Debt Profile To Remain Attractive Amid Fiscal Improvements


BMI View: After posting a near record fiscal defi cit in 2012, we believe the Domin ican Republic is on tra ck f or major fiscal improvements this year . Moreover, w e anticipate that a positive fiscal trajectory, combined with robust growth, will ensure that yields on government external debt remain near record lows over the medium term.

In October 2012 , we highlighted that the Dominican Republic ' s government US$2021 Global bond was positioned to see additional gains as we believe d officials were taking important steps to narrow its fiscal deficit ( see our online service, October 17, 2012, ' Fiscal Consolidation Efforts To See Further Bond Gains ' ) . Since then, the yield on the bond has compressed by 40 basis points to 4.6% as of January 23. While the bond looks technically overextended and could be due for a near-term correction, w e believe that steady fiscal im provements , a relatively low debt burden, and a favourable growth trajectory will ensure that the government ' s debt profile remains attractive over the coming years.

Record Low Yields To Remain Over The Coming Months
Dominican Republic - US$ 2021 Global Bond Yield, %

Muddling Through Unpopular Fiscal Reforms

Following one of its largest fiscal deficits in recent history, which we estimate at 3.9% of GDP in 2012, we forecast the government ' s budget deficit to narrow to 2.4% of GDP in 2013, and fall below 2.0% of GDP by 2015. President Danilo Medina, who was elected in May 2012, has demonstrated a strong commitment to rein ing in the fisca l deficit, which was largely driven by the previous government's pre-electoral spending . Indeed, Medina signed his tax plan into law in November, increasing the value-added tax from 16% to 18%, and introducing additional taxes on a wide range of consumer goods. While we expect the tax ref orm to dampen Medina ' s popularity ( see, ' Necessary Adjustments To Hurt Approval Rating ' , November 11, 2012 ), we believe it sends a strong signal to investors that the government is willing to take the necessary steps to reduce the government ' s fiscal burden, ultimately improving the country ' s sovereign credentials.

A Period Of Fiscal Improvements To Begin In 2013
Dominican Republic - Government Fiscal Balance

Low Debt Burden Bolsters Government's Credentials

In addition to improvements in the government ' s budget deficit, we believe that the Dominican Republic ' s relatively low levels of debt wi ll ensure the country maintains a favourable sovereign profile. Indeed, we estimate total public debt stood at 32.3% of GDP in end- 2012, a nd debt servicing only account ed for about 14.0% of total fiscal expenditures, some of the lowest levels in Latin America. In order to take advantage of the country ' s current record low bond yields , President Medina sent a bill to Congress on January 18 proposing the issuance of new government debt . We believe that an y newly issued bonds will remain attractive to investors , and facilitate the financing of the government ' s fiscal deficit at relatively low borrowing costs.

Among The Lowest Levels Of Indebtedness In The Region
Latin America - Total Public Debt in 2011, % of GDP

Golden Growth Opportunities Will Increase Investor Optimism

Moreover, we believe that a robust growth story will further ensure the country ' s debt profile remains attractive over the coming years. We forecast real GDP growth to accelerate from an estimated 3.6% in 2012 to 4.4% in 2013, and remain above 4.0% over a multi-year period. In our view, rising investment into Dominican Republic's mining sector, particularly into the gold sector will be a major driver of growth over the coming years ( see, ' Gold Rush To Boost Growth ' , December 12, 2012 ). Our mining team identifies the joint venture between Canadian firms Barrick Gold and Goldcorp in the Dominican Republic ' s Pueblo Viejo mine, as potentially adding up to 2.0% to real GDP growth through gold exports. Consequently, a strong performance by the mining sector will increase the tax revenue the government receives from mineral exports, further bolstering fiscal consolidation efforts. Ultimately, the Dominican Republic ' s favourable economic trajectory will ensure investor ' s perception of government debt remain positive.

Rising Gold Sector To Bolster Growth
Dominican Republic - Current Gold Projects

Risks To Outlook

A deterioration in the country's security environment poses downside risks to our fiscal outlook. Indeed, in recent months, the country has seen a spike in crime, potentially as a result of anti-drug-trafficking efforts in Mexico and Colombia which has forced drug traffickers to search for alternative routes. If crime continues to escalate, the current optimism that prevails among investors could fade. Under such scenario, the strong gains that government debt has seen over the coming months could be reversed, overriding the positive macroeconomic trajectory we currently expect in the Dominican Republic.

This article is tagged to:
Sector: Country Risk
Geography: Dominican Republic, Dominican Republic