Country Forecast July 2010

1. Country Forecast July 2010 Dominican Republic Editor: Stephen Keppel Editorial closing date: July 7th 2010

2. Five-year forecast summary

3. Five-year forecast summary The ruling Partido de la Liberación Dominicana (PLD) succeeded in expanding its legislative majority in the May 2010 legislative and municipal elections, and new election rules mean that the party will maintain this majority until 2016, enhancing political stability until at least the next presidential election in 2012. The Dominican Republic's business environment will continue to improve gradually during the forecast period, but the country will remain in the bottom third of the Economic Intelligence Unit’s global business environment rankings. Dominican economic growth will continue to outpace growth in the US and many countries in Latin America, but the rate will be much slower in the forecast period (2010-14) at an annual average of just 4.5% compared with 7.4% average annual growth in 2005-09. Real GDP growth(%)

4. Five-year forecast summary The forecast for market opportunities is mixed. GDP growth in US dollar terms was weak in 2009, and market opportunities will be restricted by the gradual recovery and the country’s small population and low income per head during the rest of the forecast period. Prospects for long-term economic growth will be influenced by external factors and domestic policy reforms. The Dominican Republic will struggle to overcome structural constraints in human and physical capital, as well as in its governance institutions. However, assuming a continuation of generally cautious, market-oriented policies, the economy should expand steadily from 2012. Household consumption per head(US$)

5. Business environment rankings Methodology

6. The political environment

7. Political outlook Highlights The dominance of the ruling PLD should enhance political stability until at least 2012 while securing a moderate pro-business agenda throughout the forecast period. Progress on energy sector and government efficiency reforms will be slow and piecemeal as weak institutional capacity and vested interests hold back progress. The new constitution bans consecutive presidential re-election but allows for unlimited non-consecutive re-elections, meaning that the president, Leonel Fernández, cannot run in 2012 but could return in 2016. As a result, the race for the presidency in 2012 is wide open and will be a significant source of political and social tension. Both of the main political parties will struggle to select and appoint their presidential candidates in the run up to the 2012 election. There are no clear successors within the PLD and the leadership battle could be contentious.Within the opposition Partido Revolucionario Dominicano (PRD), Miguel Vargas Maldonado, the 2008 presidential candidate, is the current party leader, but he has lost some popularity owing to the PRD’s poor performance in mid-term elections and will face challenges from rivals. At this point in time, a PLD candidate would be the most likely winner, if he receives the firm backing of the current president, Mr Fernández. More from ViewsWire…

8. Demographics

9. Demographic outlook Population growth will be 1.4% per year during the forecast period, slightly slower than in 2004-08. Migration to the US and Spain will slow slightly, owing to the global economic crisis. Remittances from workers abroad will continue to support the economy of the Dominican Republic, although remittance growth will be weaker in the forecast period than during 2004-08. The population of the Dominican Republic is still relatively young and the old-age dependency ratio will remain low. Although improvements in education spending and attainment will continue in 2010-14, the quality of the labour force will still be undermined by low skills levels, and unemployment will remain in double digits.

10. The business environment forecast

11. Business environment outlook The Economist Intelligence Unit’s business environment rankings assess a country’s relative attractiveness as an investment location, both globally and regionally. The Dominican business environment still suffers from significant weaknesses including a lack of a well-trained bureaucracy and excessive clientelism, which will continue to hamper political effectiveness. Telecommunications infrastructure is better than in neighbouring countries, but the electricity sector, which is characterised by indebtedness and persistent blackouts, will continue to suffer from deep shortcomings.Some progress on a backlog of structural reforms will result in a rise in its score, but it will remain in the bottom third in the regional and global rankings in 2010-14.

12. Macroeconomic environment • Like other small, open economies, the Dominican Republic will face a challenging policy environment for most of the forecast period, and its medium-term path will depend in large part on how fast the US economy recuperates. • Economic growth will rebound in 2010 but average growth in the forecast period will be slower than in 2005-09 owing to weaker growth in exports, remittances and domestic investment. • On the domestic front, the banking sector has weathered the global storm better than expected thanks in part to more effective regulation since the 2003 banking crisis. Nevertheless, a shock to the system—triggered, for example, by a rapid depreciation of the Dominican peso—constitutes a persistent risk.

13. Fiscal policy Central government budget balance(% of GDP) Emergency financial support from multilaterals averted a fiscal financing crisis in 2009, but the underlying fiscal position will remain weak in 2010-11, recovering gradually thereafter. Arrears to suppliers will continue to accumulate as structural weaknesses in the public finances are aggravated by the slow recovery in revenue and the inability of the authorities to rein in current spending. The primary balance (excluding interest payments) will post a deficit of 1.5% of GDP in 2010 before reaching a surplus of 1.5% in 2014. Public debt (including the quasi-fiscal debt) will rise to 43% of GDP in 2011, owing to the size of the deficit and comparatively weak economic growth, before easing steadily thereafter. Around 45% of the public debt is denominated in foreign currency, so a more rapid than forecast currency depreciation would worsen these ratios.

14. Monetary policy Money market interest rate(%) • The Banco Central de la República Dominicana (BCRD, the Central Bank) will generally adopt an orthodox monetary stance over the forecast period, but will also be responsive to changing external conditions. • Disinflation has allowed the BCRD to cut the benchmark interest rate to 4%, which is at a low in the current cycle. After a rapid expansion of the money supply in 2010, monetary policy will tighten gradually in 2011-12. A spike in inflation could prompt the BCRD to raise policy rates earlier than expected, potentially leading to a sharper than forecast rise in commercial rates. • IMF support has improved confidence and bolstered international reserves.

15. Policy towards private enterprise & competition Implementation of legislation to increase transparency in public procurement is slow. Patchy implementation of a competition defence law. Tighter protection of property rights within the Dominican Republic-Central America Free-Trade Agreement (DR‑CAFTA). 2010-11: Government works to improve competition policy and facilitate a more efficient business environment, but weak transparency and limited competition persist. State remains involved in electricity distribution. 2012-14:

16. Policy towards foreign investment Liberal regulatory system towards foreign firms with attempts to attract foreign investment in IT and BPO sectors. DR-CAFTA and other trade agreements gradually result in a more secure and transparent environment. Attracting foreign investment constitutes a key component of the country’s development strategy. 2010-11: Discussions regarding the divestment of state-owned electricity companies begin. Foreign investment remains integral to policy mix. 2012-14:

17. Foreign trade and exchange controls DR-CAFTA enhances trade and investment ties with the US and Central America. EPA with the EU and CARICOM gradually increases trade flows. FTAs with Canada and Mexico. Sporadic trade conflicts with neighbouring countries. 2010-11: Stable regulatory environment for trade and capital flows. Temporary taxes on imports and exports are possible. Institutional modernisation proceeds slowly. 2012-14:

18. Taxes Increasing tax burden. There are numerous exemptions, but the IMF exerts pressure to reduce these. DR-CAFTA and EU EPA reduces taxes levied on foreign trade and efforts to fight tax evasion make progress. 2010-11: Low income tax rates and the expansion of the public deficit before the election may require new tax reforms to increase revenue after May 2012. 2012-14:

19. Financing A high degree of concentration in the financial system and supervisory shortcomings contribute to sustaining generally high lending costs. Still-tight international financing conditions continue to add some pressure to interest rates. 2010-11: International financing conditions improve. Slow improvement in banking sector efficiency. Stockmarket continues to grow strongly, but will not provide a significant channel for equity finance. 2012-14:

20. The labour market High unemployment and low productivity. Fiscal constraints restrict efforts to improve education and health. The quality of the labour force is undermined by low skills levels. High levels of informality and low productivity persist. 2010-11: Unemployment declines but is still high. Insufficient number of skilled workers fully to develop high-tech sectors. Scarcity of workers with secondary and university education limits productivity growth. 2012-14:

21. Infrastructure Quality of physical infrastructure is uneven and often inadequate, except in telecommunications. Severe structural problems in the electricity industry persist. Some large-scale rail and highway projects begin, but financing them is difficult. 2010-11: Further advances in telecoms. Other large-scale projects are proposed, but financing difficulties persist. Electricity industry is slow to improve, owing to a lack of investment. 2012-14:

22. The economic forecast

23. International assumptions Economic growth (%) International conditions during the first half of the forecast period will be much less conducive to growth for the Dominican Republic than in 2004-08. Although our baseline forecast assumes that the global economy has stabilised, higher risk aversion than in 2003-07 and a shrinkage of the world's financial sector will have an impact on the Dominican Republic as foreign investors will find it more difficult to raise finance for infrastructure, tourism and communications projects—all key factors in recent economic growth. Commodity prices will be supported into the medium term by structural factors, maintaining some pressure on prices and providing little relief to the external accounts of import-dependent economies like the Dominican Republic.

24. Economic outlook Economic outlook(% real change) We expect the Dominican economy to continue to outperform the US and Latin American average growth rate, but real GDP growth will be much slower in the forecast period, at 4.5% a year, than in the historical period, when growth averaged 7.4% a year. Our forecast reflects a weak rebound in exports (as a result of both global dynamics and competitiveness issues) and internal demand, owing to high unemployment, rising inequality and slower exchange inflows from tourism and remittances—major drivers of consumption growth in recent years. Services will continue to outperform industry, but the sector's expansion will be held back by the lack of skilled labour.

25. Wage and price inflation Consumer price inflation(%; annual av) We expect that the government will maintain relatively cautious economic polices over the forecast period after an easing cycle to stimulate the economy in 2009. Annual inflation has risen during the first half of 2010 on the back of higher oil prices and lower interest rates, but we expect a gradual easing in 2011-14 to rates comfortably within the medium-term target range of 5‑7%. Oil prices will continue to have a strong influence on consumer prices, and if average annual prices were to rise significantly beyond forecast levels high inflation would return, with serious effects. After rising by 15% in 2009 the next minimum wage increase is in 2011, but high unemployment and inflation will keep real wages down. Real wages for most public-sector workers will rise in the periods around elections in 2010 and 2012.

26. Exchange rates Exchange rates With the current-account deficit and the gross financing requirement remaining substantial, the peso will depreciate steadily against the US dollar in nominal terms throughout the forecast period. Since 2005 the currency has traded in a range of Ps32-37:US$1, with low volatility, but this range will rise to Ps37-42:US$1 in 2010-14. However, owing to still relatively high inflation, the real exchange rate will appreciate. Cautious economic policies, improved reserve coverage ratios and controlled inflation mean that the peso volatility of 2003-04 is unlikely. But fragilities in the banking sector will contribute to pressures in the foreign-exchange market and could hit confidence.

27. External sector External sector(US$ bn unless otherwise indicated) The size of the current-account deficit will fluctuate with the cost of oil imports and the size of the trade deficit. We expect the current-account deficit to widen in 2010, owing to rises in oil prices, before being relatively stable in 2011-14 as a percentage of GDP. The structural services surplus and income deficit will remain relatively stable (as a percentage of GDP) and the transfers surplus will continue on a downward trend (in GDP terms).

28. Foreign direct investment

29. Foreign direct investment Stocks and flows Inflows of foreign direct investment (FDI) increased from an annual average of US$209m in 1990-94 to US$1bn in 1998-2002, owing to privatisation. FDI reached US$2.2bn in 2009, a decline on the year-earlier period but up strongly from levels in 2007. In 2008 the stock of inward FDI was US$17.8bn (38.6% of GDP), and that of outward FDI was US$59m. The inward stock of FDI as a share of GDP is higher than in El Salvador and just below the subregional leader, Costa Rica. Inward foreign direct investment stock, 2010(% of GDP)

30. Foreign direct investment Determinants Efficiency-seeking investment in the free-trade zones (FTZs) and investment opportunities in tourism, real estate and mining are the main determinants. IT services and call centres are of increasing interest but the potential is unproven. Tax incentives, political stability, low wages and favoured access to the US market led US companies to move labour-intensive assembly operations to Dominican FTZs during the 1990s. FDI in the tourism sector has grown rapidly since the late 1980s. Initial foreign investment was tied to large all-inclusive resorts, attracted by the quality of the beaches and climate, adequate domestic management capacity and low wages. However, in recent years investment has focused on more lucrative luxury real estate complexes, flats and golf courses. Inward foreign direct investment stock per head, 2010(US$)

31. Foreign direct investment Potential A return to macroeconomic stability and a favourable regulatory environment should result in continued foreign investment in telecoms, tourism, manufacturing, construction and finance. FDI in the FTZs has eased in recent years and the government is now promoting higher-tech manufacturing and IT services, and business process outsourcing (BPO). Although some investment in pharmaceuticals and electronics is likely to materialise, investment in other high-tech areas, such as BPO and call centres, will be limited by skills shortages. Relative macroeconomic stability and a more favourable regulatory environment should result in higher foreign investment in tourism, real estate, construction, mining, telecommunications, electricity and finance. Foreign investment will rise gradually and average US$2.1bn in 2010-14. Annual inflows of foreign direct investment(US$ m)

32. Market opportunities

33. Market opportunities GDP per head(US$ at PPP) Market opportunities will be restricted by the country’s small population and low income per head. The population is forecast to reach 10.2m by 2014 and GDP per head is expected to reach US$13,590 (at PPP), or around 15% of the average for western Europe. The size of the Dominican market will expand by 32.3% in current US dollar terms in 2010-14, as GDP growth rates strengthen in the medium term. But even this strong growth will not be enough to increase market opportunities significantly. Income inequalities will persist and consumers in the lower- and middle-class brackets will continue to face high interest rates. High-income consumers will enjoy easier access to credit in US dollars at lower interest rates, accentuating market segmentation.

34. The long-term forecast

35. Long-term outlook Real GDP growth (% annual change) The Dominican Republic has significant assets that have made it one of the fastest-growing countries in the region in the last few decades. However, advances in human development have been disappointing, which has restricted growth in labour productivity. The Economist Intelligence Unit expects a move up the value chain for the FTZ sector, but this will be gradual and will require significant improvements in human capital and infrastructure. Despite advances in the past decade, the country's institutions are below international standards. Structural economic problems, including a small domestic market, an unreliable energy sector, weak institutions and poor advances in human development will limit long-term growth.

36. Long-term outlook Demographic trends:Population growth will gradually slow as increasing opportunities for women in the labour market contribute to a fall in the birth rate. Until 2020 labour supply will grow faster than population growth, at an annual average rate of 1.5%. As job creation in the formal sector expands at a slower rate, unemployment will remain high, dampening real wage growth. This will keep the informal sector growing and will encourage Dominicans to migrate to the US and European countries where they have family ties. External conditions: Economic performance has been closely tied to fluctuations in external economic and financial conditions. DR-CAFTA has extended economic dependence on the US, but agreements with Latin America, Europe and Asia will continue to help to diversify trade. If the US economy underperforms, the Dominican Republic will feel the impact through lower workers’ remittances, manufacturing exports and tourism arrivals. Tougher immigration policies in the US would also hit the country. The large external financing requirement exposes the economy to a freeze in international capital markets. Long-term performance:In common with other countries in the Caribbean Basin, the Dominican Republic will continue to struggle to find a thriving niche in the global economy and a lack of reforms to improve competitiveness will limit future growth. Improvements will be made but economic growth will be highly dependent on the expansion of labour and capital. As the growth of labour supply decreases with changing demographics and capital accumulation does not keep up, GDP growth will ease.

37. Long-term outlook GDP per head(US$ at PPP; index, US=100) Nominal GDP(US$ at PPP; index, Dominican Republic=100)

38. Resources

39. Map

40. Comparative GDP, 2009 Gross domestic product(US$ bn; market exchange rates) Gross domestic product per head(US$; market exchange rates)

41. Basic data Land area 48,511 sq km Population 9.3m (2007 Central Bank estimate) Climate Subtropical Weather in Santo Domingo Hottest month, August, 23-31°C (average daily minimum and maximum); coldest month, February, 19-28°C; driest month, March, 19 mm average rainfall; wettest month, June, 185 mm average rainfall Language Spanish 1 peso (Ps)=100 centavos Currency Time 4 hours behind GMT Public holidays January 1st, 6th, 21st and 26th; February 27th (Independence Day); Good Friday; May 1st; Corpus Christi; August 16th (Restoration Day); September 24th; November 6th (Constitution Day); December 25th

42. Business environment rankings: Methodology Outline of the model The business rankings model measures the quality or attractiveness of the business environment in the 82 countries covered by Country Forecasts using a standard analytical framework. It is designed to reflect the main criteria used by companies to formulate their global business strategies, and is based not only on historical conditions but also on expectations about conditions prevailing over the next five years. This allows the Economist Intelligence Unit to utilise the regularity, depth and detail of its forecasting work to generate a unique set of forward-looking business environment rankings on a regional and global basis. The business rankings model examines ten separate criteria or categories, covering the political environment, the macroeconomic environment, market opportunities, policy towards free enterprise and competition, policy towards foreign investment, foreign trade and exchange controls, taxes, financing, the labour market and infrastructure. Each category contains a number of indicators that are assessed by the Economist Intelligence Unit for the last five years and the next five years. The number of indicators in each category varies from five (foreign trade and exchange regimes) to 16 (infrastructure), and there are 91 indicators in total. Almost half of the indicators are based on quantitative data (eg, GDP growth), and are mostly drawn from national and international statistical sources for the historical period (2005-09) and from Economist Intelligence Unit assessments for the forecast period (2010-14). The other indicators are qualitative in nature (eg, quality of the financial regulatory system), and are drawn from a range of data sources and business surveys adjusted by the Economist Intelligence Unit, for 2005-09. All forecasts for the qualitative indicators covering 2010-14 are based on Economist Intelligence Unit assessments. The main sources used in the business rankings model include CIA, World Factbook; Economist Intelligence Unit, Country Risk Service, Country Finance, Country Commerce; Freedom House, Annual Survey of Political Rights and Civil Liberties; Heritage Foundation, Index of Economic Freedom; IMF, Annual Report on Foreign Exchange Restrictions; International Institute for Management Development, World Competitiveness Yearbook; International Labour Organisation, International Labour Statistics Yearbook; UN, Human Development Report; US Social Security Administration, Social Security Programs Throughout the World; World Bank, World Development Report; World Development Indicators; World Economic Forum, Global Competitiveness Report. Back to Rankings

43. Business environment rankings: Methodology Calculating the rankings The rankings are calculated in several stages. First, each of the 91 indicators is scored on a scale from 1 (very bad for business) to 5 (very good for business). The aggregate category scores are derived on the basis of simple or weighted averages of the indicator scores within a given category. These are then adjusted, on the basis of a linear transformation, to produce index values on a 1-10 scale. An arithmetic average of the ten category index values is then calculated to yield the aggregate business environment score for each country, again on a 1-10 scale. The use of equal weights for the categories to derive the overall score reflects in part the theoretical uncertainty about the relative importance of the primary determinants of investment. Surveys of foreign direct investors' intentions yield widely differing results on the relative importance of different factors. Weighted scores for individual categories based on correlation coefficients of recent foreign direct investment inflows do not in any case produce overall results that are significantly different to those derived from a system based on equal weights. For most quantitative indicators the data are arrayed in ascending or descending order and split into five bands (quintiles). The countries falling in the first quintile are assigned scores of 5, those falling in the second quintile score 4 and so on. The cut-off points between bands are based on the average of the raw indicator values for the top and bottom countries in adjacent quintiles. The 2005-09 ranges are then used to derive 2010-14 scores. This allows for intertemporal as well as cross-country comparisons of the indicator and category scores. Measurement and grading issues The indices and rankings attempt to measure the average quality of the business environment over the entire historical or forecast period, not simply at the start or at the end of the period. Thus in the forecast we assign an average grade to elements of the business environment over 2010-14, not to the likely situation in 2014 only. The scores based on quantitative data are usually calculated on the basis of the numeric average for an indicator over the period. In some cases, the "average" is represented, as an approximation, by the recorded value at the mid-point of the period (2007 or 2012). In only a few cases is the relevant variable appropriately measured by the value at the start of the period (eg, educational attainments). For one indicator (the natural resources endowment), the score remains constant for both the historical and forecast periods. Back to Rankings

44. Indicator scores in the business rankings model aOut of 12 countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Mexico, Peru and Venezuela. Note. A single asterisk (*) denotes scores based on quantitative indicators. Indicators with a double asterisk (**) are partly based on data. All other indicators are qualitative in nature.

45. Indicator scores in the business rankings model aOut of 12 countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Mexico, Peru and Venezuela. Note. A single asterisk (*) denotes scores based on quantitative indicators. Indicators with a double asterisk (**) are partly based on data. All other indicators are qualitative in nature.

46. Indicator scores in the business rankings model aOut of 12 countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Mexico, Peru and Venezuela. Note. A single asterisk (*) denotes scores based on quantitative indicators. Indicators with a double asterisk (**) are partly based on data. All other indicators are qualitative in nature.

47. Indicator scores in the business rankings model aOut of 12 countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Mexico, Peru and Venezuela. Note. A single asterisk (*) denotes scores based on quantitative indicators. Indicators with a double asterisk (**) are partly based on data. All other indicators are qualitative in nature.

48. Indicator scores in the business rankings model aOut of 12 countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Mexico, Peru and Venezuela. Note. A single asterisk (*) denotes scores based on quantitative indicators. Indicators with a double asterisk (**) are partly based on data. All other indicators are qualitative in nature.

49. Indicator scores in the business rankings model aOut of 12 countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Mexico, Peru and Venezuela. Note. A single asterisk (*) denotes scores based on quantitative indicators. Indicators with a double asterisk (**) are partly based on data. All other indicators are qualitative in nature.

50. Indicator scores in the business rankings model aOut of 12 countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Mexico, Peru and Venezuela. Note. A single asterisk (*) denotes scores based on quantitative indicators. Indicators with a double asterisk (**) are partly based on data. All other indicators are qualitative in nature.