Consultative Group for the Reconstruction and Transformation of Central America

"reconstruction must not be at the expense of transformation"

Central America After Hurricane Mitch
The Challenge of Turning a Disaster into an Opportunity


A. Summary

The Nicaraguan economy confronted two different periods in 1998: up to the third quarter, the macroeconomic indicators, with the exception of inflation, were very favorable, since GDP was growing at the anticipated rate and the fiscal situation was surpassing the projections of the economic program. Likewise, at the beginning of the year, the country had signed a second adjustment program with the IMF (ESAF II) and made significant progress at the Consultative Group in April, in Geneva, and at the Paris Club in May. In the fourth quarter, however, Hurricane Mitch whipped through the country, causing destruction, damages to production and to the infrastructure which slowed down the rate of GDP growth and put pressure on fiscal accounts.

Hurricane Mitch affected Nicaragua form for a period of ten days, with torrential rains that produced landslides and floods. Although the natural phenomenon extended through almost all the national territory, the greatest damages occurred in the northwestern part and was principally concentrated in the departments of Chinandega, León, Matagalpa and Jinotega. Human lives were lost, crops were destroyed, major environmental damage occurred, and there was also damage to highways, bridges, schools, dwellings, electrical and water supply systems. The effects of the hurricane will have a negative impact on the fragile Nicaraguan economy, the institutional structure, the social network and its governability.

The support of the Bank in the short term has been in the form of technical cooperation grants to attend to the necessities of greatest urgency, the reorientation of loans in execution with the purpose of attending the emergency and the modification of the priorities of the previously agreed program with the country. The portfolio in execution was revised and it was agreed with the authorities to allocate funds to the immediate needs and the initial reconstruction efforts. The program of the Bank prioritizes operations directed towards rehabilitating the highway infrastructure and to attend to the vulnerable sectors of the population.

B.  Country Analysis

B.1 Recent economic situation
During 1998, growth of GDP slowed down to 4% (5.1% in 1997). This was the result of losses caused by the El Niño phenomenon and by Hurricane Mitch, which together lowered one or two points of GDP growth (Graph 1). Despite the fact that the hurricane occurred at the end of the year, it produced effects on almost all productive subsectors. Thus, primary activity grew 4% (8% in 1997) and agricultural activity grew 7% (10% in 1997). The products most affected were the basic grains, those of late harvests and some permanent ones such as coffee, sugar cane and bananas. Manufacturing industry grew 2% (4% in 1997) and construction grew 8% (10% in 1997). Tertiary activities, all together, grew 3.4% (3% in 1997).

Graph 1

In 1998, fiscal accounts improved (Graph 2). Tax collections increased because of growth of the economic activity, administrative improvements, and, in the case of the income tax, due to a widening of the tax base. Expenditures increased but at a much lower rate influenced by a lower payment of the interest on foreign debt, a moderated expansion in the investment of fixed capital and lower transference of capital. As a result, the non-financial public sector attained a deficit of only 2.1% of GDP (7% in 1997). Including donations (equal to 3.4% of GDP in 1998) a surplus of 1.1% of GDP was achieved. This last result allowed the government to carry out a net amortization of its obligations with the central bank and with the financial system Inflation as of December, 1998, was 18% (Graph 3). The drought caused by El Niño, the destruction caused by Hurricane Mitch and tariff adjustments affected the prices of basic family needs. In this context, the lower growth of GDP meant a very limited expansion in per capita income. Likewise, the unemployment rate reached 13.2% (14% in 1997)

Graph 2

External accounts deteriorated due to the drop in exports and the increased imports. (Graphs 3, 4, and 5). Reduction of exports is explained by: the elimination of export tax certificates; effects of El Niño and Hurricane Mitch; deterioration of the terms of exchange and the decrease in demand for Nicaraguan products because of the international financial crisis. In this context, some products, such as coffee, whose sales had been assured before the hurricane, showed a significant increase because of the greater volume produced; harvesting of shellfish grew because of water warming.

Graph 3

Nevertheless, non-traditional exports decreased by 40% due to the drop of the incentives mentioned; sorghum, rice, corn and beans experienced decreases due to the loss of crops and lower sales due to the hurricane emergency. Export of manufactured products, meat and sugar showed also decreased.

Graph 4

External debt at the end of 1998 reached US$6.3 billion, of which 65% was bilateral and the rest was multilateral. Annual service amounts to around US$200 million. Which is about 25% of exports.

Economic policy during 1998 was framed by the ESAF agreement and included prudent fiscal and monetary management, with a goal of preserving macroeconomic stability and improving external accounts. At the same time, structural reforms continued and important steps were taken towards the reduction of foreign debt. Fiscal policy was the basis for the economic and financial program which achieved encouraging results in 1998. The Central Government had less need for financing, which allowed a reduction of net internal credit from the Central Bank to the government. This reduction allowed for the sterilization of monetary expansion derived from the net redemption of public titles. A combined series of actions made this result possible, among them, that of continuing with tax and trade reform such as: import and temporary import tariffs were reduced 5 percentage points, (maximum tariff level 20%, minimum 5%), reducing specific tax rates on products, reintroducing the land taxes (which allowed for an increase in collections from the agricultural sector), and substituting certificates of tax credit by reducing the subsidy granted to certain exports, etc. In addition, from the beginning of 1998, a specific tax to exported coffee began to be applied, which allowed for a reduction of evasion. On the other hand, the government implemented in the second half of 1998 the Integrated System of Financial, Administrative and Auditing Management, which resulted in improved efficiency and transparency of public finances.

Monetary policy took on the task of a rigorous control of liquidity to avoid the pressure on prices, at the same time that it took on the objective of a net reduction of internal debt in order to decrease the losses that the central bank was experiencing in this area, all of which required a tight coordination with fiscal policy. In order to continue controlling liquidity, the monetary authority made use of open market operations via the placement of public titles (CENIS), the rediscount rate was applied with a margin of 10 points over the active average market rate in order to rationalize bank credit and maintain the high legal reserve rate.

Important progress was made in structural reforms. In the field of State Reform, in September of 1998, the Executive Branch restructuring law came into effect. Through this law, which seeks to make the work of the different branches of the state more efficient, some ministries were eliminated and the tasks of others redefined. During 1998, also in the context of State Reform, about 1000 jobs were eliminated. Likewise, laws for the sale of the state-owned telephone company (ENITEL), for the restructuring of the electrical company (ENEL), for the private administration of water supply, and for the opening of the petroleum sector to private investors were approved. With respect to ENEL, the Government expects that the invitation for bids will take place late 1999.

With respect to the reform of the financial system, the National Development Bank, source of many losses for the State, was closed. In its place, the Fund for Rural Development was created to service small and medium-sized agricultural businesses. Towards the end of 1998, a proposal for a law for the partial sale of the Banco de Crédito Popular was sent to the National Assembly; it is anticipated that 49% of the shares will be sold during 1999 as well as 50% of the Nicaraguan Investment Finance Corporation (FNI). At the beginning of 1999, 51% of the Nicaraguan Bank of industry and commerce were sold; the rest will be sold during the course of this year.

B.2 Damages caused by Hurricane Mitch
According to the National Emergency Committee, the hurricane caused the death of 3,000 people, 1,000 missing, 280 injured, and 870,000 people affected (almost 20% of the population). Nevertheless, the opportune measures taken reduced to half the number of people affected, although there was still an important number remaining in provisional shelters at the end of the year.

The problem of poverty in a country where half the population was already poor, and a large number of them living in conditions of misery, was made all more severe by the hurricane. This situation will affect the poverty map due to the effects, primarily on the most vulnerable sectors of the population.

The storm impacted the agricultural sector particularly hard, affecting the income of poor farmers and salaried rural laborers. According to ECLAC, about 13% of the area for internal consumption production and 10% of the area for export and industrial production were affected. Likewise there were significant losses in livestock, since about 50,000 animals, primarily bovines, died. ECLAC estimates that direct and indirect damages to the agricultural, livestock and fishery sectors totaled about US$185 million, including other negative effects as a result of the proliferation of plagues and diseases attributable to the excess humidity and to the development of unsanitary conditions.

On industry and commerce, the damages have been estimated at US$184 million. The greatest losses occurred in tourism (empty hotels, in addition to the damages at hotels in Chiltepe, Omotepe and the north of the country), agroindustry (with losses in some infrastructure due to damage of buildings and machinery), and in mining.

The infrastructure also suffered severe losses, primarily in the northwestern departments. In the highway subsector it will be necessary to repair about 2,700 kilometers of highway and access roads, especially in the Natural Corridor and sections of the Pan-American Highway. Likewise, 22 bridges were destroyed and another 49 seriously damaged. If all of this is added to the damages to ports and telecommunications, the direct and indirect damages to the physical infrastructure surpassed US$300 million.

In the electrical subsector, the damages principally affected the structures and components of the hydroelectric Centroamérica and Santa Bárbara plants that together generate about 25% of the national output. The National Interconnected Transmission System was damaged in the central, north and south zones, and nearly 330 kilometers of transmission lines were destroyed; 15 major substations were out of service, and there were also important damages to the municipal systems in the northwestern part of the country and in Managua. Direct and indirect damages for this subsector are estimated at US$20 million.

The hurricane caused heavy damage to the social infrastructure, destroying schools, health centers, water and sewerage systems, and housing: 340 schools were destroyed or seriously damaged, and there were losses of materials and textbooks; 90 health centers and 40 health stations were destroyed or seriously damaged, in addition to the six hospitals that were affected. Nevertheless, the 50,000 homes destroyed, and the 94,500 affected, the losses of real estate and personal belongings constitute the greatest economic damage. ECLAC has estimated direct and indirect damages to the social sectors at US$280 million, including schools, health centers, water systems, sewers and housing with furnishings and personal belongings.

B.3  Medium term perspectives
Growth in GDP is projected at 6% for 1999. This will help with reserves recovery, although the fiscal situation could deteriorate and the level of prices increase due to the reconstruction efforts. An increase in prices of 10% to 12% is projected, although in order to attain this level the Government must take strict fiscal measures. On the other hand, exports are projected to drop by 4% due to the above mentioned problems. The government expects lower export revenues to be compensated by external aid, lower expenditures due to debt reduction and service reprogramming, as well as the inflows from loans and family remittances.

The International Community has provided debt service relief with actions such as the following: (a) the Paris Club agreed to postpone service of obligations between December, 1998, and February, 2001, until March, 2002: (b) likewise, the Paris Club is considering a reduction of up to 80% of the Nicaraguan external debt (Lyon Terms) once the country is eligible for the HIPC initiative; (c) the World Bank created a Trust Fund to service multilateral debt that will principally benefit Honduras and Nicaragua.

In the context of widespread international support, the authorities face the challenge of formulating a new sustainable development model, centered on the development of all groups, which would eradicate poverty and allow for better use of natural resources. Reforms contemplated in the ESAF include privatization of telecommunications and energy, strengthening the financial system and modernization of the state, including the Judicial Branch, and the improvement of governability, principally in the transparency of public accounts, as well as an initial reform of the social security system. To the fiscal measures contemplated in the ESAF, new taxes on cigarettes, alcoholic beverages, etc., would be added, as well as the continuation of improvement in tax and customs administration.

The effort for reconstruction of the country is enormous. ECLAC estimates that the cost of replacing the public and private infrastructure affected will surpass US$1.5 billion, including the additional social expenditures to acceptable levels for fighting poverty, which has increased as a result of the hurricane. The Government's efforts would deal with processing reforms that would improve the supply of services, the quality and equity of social expenditures, provide social protection to vulnerable groups, institutional development in the social sectors, and definition of policies and training of human resources.

The Nicaraguan authorities have to confront an external sector that continues to show great vulnerability, with a high current account deficit, which increased with Hurricane Mitch. The perspectives for medium term will depend on careful economic policy to maintain stability, recover production capacity, and make good use of the international community support for national reconstruction.

C.  Activities of the Bank

The Bank approved loans for Nicaragua in 1998 for US$191 million. The Bank also approved non-reimbursable technical cooperation operations in 1998 for of US$2 million.

The strategy of the Bank in the social sectors, considers special actions for poverty relief, providing protection to vulnerable groups and supporting institutional development, all within the framework of the reforms already underway. In the area of electricity, privatization of the electrical distribution systems will continue, with the promotion of private sector generation, while in of highways, the rehabilitation and improvement of rural roads and main highways, and institutional strengthening will continue. The strategy for the financial sector contemplates continuation of support to the reform and strengthening this sector. Likewise, the reform of the pension system and the institutional strengthening of the Municipality of Managua will be supported.

Additionally, the possibility of greater participation of the private sector has increased with the guidelines established by tax reform in the financial sector, the reform of government's administrative and tax management, and the new juridical and regulatory frameworks in the area of public service enterprises. Likewise, the progress made in the resolution of property rights and the application of prudent fiscal and monetary policies in support of maintaining macroeconomic stability are leading to a more a favorable climate to private initiative. The IDB Group, will work within this improved environment by processing operations directed to the private sector through its different windows. Thus, the Interamerican Investment Corporation (IIC), The Multilateral Investment Fund (MIF) and the Bank itself, through its private sector Department, will support different areas of private activity.

D.  Consultative Group for Nicaragua

The Consultative Group for Nicaragua was constituted in June of 1996 with the goal of supporting Nicaragua's development plans with loans, technical cooperation and donations.

The last CG meeting took place in April of 1998, in Geneva, Switzerland where U$1.8 billion was pledged for the period 1998-2000, of which about 50% would be grants. One important aspect that will benefit the social sectors was the consensus obtained at the Consultative Group meetings in Geneva to create a Supplementary Social Fund with support from grants and soft funds to be allocated exclusively to projects in the social sectors.

During this meeting, the Government of Nicaragua was congratulated for its achievements, particularly for the efforts to integrate the country in the world economy, the approval of the law on property rights, and its impressive economic growth, which was the highest in Central America. It was pointed out that the country needs to increase public finance sustainability, continue the fight against poverty, complete the transition to a market economy, support the role of civil society and improve the work of government. In this last area, several aspects were emphasized, including those of reform and professionalization of public administration, the strengthening of the General Comptroller’s Office, and the development of a coordinated decentralization strategy.

Basic Data

Macroeconomic indicators 1990 1995 1996 1997 1998* 1999**
GDP (rate of growth) 0 4,3 4,5 5 4 6 (1)
Inflation (average rate of growth) 7485.2 10.9 11.6 10 13 12
Deficit Non-financial Public Sector (% of GNP) 18.4 6.4 6.8 3.5 4.2 9.5
Balance of payments-Current Account (US$ millons) -305 -492 -435 -637 -734 -835
International Reserve Balance (US$ millons) -7 -9 79 211 -82 135
Social indicators
Population (rate of growth) 3.1 3.1 2.9 2.9 2.9  
Income 20% poorest (% total)   5.2     5.0  
Infant mortality (por 1000 born)   5.1     5.0  
Illirateracy (% population over 15 years old)   13     13  
* Preliminary data
** Estimations (1) IMF Projection

Central America     Honduras    Nicaragua    El Salvador    Guatemala     Costa Rica


Nicaragua, May 2000   -   Honduras, February 2000   -   Stockholm, May 1999

Inter-American Development Bank