H1 marked by very strong growth
Preliminary data from the Central Bank indicates that in H1 2018 economic activity expanded by 6.7% year over year. In Q1, GDP growth measured by the Monthly Indicator of Economic Activity (IMAE) was 5.4%, and in Q2 it was 7.1%, an extraordinary and surprising expansion. More modest growth had been expected, especially because of higher oil prices, which increased the oil bill by more than USD 430 million. It is very likely that the intervention in the FX market and the sale of reserves counteracted the pressure from the oil bill, thus allowing higher growth than expected.
Inflation was 0.21% in June, placing accumulated inflation since January at 1.43%, and annualized inflation at 4.63%. This level is still within the target range of the Monetary Program (4.0% ± 1.0%), but has been gradually approaching its upper limit.
In H1 exports reached USD 5.4 bn, an increase of USD 421 million or 8% above Q1 2017. Total imports grew by 13.5%, which is consistent with the expansion of domestic demand. Revenues from tourism grew by USD 212 million (5.6%), and remittances increased by 10.6% (USD 307 million). As a result, the Central Bank reported that the current account deficit reached USD 141 million.
At the end of July, the Monetary Board decided to increase the monetary policy interest rate by 25 basis points, from 5.25% to 5.50%. This seeks to counteract the increase in inflation resulting mainly from higher oil prices, while monetary policy begins to respond to increases in interest rates and yields in the United States.
We project a growth rate of 5.6% for Q3. This should drive the unemployment rate down modestly or leave it unaltered. GDP growth above the potential level in H1 and an oil bill above the predicted levels could produce inflationary pressures and pressure on the FX market. Those pressures could be moderated by Central Bank´s sales of reserves and/or a more contractionary monetary policy. We expect intervention in the FX market to continue.
Due to revenues from the allocation of USD 1.3 bn in Global Bonds, reserves recovered at the end of July, reaching almost USD 7.6 bn. However, it is expected that towards the end of Q3, the level of reserves will decline to USD 6.6 bn.
Consistent with the inflation target of 4% (+/- 1%), in Q2 the restricted monetary base declined by 2.2%, more than was set in the monetary program. This seeks to dissipate the effect of the impact produced by the reduction of the legal reserves in 2017 and to counteract the inflation of external origin generated by the increase in oil prices.
The CAD should increase as total imports grow in response to higher prices for oil and other commodities, and as proceeds from exports and tourism grow modestly. The CAD for Q3 could reach 1.0-1.2% of GDP. We expect the rate of depreciation of DOP with respect to the USD will continue to be low, and that by the end of Q3, the exchange rate will stand at 50.30 DOP per USD.
For Q3, we expect an acceleration of primary expenditure, which will reach up to 13.3% of GDP because of higher spending on public infrastructure (hospitals, schools and transportation) and some social programs. The deficit for the Non-Financial Public Sector should reach 2.1% of GDP. Until the end of July, total debt contracted by the government reached the equivalent of 77% of the total financial sources authorized in the budget, and, as of the end of June, financial applications reached 56% of the budgeted amount. The novelty in financing, as we reported in our most recent “In Brief”, has been the drastic change in strategy. Domestic financing has been virtually abandoned as the bulk of the weight has been placed in external financing. FX pressures are likely to be the main cause of the shift.
After a few months of pause, corruption cases have again hit Medina’s government and the PLD. Three PRM representatives led by Congresswoman Faride Raful have presented potentially compromising evidence against the government and have requested an investigation by the Chamber of Representatives. Raful and the others provided evidence that two firms owned by Joao Santana and his wife, Mónica Moura, had contracts with the Presidency, something that had not been known previously, that payments made to them were nearly USD 30 million, and that disbursements were made up until 2017, when Santana and Moura had already been convicted in Brazil for their participation in the Lava Jato scheme. The government responded by saying that the contracts ended in mid-2015 and that everything was done in a totally legal manner, respecting the law of public procurement.
Regardless of the legal merits of this complaint, the information has hurt the government because it revealed that the government had signed contracts and made payments of millions of USD to individuals and companies that were part of a corruption scheme, and that these same people were also top-level advisers of the Medina campaign. The scandal put the Medina government back on the defensive, and has given new vigor to the Green March Movement.
The bill on political parties continues in limbo. The Central Electoral Board expressed serious doubts about the feasibility and practicality of ordering by law open and simultaneous primaries organized by that institution, arguing that it would be both very risky and expensive. In view of the upcoming closure of the legislative period, President Medina requested an extension of the legislature so that Congress can discuss the bill on political parties as well as the bill on elections. However, it is still not clear that an agreement will be reached.
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