Dominican Republic shifting to renewable energy
Friday, September 19 2014 @ 01:15 AM AST
Contributed by: michaelariston
Still facing electricity woes, the Dominican Republic turns to renewables.
The following is from Moody's Investor Services September 18 research on the Dominican Republic.
Dominican Republic: 4 Factors That Weigh Heavily on the Sovereign's Credit Profile
The Dominican Republic has sustained robust economic growth since 2005, and the medium-term growth outlook is broadly favorable given a relatively high potential growth rate that the IMF estimates at 4.5%. Authorities have also partially reversed the large 2012 fiscal deficit, with prospects for continued consolidation remaining favorable. Nevertheless, increasing uncertainty on the fiscal front is creating substantial challenges that could weigh heavily on the sovereign’s credit prospects. From Moody’s standpoint, four areas are of particular concern:
1. Government debt has increased markedly. Despite favorable economic performance, debt ratios have weakened markedly in recent years, rising to just under 40% of GDP in 2013 from approximately 19% in 2007. A key credit concern is when – or if – debt ratios will peak, reach an inflection point, and then begin to decline. Material fiscal easing in 2016 could prolong negative debt dynamics and exert downward pressure on the sovereign’s creditworthiness.
2. The interest burden has risen sharply. The interest payment-to-revenue ratio deteriorated to 16.2% in 2013, from 6.4% in 2005, and is significantly weaker than the 8.2% median among ‘B’-rated sovereigns. Higher interest payments constrain fiscal space, making public finances more rigid.
3. The electricity sector. The financial burden imposed by persistent electricity subsidies remains an ongoing feature of the Dominican Republic’s credit profile. Although there is now some evidence of improvement on the generation front, structural issues persist.
4. The electoral cycle. Expansionary fiscal policies have continued to be the norm during pre-electoral periods. Even though the authorities have usually adopted corrective measures to ensure fiscal tightening after each general election, the end result has been stop-and-go fiscal policies that reduce the capacity to absorb fiscal shocks.
The outlook on the sovereign’s B1 rating remains stable, but fiscal developments through 2016 will remain an important area of analytical focus and a key ratings driver. In this regard, stable deficit levels and declining debt ratios would support the Dominican sovereign’s creditworthiness.
Despite Sustained Economic Growth, Debt Ratios Have Weakened Markedly
The Dominican economy has sustained robust growth since 2005, and in 2009-13 output expanded 4.7%, on average. Despite the favorable economic performance, debt ratios have weakened markedly, reaching just under 40% of GDP in 2013 from approximately 19% in 2007 (see Exhibit 1).
Debt-to-GDP last peaked in 2003 following the default and exchange rate depreciation, but declined through 2007, outperforming ‘B’ category medians. Nevertheless, the ensuing deterioration in debt metrics since 2007 has been more pronounced than that of its peers and led to a convergence with category medians. The movement suggests that the Dominican sovereign’s credit profile is losing strength among ‘B’-rated sovereigns.
Going forward, a key credit concern remains at which point the debt will peak, reach an inflection point, and begin declining. Although we expect that consolidation will continue, albeit at a slower pace, there is a high degree of uncertainty surrounding fiscal performance against the backdrop of the general election looming in 2016.
Material fiscal easing in 2016 could prolong negative debt dynamics, potentially exerting downward pressure on the sovereign’s creditworthiness.
Interest Payments Consuming an Increasing Share of Government Revenues
The development of a domestic market for government bonds is an important achievement for the sovereign. Since 2009, gradual and steady progress toward developing a local currency yield curve and domestic capital markets has helped diversify sources of funding. Nevertheless, this progress has come at a price. Yields on domestic currency bonds are relatively high given the sovereign’s relatively short track record on maintaining low inflation and macroeconomic stability.
Conscious of the elevated cost of domestic funding, the authorities have shifted their focus to external markets as the primary source of financing to cover borrowing needs.1 Although yields on foreign currency bonds are lower than those on local-currency instruments, the cost remains higher than for multilateral financing. Larger deficits in recent years have not been fully financed by cheaper multilateral loans, and as the debt-to-GDP ratio rises, the volume of interest payments also increases. The result is a sharp rise in the interest burden relative to the government’s revenues (see Exhibit 2).
The interest payment-to-revenue ratio deteriorated to 16.2% in 2013 from 6.4% in 2005, and is weaker than the 8.2% median among ‘B’-rated sovereigns. Higher interest payments crowd out other spending items, including infrastructure investment and capital expenditures. The higher payments constrain fiscal space, making public finances more rigid. In the event of a shock, cutting expenditures becomes much more challenging, which in turn reduces the capacity for making the fiscal adjustments the sovereign has relied in post-electoral periods.
The Electricity Sector Is Still a Major Fiscal Hurdle
Problems in the electricity sector have recurrently negatively affected the sovereign’s credit profile. These problems have included regular blackouts, heavy technical and non-technical losses (including electricity theft through illegal connections), elevated generation costs, erratic bill collection rates, direct and indirect subsidies to cover distribution inefficiencies, and high costs for consumers as many of them rely on expensive alternatives such as self-generated electricity. These problems have become a drag on competitiveness and economic performance. The sector is a source of budgetary inflexibility and the persistent transfers (i.e., subsidies) are a burden on the fiscal accounts. The transfers equal 1%-3% of GDP every year (see Exhibit 3).
The government covers the largest part of the electricity sector deficit, but electric companies are also forced to seek financing from multilateral creditors and run arrears domestically. Although distribution companies account for the largest losses, the structural elements that lead to the sector’s deficit run from the point of energy generation to final collections on billing electricity use.
Electricity tariffs are broadly subsidized and the difference between the cost of generating electricity and the amount billed to the final user account for roughly 20%-25% of the distribution company losses. Operational inefficiencies contribute a similar amount to the deficit, while non-payment (collection losses) on billed usage accounts for almost 10%. The heaviest contributor to the deficit are technical and non technical losses (approximately 40% of the deficit), which include electricity theft, non-billing for usage and a lack of electric meters, as well as technical challenges from old transmission lines and an inefficient grid.
Conscious of the substantial challenges, the authorities began implementing measures to stabilize the sector in 2008 when the cost of subsidies peaked due to high oil prices. Since then, the energy matrix, which depended heavily on expensive fuel oil for electric generation, has shifted towards a more diversified mix with an increasing reliance on natural gas (see Exhibit 4).
Moreover, the authorities have announced the construction of two coal-fired power plants with a combined capacity of 674 megawatts, which will reduce the cost of the electricity sold to Dominican power distributors, cutting their losses. The new plants are scheduled to enter into operation in 2017. The government’s strategy for addressing the electric sector challenges relies heavily on continuing to replace fuel-oil generating capacity with the coal-fired plants, as well as increase the participation of natural gas and combined-cycle turbines.
We estimate that the shift in the energy matrix will cut the sector’s yearly deficit by approximately $700 million (1.1% of 2014 GDP) by the time the new plants begin operating in 2017. Nevertheless, important structural challenges remain for the sector. The deficit that remains will be more difficult to tackle because it will require greater effort being placed on increasing billing and collections, a better targeting of subsidies, and strong political will to eliminate theft and raise investment to curb technical losses.
Fiscal Performance Remains Vulnerable to the Electoral Cycle
A strong consolidation effort in 2013 cut the fiscal imbalance to 2.9% of GDP from 5.6% in 2012, highlighting the Dominican sovereign’s capacity for fiscal adjustment. A combination of revenue-augmenting measures and expenditure cuts led to the favorable result, following substantial slippage in 2012 primarily related to election spending. The Dominican Republic holds general elections every four years. Repeatedly, expansionary fiscal policies have been the norm during pre-electoral periods, indicative of a weak policy framework (see Exhibit 5). and denoting a high degree of discretionality.
Fiscal susceptibility to electoral periods is common among several of the ‘B’ and ‘Ba’-rated sovereigns, but the condition has been particularly pervasive in the Dominican Republic. Even though authorities usually adopt corrective measures to ensure fiscal tightening after each election, the end result has been stop-and-go fiscal policies that introduce an element of volatility to economic performance and a deterioration of debt ratios.
These stop-and-go policies greatly reduce fiscal space and the ability to adopt counter-cyclical policies to deal with external shocks. Despite the strong consolidation effort following the 2012 fiscal easing and the authorities’ intention to avoid a similar episode in 2016, risks remain skewed toward the downside and the probability of fiscal slippage in the next general election is still present.