July 26, 2024
Santo Domingo, Dominican Republic:
A track record of sound policies and institutional policy frameworks has helped the Dominican Republic achieve robust and resilient economic growth and low inflation over the last two decades. Effective policies contributed to a growth moderation that appropriately supported inflation’s rapid and sustained return to its target last year. The authorities provided agile policy support to aid the recovery while monitoring closely the financial sector, which weathered the period of high interest rates and slower growth well in 2023. Going forward, policies should focus on maintaining macroeconomic and financial stability, including by gradually normalizing the monetary policy stance while rebuilding fiscal and external buffers. In the medium-term, planned enhancements to policy frameworks and deepening structural reforms—in particular, comprehensive fiscal and electricity reforms—have the potential to support competitiveness and inclusive growth.
Sound and decisive policies brought inflation firmly back to target…
Following a strong post-pandemic recovery, economic growth slowed to 2.4 percent in 2023 due to tighter global and domestic financial conditions, weak export demand, and transient domestic factors, largely climate related. The growth slowdown, alongside lower commodity prices, drove inflation’s faster-than-expected convergence to its target range (4±1 percent) by May 2023. In response, the BCRD cautiously and appropriately reduced its key policy rate, allowing for greater exchange rate flexibility, while fiscal policy was prudently adjusted—increasing public investment—to support the economy. Given historically low interest rate differentials with the US Fed Funds rate, the BCRD increased foreign exchange interventions to smooth daily exchange rate volatility.
The current account deficit in 2023 narrowed markedly to 3.6 percent of GDP, driven by the domestic demand-led import compression, receding commodity prices, and record travel receipts, and was fully financed by FDI flows, with continued positive market access. Higher spending and interest rates and lower GDP growth drove increases in the public sector deficit and debt in 2023, the latter also in response to greater exchange rate flexibility. The financial sector weathered the period of tight monetary policy and slower growth in the first half of 2023 and is adequately capitalized and profitable.
…and laid the ground for sustained growth…
Supported by sound policies, fundamentals and favorable external conditions, the outlook is favorable despite elevated—mostly global—uncertainty. Real GDP growth is projected around its long-term trend of 5 percent in 2024 and thereafter, with inflation around its 4 percent target. The current account deficit, expected to be fully financed by FDI, is projected to gradually narrow to less than 3 percent of GDP over the medium term supported by a lower energy bill, and higher tourism and free trade zones’ receipts. While near-term risks to the outlook—including from tighter global financial conditions, geopolitical tensions, and volatile commodity prices—have moderated since last year, they remain elevated and tilted to the downside. Over the medium-term risks are more balanced and include upside risks if key domestic reforms are implemented successfully.
…which provides space to rebuild buffers …
Short-term policies should ensure that inflation remains within the target range while preserving financial stability, and that fiscal and external buffers are rebuilt. Priorities include:
- Fiscal policy should remain focused on rebuilding buffers. The authorities’ planned gradual fiscal consolidation, consistent with the fiscal responsibility law in the Senate, is appropriate to place debt on a firmly downward path. Furthermore, an integral fiscal reform that durably raises revenues through broadening the tax base and removing exemptions while reducing tax evasion and improving spending efficiency—including reducing subsidies to the electricity sector and untargeted transfers—is imperative. Such reform will both create additional buffers and provide the space for needed development spending (including disaster-resilient infrastructure). Well-targeted measures through existing social programs can be used to mitigate the impact of reforms on the most vulnerable.
- Monetary policy normalization can continue, given remaining economic slack and that inflation is firmly within the target range. To further cement the hard-won credibility of the inflation-targeting framework, foreign exchange rate interventions and liquidity measures should focused on large shocks. Further exchange rate flexibility can play a shock absorber role while further reserve accumulation can increase buffers to deal with future shocks.
- The financial sector remains resilient and well capitalized. Stress tests conducted by IMF staff—consistent with those published by the BCRD—show that the banking sector can absorb a range of shocks. Continued close monitoring to contain any build-up of vulnerabilities remains warranted amid higher for longer interest rates and past increases to credit growth.
…and undertake crucial structural reforms to foster inclusive growth.
The team commends the authorities for their ongoing efforts to enhance policy frameworks and carry out reforms. Additional enhancements to policy frameworks, governance, the business climate, social safety nets and the electricity sector can foster inclusive growth over the medium term and reduce vulnerabilities:
- The fiscal policy framework, and spending and revenue efficiency can be further enhanced by continued improvements to public financial management (notably the transparency and effective oversight of public enterprises, and investment planning) and further strengthening of revenue administration. The development of a cost/benefit framework to evaluate tax exemptions and subsidies would also ensure that planned increases to tax revenues through tax reforms are durable.
- The mission welcomes the authorities’ commitment to increase resources to expedite the recapitalization of the central bank to reinforce its autonomy. Efforts should continue to deepen the FX market and expand the use of hedging mechanisms, to support further flexibility of the exchange rate and therefore further enhance the effectiveness of the inflation targeting framework.
- Bringing the financial and prudential regulatory framework up to the latest international standards, alongside the expansion of the macroprudential toolkit, and closing regulatory/supervisory gaps (e.g. for savings and loans cooperatives) , will further increase financial sector resilience.
- Ongoing efforts to improve public institutions and the business climate are bearing fruit and are essential to maintaining the strong investment and growth trajectory. Reforms to, education and the labor market, together with further improvements to social outcomes and implementation of climate adaptation and mitigation policies will be critical to support inclusive and resilient growth and continue to reduce vulnerabilities.
The mission met with Central Bank Governor Héctor Valdez Albizu, Minister of Finance José Manuel Vicente Dubocq, other senior officials, and representatives of the civil society and the private sector. The team would like to express its sincere gratitude to the authorities for their exceptional hospitality, full cooperation, and open, frank and productive dialogue.