of land area) .. ..

Total debt (% of GDP) 76.0 31.9 Freshwater resources per capita (cu. meters) 14,782 13,372

Total debt service (% of exports) 8.8 3.0 Freshwater withdrawal (billion cubic meters) 1.2 ..

Foreign direct investment (net inflows) 282 877 CO2 emissions per capita (mt) 0.81 1.2

Portfo lio equity (net inflows) 0 0

GDP per unit o f energy use

(2005 PPP $ per kg of o il equivalent) 6.0 5.7

Energy use per capita (kg of o il equivalent) 481 632

Wo rld B ank Gro up po rtfo lio 2000 2009

(US$ millions)

IBRD

Total debt outstanding and disbursed 151 0

Disbursements 0 0

Principal repayments 27 70

Interest payments 15 3

IDA

Total debt outstanding and disbursed 838 493

Disbursements 38 45

P rivate Secto r D evelo pment 2000 2010 Total debt service 8 3

Time required to start a business (days) – 14 IFC (fiscal year)

Cost to start a business (% of GNI per capita) – 47.2 Total disbursed and outstanding portfo lio 42 147

Time required to register property (days) – 23 o f which IFC own account 27 147

Disbursements for IFC own account 9 106

Ranked as a major constraint to business 2000 2010 Portfo lio sales, prepayments and

(% of managers surveyed who agreed) repayments for IFC own account 26 4

Corruption 62.7 ..

Access to /cost o f financing 62.4 .. M IGA

Gross exposure 16 0

Stock market capitalization (% of GDP) 8.8 .. New guarantees 0 0

Bank capital to asset ratio (%) 8.8 ..

Note: Figures in italics are for years other than those specified. 2010 data are preliminary. 8/18/11

.. indicates data are not available. – indicates observation is not applicable.


0 25 50 75 100

Control of corruption

Rule of law

Regulatory quality

Political stability

Voice and accountability

Country's percentile rank (0-100)higher values imply better ratings

2009

2000

Governance indicators, 2000 and 2009

Source: Kaufmann-Kraay-Mastruzzi, World Bank

IBRD, 0IDA, 628

IMF, 226

Other multi-lateral, 1,256

Bilateral, 854

Private, 1,636

Short-term, 317

Composition of total external debt, 2010

US$ millions

78

Millennium Development Goals Honduras

With selected targets to achieve between 1990 and 2015(estimate closest to date shown, +/- 2 years)

Go al 1: halve the rates fo r extreme po verty and malnutrit io n 1990 1995 2000 2009

Poverty headcount ratio at $1.25 a day (PPP, % of population) 43.5 15.6 14.4 23.3

Poverty headcount ratio at national poverty line (% of population) .. .. 52.5 ..

Share of income or consumption to the poorest qunitile (%) 2.8 3.1 3.3 2.5

Prevalence of malnutrition (% of children under 5) .. 19.2 12.5 8.6

Go al 2: ensure that children are able to co mplete primary scho o ling

Primary school enro llment (net, %) 88 .. 88 97

Primary completion rate (% of relevant age group) 64 71 .. 90

Secondary school enro llment (gross, %) 33 32 .. 65

Youth literacy rate (% of people ages 15-24) .. .. 89 94

Go al 3: e liminate gender disparity in educat io n and empo wer wo men

Ratio of girls to boys in primary and secondary education (%) 106 .. .. 107

Women employed in the nonagricultural sector (% of nonagricultural employment) 33 31 38 33

Proportion of seats held by women in national parliament (%) 10 8 9 23

Go al 4: reduce under-5 mo rtality by two -thirds

Under-5 mortality rate (per 1,000) 55 45 40 31

Infant mortality rate (per 1,000 live births) 43 36 33 26

M easles immunization (proportion of one-year o lds immunized, %) 90 89 98 95

Go al 5: reduce maternal mo rtality by three-fo urths

M aternal mortality ratio (modeled estimate, per 100,000 live births) .. .. .. 280

B irths attended by skilled health staff (% of to tal) 45 55 56 67

Contraceptive prevalence (% of women ages 15-49) 47 50 62 65

Go al 6: halt and begin to reverse the spread o f H IV/ A ID S and o ther majo r diseases

Prevalence of HIV (% of population ages 15-49) 1.1 1.5 1.3 0.8

Incidence of tuberculosis (per 100,000 people) 125 125 116 64

Tuberculosis case detection rate (%, all forms) 59 71 89 68

Go al 7: halve the pro po rt io n o f peo ple witho ut sustainable access to basic needs

Access to an improved water source (% of population) 72 77 80 84

Access to improved sanitation facilities (% of population) 45 51 58 66

Forest area (% of land area) 66.0 57.3 48.5 38.7

Terrestrial protected areas (% of land area) .. .. .. ..

CO2 emissions (metric tons per capita) 0.5 0.7 0.8 1.2

GDP per unit o f energy use (constant 2005 PPP $ per kg of o il equivalent) 5.5 5.5 6.0 5.7

Go al 8: develo p a glo bal partnership fo r develo pment

Telephone mainlines (per 100 people) 1.8 2.9 4.8 11.1

M obile phone subscribers (per 100 people) 0.0 0.0 2.5 103.3

Internet users (per 100 people) 0.0 0.0 1.2 9.8

Personal computers (per 100 people) .. 0.3 1.1 2.5

Note: Figures in italics are for years other than those specified. .. indicates data are not available. 8/18/11


H o nduras

0

25

50

75

100

125

2000 2005 2009

Primary net enrollment ratio

Ratio of girls to boys in primary & secondary education

Education indicators (%)

0

20

40

60

80

100

120

140

2000 2005 2009

Fixed + mobile subscribers

Internet users

ICT indicators (per 100 people)

0

25

50

75

100

1990 1995 2000 2009

Honduras Latin America & the Caribbean

Measles immunization (% of 1-year olds)

79

Annex 5: Debt Sustainability Analysis

The debt sustainability analysis (DSA) yields results similar to those reported in the IMF

program report—the risk of debt distress continues to be regarded as low. The analysis

continues to be based on the assumptions that Honduras will strengthen macroeconomic

policies to stabilize the current account deficit at sustainable levels and maintain a prudent

borrowing strategy. Under those assumptions, the country’s debt would remain sustainable,

with all debt indicators remaining below their indicative thresholds and robust under various

stress tests. However, debt dynamics would weaken if policies deviate from the IMF program

and/or GDP growth suffers a permanent adverse shock.

Key Assumptions

1. Strengthened macroeconomic policies. The scenario assumes that the strengthening

of macroeconomic policies started in the second half of 2010, and the commitment to the new

policies will remain strong over the medium term. In addition, the baseline assumes certain

measures will be adopted during 2010, such as controlling the wage bill, reducing subsidies,

and adjusting electricity tariffs to reduce the public sector deficit to about 2 percent of GDP

over the medium term. It incorporates the flexibilization of the exchange rate, based on the

methodology of the Central Bank of Honduras, too. It also includes the expected impact of the

tax reform approved in April 2010 that would yield revenue equivalent to 0.7-1.2 percent of

GDP (on an annual basis) over three years. The baseline also considers the medium term

effects of several regulations approved during 2011, including anti-evasion measures, wage

bill control, and the IMPREMA’s pension system reform.

2. Real GDP will grow at an average of 4 percent a year in the medium term. The

baseline includes the most recent growth outlook (see Table 1). In this regard, improved

performance in commodity exports, the maquila44

sector, and remittances will boost the

economy. In addition, growth prospects are based on public investment, assumed to reach 4.8

percent of GDP over the medium term.

3. The overall fiscal deficit of the public sector will stabilize at about 2 percent of

GDP.45

Public sector revenues and grants are projected to increase to approximately

23.4 percent of GDP by 2014. The composition of expenditure would be tilted toward

investment and poverty reduction. The fiscal deficit would be financed mostly by

concessional resources from multilateral and bilateral creditors.

4. The noninterest current account deficit is projected to decline to below 6 percent

of GDP in the medium term. This would be the result of favorable dynamics in the trade

balance, tourism, and remittances. The current account deficit would be largely financed by

44 A maquila or maquiladora is a manufacturing plant that imports and assembles duty-free components for export. Maquila

exports represent 50 percent of total exports and are mainly related to textiles and confections. 45

The consolidated public sector includes the central government, local governments, decentralized agencies,

social security institutions, the central bank, and public enterprises.

80

official sources, foreign direct investment (FDI), and the projected expansion in maquila

activity and tourism.

5. Annual export growth would average 7.5 percent over the long run. While current

commodity prices are high, a projected decline in the prices of Honduras’ main commodity

exports (coffee and bananas) is expected in the medium term. However, this effect will be

offset by continued productivity gains and greater access to international markets through

CAFTA and a trade agreement with the European Union, effective until 2012.

6. Annual import growth would average about 6.8 percent per year. Nonfuel imports

are projected to increase moderately in line with domestic demand growth and maquila

activity. Fuel imports volumes are assumed to grow in line with real GDP.

7. Non-concessional financing. Non-concessional financing is estimated at US$350

million;46

of the total, US$280 million corresponds to a multi-sector loan from the Central

American Bank for Economic Integration (CABEI).47

As in the IMF 2010 Article IV, it is

assumed that Honduras would progressively tap additional non-concessional sources of

financing (which would rise from 5 percent to 23 percent of total disbursements in the long-

run), mostly in loans from bilateral (Paris Club and non-Paris Club countries) and commercial

sources.

External debt sustainability analysis

8. Honduras’ external debt would remain sustainable. All external debt indicators

remain below their thresholds,48

with the present value of external debt projected to stay

below 22 percent of GDP over the entire horizon of the analysis (Table 3 and Figure 1).

9. External debt indicators remain below their indicative, policy-related thresholds

under all stress tests and alternatives scenarios (Figure 1). Debt-burden indicators are

lower under the historical scenario than under the baseline scenario because the projected

average real GDP growth for 2011 is higher than the estimated values for 2010. On the other

hand, the noninterest current account average is lower for 2011 than for 2010.

46

Honduras is classified as a low-capacity, low-vulnerability country, and is allowed to have untied non-

concessional financing (See Debt Limits in Fund-Supported Programs—Proposed New Guidelines (SM/09/215)

and Capacity Assessment-Preliminary Results (IMF), and Introducing Greater Flexibility into the

Implementation of IDA’s Non-Concessional Borrowing Policy (NCBP) Capacity Assessment Exercise (World

Bank, 2010). 47

Lending from CABEI is on non-concessional terms. However, recently CABEI lending to Honduras for some

projects (e.g. infrastructure) was combined with concessional lending from the other institutions (e.g. World

Bank and IDB) to reach of concessionality of 35 percent. For the purpose of this DSA update, however, the

US$280 million lending has been considered non-concessional. 48 Based on the recent update, the three-year average of the Honduras’ CPIA index (between 2007 and 2009) is 3.69. In this

context, the debt burden thresholds correspond to the ones associated with a medium policy performance—a rating above

3.75 corresponds to strong performance. The latest average CPIA represents a deterioration compared to the previous average

(2006-2008), which was 3.8 and was associated with a strong policy performance.

81

Public sector debt sustainability analysis

10. Honduras’ public sector debt would remain sustainable. Public sector debt would

remain at about 27 percent of GDP (20.5 percent in present value terms). As the fiscal deficit

progressively declines to about 2 percent of GDP and growth rebounds to its long-term rate,

the sustainable primary deficit would be about 1 percent of GDP.

Stress Tests

11. The alternative scenarios and stress tests show that public-sector debt dynamics

are vulnerable to adverse shocks, either exogenous or policy-related. The status quo stress

test, which assumes a primary fiscal deficit at the 2011 level in terms of GDP until the end of

the projection period as well as a permanent decline in real GDP growth, would place the

present value public debt-to-GDP ratio on an upward trend (Table 2). In addition, a one-time

real depreciation of 30 percent (e.g. a severe balance of payments correction) or a 10 percent

of GDP increase in other debt-creating flows (e.g. a severe financial sector distress that leads

to the realization of contingent liabilities) would increase the present value of public debt-to-

revenue ratio to more than 100 percent in the long term, compared to 88 percent under the

baseline scenario.

Conclusion

12. Based on the above analysis, Honduras is considered at low risk of debt distress.

Assuming consistent pursuit of strengthened macroeconomic policies, Honduras’ debt

indicators would remain below their indicative thresholds and broadly resilient to adverse

shocks. Under alternative policies, however, public-sector debt dynamics would weaken.

Honduras’ favorable debt outlook reflects the low initial levels of public debt, which resulted

from the large debt relief granted to Honduras during the 2000s.

13. Given that Honduras would progressively tap more nonconcessional sources of

financing, it will be important to build on the existing capacity to manage debt and

formulate a strategy linked to medium-term fiscal framework. Authorities are committed

to strengthening their debt-management capacity—with the availability of additional technical

assistance.

82

Estimate

2009 2010Average

Standard

Deviation 2011 2012 2013 2014

Public sector debt 1/ 23.9 26.3 27.8 28.0 27.8 27.6

o/w foreign-currency denominated 17.3 19.1 20.5 20.7 20.8 20.8

Change in public sector debt 3.2 2.4 1.5 0.2 -0.2 -0.2

Identified debt-creating flows 5.0 1.8 1.5 1.6 -0.5 -0.6

Primary deficit 5.5 2.3 1.3 2.8 2.9 2.2 0.9 0.9

Revenue and grants 25.1 24.8 22.9 22.9 23.5 23.5

of which: grants 2.0 1.6 1.2 1.0 1.3 1.3

Primary (noninterest) expenditure 30.6 27.2 25.8 25.1 24.4 24.4

Automatic debt dynamics -0.5 -0.5 -1.4 -0.6 -1.4 -1.5

Contribution from interest rate/growth differential 0.0 0.3 -0.3 0.2 -0.6 -0.6

of which: contribution from average real interest rate -0.4 0.9 0.6 1.1 0.5 0.4

of which: contribution from real GDP growth 0.4 -0.6 -0.9 -1.0 -1.1 -1.1

Contribution from real exchange rate depreciation -0.5 -0.8 -1.2 -0.7 -0.8 -0.9

Other identified debt-creating flows -0.1 0.0 0.0 0.0 0.0 0.0

Privatization receipts (negative) 0.0 0.0 0.0 0.0 0.0 0.0

Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0

Debt relief (HIPC and other) -0.1 0.0 0.0 0.0 0.0 0.0

Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0

Residual, including asset changes -1.8 0.6 0.1 -1.4 0.3 0.4

Other Sustainability Indicators

PV of public sector debt 19.0 18.4 20.1 20.5 20.7 21.0

o/w foreign-currency denominated 12.5 11.2 12.7 13.2 13.7 14.1

o/w external 12.5 11.2 12.7 13.2 13.7 14.1

PV of contingent liabilities (not included in public sector debt) ... ... ... ... ... ...

Gross financing need 2/ 8.6 5.9 7.1 7.9 6.6 6.7

PV of public sector debt-to-revenue and grants ratio (in percent) 76.0 74.1 87.6 89.4 88.1 89.2

PV of public sector debt-to-revenue ratio (in percent) 82.7 79.3 92.4 93.5 93.3 94.5

o/w external 3/ 54.4 48.4 58.4 60.2 61.6 63.7

Debt service-to-revenue and grants ratio (in percent) 4/ 10.7 14.5 18.3 19.0 15.0 14.3

Debt service-to-revenue ratio (in percent) 4/ 11.6 15.5 19.3 19.8 15.9 15.2

Primary deficit that stabilizes the debt-to-GDP ratio 2.3 -0.1 1.3 2.0 1.1 1.1

Key macroeconomic and fiscal assumptions

Real GDP growth (in percent) -1.9 2.7 4.1 2.6 3.4 3.6 4.0 4.0

Average nominal interest rate on forex debt (in percent) 2.4 2.3 1.9 0.5 1.8 1.4 1.5 1.7

Average real interest rate on domestic debt (in percent) -17.4 10.9 -5.0 27.9 6.9 15.5 6.4 5.7

Real exchange rate depreciation (in percent, + indicates depreciation) -3.0 -4.6 -4.0 8.0 -6.2 -3.6 -4.0 -4.3

Inflation rate (GDP deflator, in percent) 4.0 5.8 9.7 10.4 8.9 6.2 6.0 6.0

Growth of real primary spending (deflated by GDP deflator, in percent) 22.5 -8.8 5.8 14.2 -1.8 0.8 1.0 4.3

Grant element of new external borrowing (in percent) ... ... … … 20.6 24.8 23.8 23.7

Sources: Country authorities; and staff estimates and projections.

1/ The consolidated public sector includes the central government, local governments , decentralized agencies , social security ins titutions , central bank, and public enterprises . Net debt is used.

2/ Gross financing need is defined as the primary deficit plus debt service plus the s tock of short-term debt at the end of the las t period.

3/ Revenues excluding grants .

4/ Debt service is defined as the sum of interes t and amortization of medium and long-term debt.

5/ His torical averages and s tandard deviations are generally derived over the pas t 10 years , subject to data availability.

Table 1a.Honduras: Public Sector Debt Sustainability Framework, 2008-2031

(In percent of GDP, unless otherwise indicated)

Actual Projections

83

Table 2a.Honduras: Sensitivity Analysis for Key Indicators of Public Debt 2011-2031

2011 2012 2013 2014

Baseline 20 20 21 21

A. Alternative scenarios

A1. Real GDP growth and primary balance are at historical averages 20 20 20 21

A2. Primary balance is unchanged from 2011 20 21 23 26

A3. Permanently lower GDP growth 1/ 20 21 21 22

A4. Alternative Scenario :[Costumize, enter title] 20 17 17 17

B. Bound tests

B1. Real GDP growth is at historical average minus one standard deviations in 2012-2013 20 21 23 24

B2. Primary balance is at historical average minus one standard deviations in 2012-2013 20 22 26 26

B3. Combination of B1-B2 using one half standard deviation shocks 20 21 24 24

B4. One-time 30 percent real depreciation in 2012 20 26 25 25

B5. 10 percent of GDP increase in other debt-creating flows in 2012 20 30 31 30







B. Bound tests












B. Bound tests







1/ Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

2/ Revenues are defined inclusive of grants.

PV of Debt-to-GDP Ratio

Projections

PV of Debt-to-Revenue Ratio 2/

Debt Service-to-Revenue Ratio 2/

84

Historical 0 Standard

Average 0 Deviation

2009 2010 2011 2012 2013 2014

External debt (nominal) 1/ 23.0 24.0 25.0 25.2 25.2 25.2

o/w public and publicly guaranteed (PPG) 17.3 19.1 20.5 20.7 20.8 20.8

Change in external debt -2.4 1.0 1.0 0.2 0.0 0.0

Identified net debt-creating flows -3.4 -0.8 1.0 0.4 0.0 -0.2

Non-interest current account deficit 2.6 5.7 4.5 1.9 6.8 6.0 5.6 5.3

Deficit in balance of goods and services 30.8 20.2 19.8 19.3 18.4 17.5

Exports 51.7 43.9 48.3 48.6 47.7 45.4

Imports 82.5 64.2 68.1 67.9 66.1 62.9

Net current transfers (negative = inflow) -21.3 -17.9 -15.5 5.3 -17.5 -17.5 -17.4 -16.9

o/w official -1.8 -1.3 -0.6 -0.6 -0.6 -0.6

Other current account flows (negative = net inflow) -6.8 3.4 4.6 4.2 4.6 4.8

Net FDI (negative = inflow) -6.2 -5.2 -5.4 1.1 -5.5 -5.3 -5.1 -5.1

Endogenous debt dynamics 2/ 0.1 -1.3 -0.3 -0.4 -0.5 -0.4

Contribution from nominal interest rate 0.6 0.5 0.5 0.4 0.5 0.5

Contribution from real GDP growth 0.5 -0.6 -0.7 -0.8 -0.9 -0.9

Contribution from price and exchange rate changes -1.0 -1.3 … … … …

Residual (3-4) 3/ 1.0 1.8 -0.1 -0.1 0.0 0.2

o/w exceptional financing -0.5 -0.2 -0.1 0.0 0.0 0.0

PV of external debt 4/ ... 16.1 17.2 17.7 18.1 18.5

In percent of exports ... 36.7 35.7 36.4 38.0 40.8

PV of PPG external debt ... 11.2 12.7 13.2 13.7 14.1

In percent of exports ... 25.6 26.3 27.1 28.7 31.1

In percent of government revenues ... 48.4 58.4 60.2 61.6 63.7

Debt service-to-exports ratio (in percent) 7.6 5.1 4.0 3.7 3.6 3.6

PPG debt service-to-exports ratio (in percent) 3.2 1.9 1.4 1.3 1.3 1.4

PPG debt service-to-revenue ratio (in percent) 7.1 3.5 3.1 2.9 2.9 3.0

Total gross financing need (Billions of U.S. dollars) 0.5 0.6 0.8 0.7 0.7 0.7

Non-interest current account deficit that stabilizes debt ratio 5.1 4.7 5.8 5.8 5.6 5.4

Key macroeconomic assumptions

Real GDP growth (in percent) -1.9 2.7 4.1 2.6 3.4 3.6 4.0 4.0

GDP deflator in US dollar terms (change in percent) 4.0 5.8 7.1 10.2 7.8 5.2 5.5 6.0

Effective interest rate (percent) 5/ 2.5 2.6 2.2 0.5 2.2 1.9 2.0 2.1

Growth of exports of G&S (US dollar terms, in percent) 11.7 -7.8 13.2 21.9 22.5 9.6 7.7 5.0

Growth of imports of G&S (US dollar terms, in percent) 17.5 -15.5 13.6 17.4 18.2 8.7 6.8 4.9

Grant element of new public sector borrowing (in percent) ... ... ... ... 20.6 24.8 23.8 23.7

Government revenues (excluding grants, in percent of GDP) 23.0 23.2 21.7 21.9 22.2 22.2

Aid flows (in Billions of US dollars) 7/ 0.7 0.5 0.5 0.4 0.5 0.5

o/w Grants 0.3 0.2 0.2 0.2 0.3 0.3

o/w Concessional loans 0.4 0.3 0.3 0.2 0.2 0.2

Grant-equivalent financing (in percent of GDP) 8/ ... ... 1.9 1.6 1.7 1.7

Grant-equivalent financing (in percent of external financing) 8/ ... ... 40.5 47.8 57.3 58.9

Memorandum items:

Nominal GDP (Billions of US dollars) 14.2 15.4 17.2 18.7 20.5 22.6

Nominal dollar GDP growth 2.1 8.6 11.4 9.0 9.7 10.2

PV of PPG external debt (in Billions of US dollars) 1.7 2.2 2.5 2.8 3.2

(PVt-PVt-1)/GDPt-1 (in percent) 2.9 1.7 1.8 1.9

Gross remittances (Billions of US dollars) 2.8 2.7 2.9 3.1 3.4 3.6

PV of PPG external debt (in percent of GDP + remittances) ... 9.6 10.9 11.3 11.8 12.2

PV of PPG external debt (in percent of exports + remittances) ... 18.3 19.5 20.2 21.3 23.0

Debt service of PPG external debt (in percent of exports + remittances) ... 1.3 1.1 1.0 1.0 1.1

Sources: Country authorities; and staff estimates and projections. 0

1/ Includes both public and private sector external debt.

2/ Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

3/ Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

4/ Assumes that PV of private sector debt is equivalent to its face value.

5/ Current-year interest payments divided by previous period debt stock.

6/ Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

7/ Defined as grants, concessional loans, and debt relief.

8/ Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Actual

Table 3a.: External Debt Sustainability Framework, 2008-2031 1/

(In percent of GDP, unless otherwise indicated)

Projections

85

2011 2012 2013 2014


A. Alternative Scenarios

A1. Key variables at their historical averages in 2011-2031 1/ 13 12 11 10

A2. New public sector loans on less favorable terms in 2011-2031 2 13 14 15 16

B. Bound Tests

B1. Real GDP growth at historical average minus one standard deviation in 2012-2013 13 13 14 15

B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/ 13 20 32 31

B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-2013 13 14 16 17

B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/ 13 20 27 27

B5. Combination of B1-B4 using one-half standard deviation shocks 13 22 33 33

B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/ 13 18 19 20





B. Bound Tests











B. Bound Tests







PV of debt-to-exports ratio

PV of debt-to-revenue ratio

Table 3b.Honduras: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2011-2031

(In percent)

PV of debt-to GDP ratio

Projections

86

Baseline 1 1 1 1




B. Bound Tests







Baseline 3 3 3 3




B. Bound Tests







Memorandum item:

Grant element assumed on residual financing (i.e., financing required above baseline) 6/ 15 15 15 15


1/ Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

2/ Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

3/ Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming

an offsetting adjustment in import levels).

4/ Includes official and private transfers and FDI.

5/ Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

6/ Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Debt service-to-revenue ratio

Debt service-to-exports ratio

Table 3b.Honduras: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2011-2031 (continued)

(In percent)

87


Figure 1. Honduras: Indicators of Public and Publicly Guaranteed External

Debt under Alternatives Scenarios, 2011-2031 1/

1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to

a Combination shock; in c. to a Exports shock; in d. to a Combination shock; in e. to a Exports shock and

in figure f. to a Combination shock

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Grant element of new borrowing (% right scale)

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88

Figure 2.Honduras: Indicators of Public Debt Under Alternative Scenarios, 2011-2031 1/


1/ The most extreme stress test is the test that yields the highest ratio in 2021.

2/ Revenues are defined inclusive of grants.

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89

Annex 6: Consultations and context for reforms in education sector and in citizen

security

Consultations and Context for Reform in the Education Sector

1. During most of the last decade, the yearly and almost permanent conflict within the

education sector in Honduras has seriously affected results in learning, and human

development more broadly. This difficult context has historically been rooted in an inefficient

sector administration, corruption at various levels, poor performance levels, ineffective

mechanisms for accountability, and poor local oversight and citizen participation. Various

initiatives in education reform have been put forth over the years, but have largely failed to be

approved or to enact substantive improvements. The 2009 political crisis further exacerbated

social tensions surrounding this and other issues, but also served as a wake-up call among

social sectors, highlighting the urgent need for reform in politics and public administration;

above all, the need to shift policy dialogue towards an enhanced focus on results in

development, with an improved approach based on multi-sector partnerships, and effective

mechanisms for transparency and accountability that will limit state capture.

2. The context of present-day Honduras is quite different from that of a decade ago,

however, and the conditions determining the possibility of enacting meaningful reforms in

education today are much greater, considering: increased public awareness regarding the

growing and unsustainable public-sector wage bill, fueled by relatively high wages for

teachers; the lack of significant improvements in levels of learning in recent years; the

frustration among teachers themselves, as well as among the Honduran population (which

over the last decade has been strengthened in its awareness and capacities for improved

citizen engagement and social accountability) regarding the seemingly permanent crisis

situation in education; as well as a new Government administration and Congress

demonstrably committed to resolving the most urgent of the lasting problems in education, in

order to set the sector on a path towards national transformation. Recent developments that

have also greatly contributed to a context conducive towards reform, include an audit of

teachers’ posts by the Government to detect and eliminate ―phantom teachers‖ and other

irregularities, and the role of civil society organizations in social auditing and dialogue

processes representing more broad based citizen interests in their demand for good

governance and performance in the education sector.

3. In 2011, the National Congress, having approved a new Law of Incentives for

Community Participation in Education, had also initiated discussion of a proposal for a

completely new General Law of Education (the current Law was approved in 1962). Faced

with strong insistence from various sectors (particularly teachers’ unions) that any such law

would have to be the product of ample consultation and consensus, the National Congress

withdrew the original proposal, and together with the Lobo Administration, has initiated a

broad process of open consultation for the drafting of the new Education law.

4. The dialogue process has been completely open and widely disseminated in national

media; it has included participation on the part of the Government, the teachers’ unions,

parents’ associations, students, universities, civil society organizations (national and

community based), local governments, sector experts, and anyone else interested in

participating. Several roundtables for dialogue were set up based on the key thematic issues

90

defined by the participants themselves (such as: Foundations of Education in Honduras;

Structure of the Education System; Administration; Educational Model; Teaching Career; and

Community Participation). At the time of this writing, after several meetings and plenary

sessions in Tegucigalpa and several different regions of the country, the results have been

delivered to a special Congressional Committee to be drafted into a formal Law proposal to be

further discussed, and approved by the end of 2011. Participants of the various sectors

involved have expressed their satisfaction with the process up to now, highlighting the

importance and the real potential of consensus-building processes among sectors for reform,

particularly in the present post-crisis context.

5. Regarding pension reform, as a prior action within the Government’s plan for the

present DPC, the teachers’ unions have publicly expressed their opposition to the changes

envisioned. However, it is reported that inside the unions there is recognition of the urgent

need for reforms in order to save the pension funds.

6. Regarding the reforms oriented towards containing the growth of the public education

sector wage bill, the teachers’ unions have maintained a strong resistance to any long-term

reform to the Teacher’s Statute, which indexes teachers’ salaries to the minimum wage, in

Article 49. The unions have ceded to Government the suspension of this Article during three

years only (with alternative means for salary negotiation), but have made clear that this is

only a temporary exception.

7. Finally, as payments to teachers have already begun to be implemented through

SIAFI, teachers’ unions have complained that some teachers are not being paid, or are being

unfairly eliminated from payrolls handled by the Secretariat of Finance, among other issues.

These are elements that were expected to a degree within the initial period of transfer to

implementation of payments through SIAFI, considering the disorderly administration in

payrolls up to that point by other institutions. However, in the medium term this will very

likely not be a point of contention anymore, as the system will allow for more orderly and

timely payments, as well as better control over the recruitment and management of human

resources.

Consultations and Context for Reform in Citizen Security

8. With regard to the consultations on the design of the citizen security policy, it is

important to mention that the proposed policy framework is based on a draft guidelines for

citizen security policy prepared under the previous administration, which had held extensive

consultations with civil society organizations working on citizen security and violence

prevention (see para 86). Formal and informal consultations held by the government and by

the Bank confirmed that the content of the policy addresses most of the main messages and

concerns from civil society, such as the need for a greater focus on prevention, strengthening

information systems, and coordination of inter-sectoral efforts at local and national levels. 49

The design of key programs of the policy such as the Safer Municipalities Program, were

discussed at the grassroots levels with mayors throughout the country and key local

49 As part of the CPS drafting process, a total of 9 formal consultation sessions were conducted by the Bank, with

representatives of civil society, local governments and members of Congress; 3 of these consultations were particularly

focused on issues related to citizen security, crime and violence. About 250 persons participated in the consultation for the

new CPS in Honduras. In addition to the formal consultation sessions, a series of semi-structured meetings and interviews

were held during field visits to several parts of the country with various stakeholders.

91

stakeholders at Department-level meetings. In addition, the citizen security policy contains

specific dispositions related to the participation of civil society organizations and private

sector at the national and local levels. Discussions are currently underway regarding how to

best ensure civil society participation at the national level, particularly in a monitoring role

(included in the policy). In this regard, civil society should continue to deepen engagement

among its own diverse sectors, recovering from its own internal tensions and divisions related

to the 2009 political crisis, in order to arrive at a more cohesive approach to monitoring and

advocacy efforts, and more articulate expression of civil society concerns and demands.

Finally, civil society organizations view the Bank as an honest broker that can help foment

this type of dialogue among sectors on this particularly issue.

9. Although it is clear that the success of the reforms involved will benefit the Honduran

population in general (as crime and violence levels have dramatically increased over recent

years), and will contribute to the strengthening of governance conditions with a more

constructive interaction among authorities and civil society, it is also very likely that powerful

vested interests that have infiltrated themselves into official security structures (whether they

be groups engaged in illicit activity, or actors that have enjoyed a certain control over sectors

of the citizen security institutions) will perceive the envisioned reforms as a threat to their

power, and will try to obstruct its success. The Honduras Institutional Governance Review

(IGR) of 2009 identifies this issue, and further suggests that:

10. ―It is doubtful that simply adding more resources would improve the situation. What is

required is first an initial, broad-based consensus on the need for change and on the objectives

to be pursued… and subsequently, a high-level agreement to reduce political interference in

the operations of the various institutions…. In the meantime, the first step would be to

acknowledge the poor level of performance within the sector, and setting productivity goals to

hold each institution accountable for the resources it receives and the services it provides.‖

11. The IGR also brings to attention the marginalization of the National Security Council

(CONASIN) in the past; civil society organizations have attributed this dynamic to a lack of

will on the part of citizen security institutions to be held accountable. Currently, however, the

Government has established the Citizen Security Council. This Council brings the relevant

security, judicial, human rights, and line ministers together with the Supreme Court,

Prosecutors Office and local governments to oversee the implementation of the policy. The

approved Integrated Citizen Security Policy also includes specific measures to include civil

society and private sector participation in the implementation of the policy at the national and

local levels.

92

Annex 7: Institutional Framework of Honduras

Citizen Security and Co-existence Integrated Policy

The purpose of this annex is to describe the institutional framework in which Honduras’

Citizen Security and Coexistence Integrated Policy operates. Even though this DPC focuses

only on the prevention aspects of this policy, it is useful to provide the institutional context for

the overall policy. This annex provides a basic analysis of the lead institution in the citizen

security sector, namely the Secretariat of Security (including police and prisons) and related

interagency coordinating bodies. The analysis also includes a summary assessment of other

justice sector institutions such as prosecutors and courts.50

Basic competencies along the security and justice value chain are distributed as follows:

1. Preventing crime and violence is the responsibility of the Security Secretariat in

coordination with a number of agencies including the Secretariat of Interior

(responsible for promoting alternative conflict resolution), social development

agencies (such as Youth Institute, Children and Family Institute, Social Development

Secretariat, Education Secretariat, Health Secretariat, National Institute of Women,

etc), local governments responsible for local citizen security plans, and specialized

NGOs.

2. Controlling crime is the responsibility of the Security Secretariat, mainly through the

different divisions of the national police.

3. Investigating crime is a responsibility shared between the national police’s General

Division of Criminal Investigation and the General Attorney’s Office (Public

Prosecutors’ Office).

4. Accusing and prosecuting those suspected of having violated the law is the

responsibility of the General Attorney’s Office (Public Prosecutors’ Office).

5. Administrating justice is the responsibility of the Judicial branch.

6. Administrating the penitentiary system is the responsibility of the Security Secretariat.

7. Rehabilitating and reinserting people in conflict with the law is the responsibility of

the Security Secretariat, in coordination with institutions like INFHA which is

responsible for juvenile detention centers.

8. In addition there are a number of coordinating and oversight bodies, namely for

coordinating within the executive branch of government (Security Cabinet), across

executive and judiciary branches of government (Citizen Security Council), with civil

society (CONASIN); as well as a Human Rights Commissioner and an active civil

society.

The Citizen Security Policy deals only with the responsibilities outlined in numerals 1, 2, 3

(only related to Security Secretariat), 6, and 7, and establishes the Citizen Security Council.

Responsibilities related to numerals 3 (as related to the GAO), 4, and 5, and the coordination

between security and justice sectors are the object of another policy which is currently being

discussed within government. The criminal justice and security policy has strong support from

the European Commission (which has it as a trigger for its second sector budget support

50 This annex is prepared based on several reports, including: Guillen-Castro (2011). Strategic Report on Crime, Violence and

Citizen Security in Honduras, draft document prepared for the World Bank; Rivera-Cira (2011). Honduras-Criminal Justice

and Human Rights. Nordic Trust Fund, World Bank; WB (2009). Institutional Governance Review. Vol I and II; Government

of Honduras (2011). Integrated Citizen Security and Coexistence Policy 2011-2022.

93

operation in 2012 for 30 million euros), and is also being proposed as an indicative policy

action for DPC 2 of these series.

Below we include a brief description of some of the key institutions involved in the security

and justice sectors. This description does not attempt to be exhaustive or comprehensive.

Further information can be found in the documents cited as background material for this

annex.

A. Agencies responsible for promoting and administering security and justice

1. Secretariat of Security

The Secretariat of Security was created in 1998 to separate the national police from the army

forces (Decree No. 155-98). This Secretariat has the mandate to formulate national policies

related to public order, peaceful co-existence, violence prevention, criminal investigation, and

citizen safety. The Security Secretariat is also the technical secretariat responsible for

implementing the citizen security and co-existence policy 2011-2022. Traditionally, The

Secretariat has been responsible for the national preventive police, national criminal

investigation, special investigation services (smuggling, fraud, etc), special preventive

services (prisons), police education, and traffic police. With the recent passage of the citizen

security policy, the Secretariat has created a new Sub-secretariat of Co-existence and

Community Participation whose specific mandate is to design and implement crime and

violence prevention programs with a human rights approach.

Concerns about the country’s increasing crime rate have resulted in an increase in the

Secretariat’s budget. In recent years, the budget of the Security Secretariat (which includes

funding for the police) was increased to allow for the recruitment of more officers. Even with

this increase, the ratio of police to population (148 per 100,000 inhabitants) is just half the

regional average, and the training and preparation of recruits could be significantly

improved.51

Donors, especially the Spanish Cooperation Agency, have contributed technical

assistance, training, and equipment in an effort to build capacity in the security sector.

Despite legal reforms for a more rehabilitation-oriented system, the prison situation in

Honduras continues to be critical, with high levels of overcrowding, escalating violence, and

only limited improvement in the percentage of pre-trial detainees. The prison situation has

changed little over the years as it has been a low priority for the government and the general

public. With respect to prison reform measures, the citizen security policy provides a

comprehensive framework for the modernization of the penitentiary system including the

professionalization of administrative personnel, equipment, etc.

According to the Institutional Governance Review (IGR) 2009, the police seems to be the

weakest link in the criminal justice chain and perhaps a key element to achieving

improvement in overall performance. New programs to finance equipment and infrastructure

and a series of outreach initiatives aimed at bringing the police closer to the community and

fostering citizen cooperation hold some promise. However, what is needed most is

organizational restructuring, efforts to improve the quality of existing staff and to attract more

51 This figure is calculated against the number or preventive and investigative police officers only (Republic of Honduras

2005. If transit officers are included, the figure reaches 169, which is still low. The region’s average is 300 per 100,000

inhabitants.

94

qualified recruits, a more efficient control of performance (including information systems,

which are significantly underdeveloped), better coordination among all parties, and the

formulation of policies for the overall sector and individual police divisions. The citizen

security policy proposes a set of programs and actions that will move the sector in this

direction, such as strengthening the police education and training system to orient it towards

respect for basic rights and civic coexistance, developing their capacities to partner in local

citizen security plans, ensuring a minimum of high school education for all policemen,

developing an inter-institutional action plan to conduct criminal investigation in a integrated

fashion with the Public Ministry, and so on.

2. Secretariat of Justice and Human Rights

The Secretariat of Justice and Human Rights was created by Executive Decree PCM-027-

2011. The Ministry is responsible for providing guidance, coordination, direction, and

supervision for the implementation of public policies on human rights and access to justice.

These activities include the elaboration of the National Action Plan on Human Rights with the

participation of civil society organizations. The Ministry also coordinates with the National

Commission on Human Rights, which investigates complaints about possible human rights

violations. Since the establishment of the Ministry was a fairy recent event and its budgetary

arrangements are still under consideration, its financial and technical capacities are limited at

this time. The Security Secretariat is coordinating with the Human Rights Secretariat are

conducting dissemination activities of the citizen security policy and will work closely on the

elaboration of the action plan for the policy. The EU has recently approved a grant of 5

million euros to strengthen the Secretariat’s capacity.

3. Secretariat of Interior and Population

This Secretariat aims to strengthen and consolidate internal governance and citizen

participation mechanisms. Its mandate includes coordination, supervision, and evaluation of

departmental and municipal development plans. The Secretariat of the Interior coordinates

with the Security Secretariat activities aimed at increasing the capacity of local governments

in the implementation of alternative justice and mediation mechanisms. A reform of the

mediation law championed by the Secretariat of Interior is under discussion. This new law is

expected to provide more responsibilities to local governments to promote alternative justice

and conflict resolution mechanisms. This is a critical service to promote a culture of peace

and respect for basic rights at the local level, and to reduce the excessive workload of judicial

system. It is being proposed as an indicative policy action for DPC2 of this series.

4. Honduran Children and Family Institute (INFHA)

INHFA was created by Decree No. 199-97 (December 29, 1997) as an autonomous agency in

charge of the protection of children and family. Under the provisions of the Children and

Adolescents Code, INHFA is responsible for the detention centers for juvenile offenders.

5. Local Governments

Local governments have been at the forefront of the innovations in citizen security. Some

municipalities, such as Puerto Cortes, have developed successful mechanisms to raise security

95

taxes and manage them transparently through a trust fund monitored by local authorities, the

private sector, and civil society organizations. Despite this critical role, the normative and

policy framework did not provide much space for local governments’ role in citizen security.

One of the key contributions of the Citizen Security Policy is the recognition of the critical

role and relevance of local governments in the implementation of the citizen security policy.

In this regard, the policy contemplates the creation of citizen security and coexistence local

councils. These councils will be made up of institutional representatives of the National

Council on Citizen Security at the municipal level and will facilitate coordination between the

national and regional levels.

6. Public Ministry (Public Prosecutors Office)

This institution was created by Decree No 228-93, published in the Official Gazette No 27241

January 6, 1994. As in most countries in Latin America, the Public Ministry is an agency

with a broad mandate that includes prosecution of common or organized crime, but also

domestic violence, abuse of children and human rights violations. The PM has a Special

Human Rights Prosecutor who has been very active in the investigation of sensitive cases of

possible human rights abuses. Cases brought to the PM have to rely on investigative capacity

of the police and there are serious complaints about the prosecutorial capacity of this

institution. Lack of resources and political external forces seriously limit its capacity and

effectiveness.

7. Judicial Branch

The judicial branch of government consists of a Supreme Court of Justice, courts of appeal,

trial courts (Juzgados de Letras), and justice of the peace courts. The Public Defense Office

is also attached to the Judiciary. The Supreme Court has 15 justices, elected for seven-year

terms by the National Congress. The principal objective of a Judiciary is to solve the conflicts

among individuals, and between them and the State. The system must provide the necessary

elements to channel social conflicts and preserve social peace. Under the rule of law, the

administration of justice is a power that must be exercised impartially. Several reforms have

been enacted to promote judicial independence, but several factors have conspired to reduce

their effectiveness. For a detailed analysis see World Bank’s Institutional Governance

Review (2009).

B. Coordinating and Oversight Bodies

8. National Citizen Security Council

The Citizen Security Council, created by the citizen security and co-existence policy will

report directly to the president and will be given responsibility for the elaboration of the

policy’s action plan and its oversight mechanisms. The Council’s multi-stakeholder

composition will ensure that the National Citizen Security and Co-existence Policy is

implemented in a way that represents the views not only of the national Government through

the Security Cabinet, but also of the judiciary, line ministries and local authorities. This

council is comprised of the President of the Republic, the Security Secretariat (which will act

as the technical secretary), the Secretariat of Interior and Population, the Secretariat of Justice

96

and Human Rights, the Office of the Attorney General, the national police, the Supreme

Court, and line ministries working on crime and violence prevention.

9. Security, National Defense, and Governance Cabinet

The Cabinet is established by the Country’s 2010-2038 Vision Law, the 2010-2022 National

Plan, and the Public Administration law. It is comprised of the Secretariat of the Presidency,

the Secretariat of Justice and Human Rights, the Secretariat of the Interior and Population, the

Secretariat of Security, the Secretariat of Defense, and the Secretariat of Planning and

International Cooperation. Its mandate is to ensure that the activities of the key actors

involved in the implementation of the comprehensive citizen security policy are in line with

the main presidential priorities. The Security, National Defense, and Governance Cabinet is

also expected to request that key line ministries such as the Social Development Secretariat

participate in the discussions of the citizen security action plan.

10. National Council of Interior Security (CONASIN)

This Council was created by the Organizational Police Law (2008). The Council is made up

of the Security Secretariat along with civil society and private sector organizations whose

function is to advise the Minister of Security on citizen participation in policy design and

implementation. However, CONASIN has been inactive in recent years. There are ongoing

discussions on how to restructure its role in light of the creation of the Citizen Security

Council and the experience gained with CONASIN.

11. Human Rights Commissioner (CONADEH)

The CONADEH was created by Decree No 2-95 that reformed Article 59 of the Constitution.

This agency is entrusted by the Constitution with the responsibilities of a Human Rights

Ombudsman. It is an independent and autonomous body with a crucial role in the prevention

of torture and ill-treatment, particularly in relation to detainees. It has a network of offices

covering the whole country. These offices must conduct periodic reviews of individual abuse

cases and prepare analyses on systemic issues that may include inspections of police and

prison facilities to ascertain the physical presence and conditions of possible victims of

abuses. CONADEH has also developed a database with a standard reporting system on

allegations of human rights violations.

12. Civil Society Organizations

A number of civil society organizations play very important roles in the promotion of citizen

security and protection of basic rights within the criminal justice system. Some of the most

active organizations are Casa Alianza, CRPTR (Centro de Prevención Tratamiento y

Rehabilitación de las Víctimas de la Tortura y sus Familiares.); CIPRODEH (Centro de

Investigación y Promoción de los Derechos Humanos); COFADEH (Comité de Familiares

de Detenidos Desaparecidos en Honduras); CEJIL (Centro por la Justicia y el Derecho

Internacional); ERIC (Equipo de Reflexión e Investigación de la Compañía de Jesús en

Honduras); Women’s Rights Center (Centro de Derechos de la Mujer); Women’s Studies

Center (Centro de Estudios de la Mujer) and; the Violence Observatory (Observatorio de

Violencia) at the National Autonomous University of Honduras.

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This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

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