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Honduras: Selected Issues Summary

Core Content

This report, prepared by the International Monetary Fund (IMF) staff, provides an analysis of key economic issues in Honduras, including revenue mobilization, electricity sector reform, and the buffering role of exchange rate flexibility. The findings are based on data available up to June 2019 and are intended to support policy consultations and fiscal planning.

Revenue Mobilization

Main Points

• Progress: Honduras has made significant strides in revenue mobilization over the last five years, contributing to fiscal consolidation and improved macroeconomic stability.
• Fiscal Deficit Reduction: The non-financial public sector (NFPS) deficit was reduced by 6.5 percentage points of GDP between 2013 and 2018.
• Tax Effort: Honduras performs well in terms of tax collection ratios, ranking among the highest in the region, despite having statutory tax rates comparable to regional peers.
• Efficiency Frontier: A benchmarking analysis using the DEA (Data Envelopment Analysis) model indicates that Honduras has a positive but smaller efficiency gap than other Latin American countries. If inefficiencies were eliminated, tax collection could increase by 4 percentage points of GDP.
• Tax Expenditures: Honduras has one of the highest levels of tax expenditures in the world (6.8% of GDP), mainly due to special corporate income tax (CIT) regimes and VAT exemptions. These expenditures reduce revenue and may distort competition and encourage tax evasion.
• Future Strategy: The report recommends reforms to reduce tax exemptions, improve tax compliance, and strengthen tax administration. It also suggests that base broadening and reducing inefficiencies could help increase revenue and reduce the need for high statutory rates.

Electricity Sector Reform: International Experiences

Main Points

• Key Components: Successful reforms typically involve:
  • Cost reduction in energy production through private sector participation and price liberalization.
  • Reduction of distribution losses via infrastructure investment and enforcement measures.
  • Cost-recovery tariffs to ensure sector solvency, often accompanied by social transfers for vulnerable households.
• Albania Case Study: Albania faced similar challenges to Honduras, including high distribution losses and debt burdens. After a failed privatization attempt, the government took control and implemented reforms that:
  • Reduced distribution losses by 14% over three years.
  • Cut the quasi-fiscal burden of the sector to 0.1% of GDP in 2017.
  • Included short-term measures like criminal penalties for theft, service disconnections for non-payment, and tariff adjustments.
  • Included medium-term measures such as infrastructure investment and automatic tariff updates.
• Lessons for Honduras:
  • A strong political will and independent regulatory framework are crucial for reform success.
  • Criminal sanctions for non-compliance (e.g., energy theft) are important.
  • Technical loss reduction and efficient generation are key.
  • Cost-recovery tariffs and coverage for poor consumers should be prioritized.
  • Privatization of distribution may not be effective in reducing losses.

The Buffering Role of Exchange Rate Flexibility

Main Points

• Exposure to External Shocks: Honduras is vulnerable to real external shocks, particularly terms of trade (ToT) shocks, which are more influenced by import price fluctuations than export prices.
• Exchange Rate Regime: Honduras uses a crawling peg to keep the real effective exchange rate (REER) stable, but this limits the buffering effect of exchange rate flexibility.
• Impact of Exchange Rate Flexibility: Evidence from Latin America shows that more flexible exchange rates help buffer external shocks by:
  • Reducing the sacrifice ratio of domestic demand.
  • Facilitating expenditure switching, which boosts exports and import substitution.
• Honduras' Experience: During periods of negative ToT shocks, Honduras' REER adjustment was minimal, compared to more flexible regimes. This suggests that greater exchange rate flexibility could help Honduras better adjust to external shocks.
• Export Sensitivity: Honduras' exports are highly sensitive to REER movements, with a 10% depreciation leading to a 2.5% increase in total exports. This highlights the importance of the export channel in adjusting to external shocks.

Key Takeaways

• Honduras has made progress in revenue mobilization, but sustaining this effort is critical for long-term fiscal stability, infrastructure development, and increased social spending.
• Tax expenditure rationalization is a key area for future reforms to improve efficiency and equity.
• The electricity sector reform in Honduras should focus on reducing losses, improving tariffs, and strengthening regulation.
• Exchange rate flexibility can help Honduras adjust to external shocks more effectively, especially through the export channel.

References

• Estevão, M. and I. Samake (2013), The Economic Effects of Fiscal Consolidation with Debt Feedback, IMF Working Paper 13/136.
• Fenochietto, R. and C. Pessino (2010), Determining Countries' Tax Effort, Revista de Economía Pública.
• Fenochietto, R. and C. Pessino (2013), Understanding Countries' Tax Effort, IMF Working Paper 13/244.
• Gupta, Abhijit (2007), Determinants of Tax Revenue Efforts in Developing Countries, IMF Working Paper 07/184.
• Kapsoli, J. and I. Teodoru (2017), Benchmarking Social Spending Using Efficiency Frontiers, IMF Working Paper 17/197.
• Simar, L. and P. W. Wilson (2000), A General Methodology for Bootstrapping in Non-Parametric Frontier Models, Journal of Applied Statistics.