"reconstruction must not be at the expense of transformation"

Nicaragua Recent Economic Developments
Managua, Nicaragua  10-11 February, 2000

Recent Economic Developments

Nicaragua experienced robust GDP growth, estimated at 6.3% for 1999 thanks to large inflows of foreign capital related to a great extent to hurricane reconstruction assistance and a steady increase in private sector construction. The agricultural sector is recovering from the hurricane damage and a prolonged drought experienced at the beginning of 1999. Despite these problems, the recovery reflects an increase in efficiency, with output for the 1999/2000 season expected to be at least as large as the 1998/1999 level, although there was a reduction in the cultivated land related to the effects of Mitch. Coffee, the principal export product, has increased its cultivated area, but depressed international prices will reduce its earnings. Some recovery is indicated in the industry sector as well, particularly in the production of inputs for construction. The free trade zone will increase its contribution through the establishment of a privately owned venture called Saratoga, that will compete with the largest free trade zone, state-owned Las Mercedes. Saratoga is slightly smaller than Las Mercedes, but is expected to employ 13,000 workers. Private construction is growing at a fast pace due to important amounts of external assistance devoted to reconstruction efforts and to Foreign Direct Investment directed towards the construction of tourism infrastructure such as hotels and commercial centers. In addition, industrial production of poultry and meal is growing and increasing its contribution to GDP growth. The transport and communication sectors are having a strong recovery as well.

Fiscal revenue of Central Government increased during 1999, but did not achieved the levels expected in the Enhanced Structural Adjustment Facility (ESAF) program, because import duties were reduced in July 1998 and in January 1999 when some exceptions were granted to imports related to reconstruction efforts. To compensate for those policies, and delays in additional revenue measures, transfers from public enterprises and the social security fund to Central Government were increased. Current expenditures increased at a slower rate than revenues, thereby increasing current saving to 5.8% of GDP, a higher level than expected in the ESAF program. But the reconstruction efforts caused the capital investment to accelerate to a growth rate of 70%, increasing the Central Government deficit. Adding the quasi-fiscal deficit from the Central Bank, the combined public deficit for 1999 reached 12.8% of GDP, which is within the framework of the revised ESAF. The fiscal gap has been externally financed. The monetary program projected external assistance to reach the equivalent of 8% of GDP.

Monetary aggregates increased during the first half of 1999 at around 20%, mainly due to capital inflows related to external assistance for reconstruction. Despite that effect, the monetary base only increased by 13% for the same period. The general tendency of the monetary variables is to accelerate their growth, consistent with the recovery in GDP growth. Private sector credit increased over 40% for the year and the Central Bank is expected to reduce further increases to prevent inflationary pressures. Interest rates remained at similar nominal levels as in 1998, signifying higher real levels. There was a slight reduction in local denominated active and passive rates, while their spread was increased. On the other hand, spread for dollar denominated interest rates was reduced.

Despite the increase in fiscal deficit and the monetary aggregates growth, inflation remained low and was 7.2% for 1999, below the target level agreed to in the ESAF. During the first semester of 1999 low agricultural prices contributed to lowering inflation. Those prices were lower than the inflated levels experienced at the end of 1998 due to the scarcity caused by Mitch. Lower prices of food and beverages contributed to this lower inflation level, offsetting increases in public services, construction material and transport prices. Urban buses fares were increased to compensate for higher oil prices. Telecommunication services were increased to prepare ENITEL for its privatization.

Nominal devaluation was at an annualized rate of 12% by June 1999. In July the Central Bank decided to reduce its rate to 9% and by November the reduction reached an annual rate of 6%. By the end of the year, the annual devaluation was just over 10%, which contributed to a low inflation rate. The faster nominal devaluation and lower inflation experienced until June caused the real exchange rate to return to pre-Mitch levels. Towards the end of the year, the real exchange rate increased again.

Exports in 1999 were reduced compared to those in the previous year. Non traditional exports were reduced by 18 % affected by lower manufactured goods exports because of the increase in real exchange rate, which offset the contribution of higher shrimp exports. Traditional exports were also reduced, by 16% due to lower international prices of commodities, particularly those for coffee, whose price is at a 6 year low, and lower prices for bananas. Imports increased by 30 %, mainly for intermediate and final consumption goods. Fuel imports were stable despite higher oil international prices, since Nicaragua is protected by the San José agreement under which Mexico and Venezuela supply oil at a discount when its price surpasses US$15 per barrel.

As a result of higher imports and lower exports, commercial trade deficit increased, which was financed by higher private remittances and official transfers. Capital flows were sufficient to finance the larger than expected current account deficit and to increase international reserves. Nevertheless, the increase of US$ 77 million in international reserves did not reach the ESAF target of US$118 million, mainly due to delays in official disbursements related to slow implementation of structural measures. Annual remittances are estimated at US$400 million, with US$250 million coming from Costa Rica and another US$150 million from the United States. However, a recent study by the Economic Commission for Latin America and the Caribbean (ECLAC) estimates remittances at US$800 million per year. Foreign Direct Investment increased during 1999 to US$200 million from US$170 million the previous year. Official assistance pledged during the Consultative Meeting in Stockholm in May reached close to US$2,600 million for the 1999-2003 period. Part of that assistance has already been committed, supporting the country's economic recovery and financing the large increase in capital investment previously mentioned. During 1999 Nicaragua signed agreements for external assistance surpassing US$600 million, of which more than US$400 million were grants and around US$200 million were soft loans. It is estimated that close to 50% of those commitments have been disbursed.

Nicaragua has qualified as a candidate to the Highly Indebted Poor Country Initiative. As such, it would receive condonation of close to 80% of its eligible debt. Its eligible debt, considering debt acquired before 1998, is close to US$4.3 billion, and is composed of multilateral and bilateral debt. The International Monetary Fund (IMF) has requested the implementation of a three year ESAF program, which is already being implemented, before Nicaragua reaches the decision point. In addition, the IMF and the World Bank are requiring the implementation of transparency and poverty alleviation programs. On the macroeconomic front, fiscal deficit is expected to be reduced to 8.2% of GDP during 2001. After reaching the decision point, the country can request debt condonation from creditors.

The Paris Club normally requires that other creditors share the same contribution towards the solution of the debt problem. Therefore, other non-Paris Club creditors may have to grant a similar forgiveness However, some of the creditors are other third world countries with scarce financial resources themselves. That is the case of Costa Rica and Guatemala that also are important creditors of Nicaragua but are in a difficult economic situation to provide a condonation of Nicaragua's debt. The debt to Costa Rica is the more important and is almost US$500 million, of which approximately 50% corresponds to principal and the rest to accumulated interest. The largest portion of this debt was incurred over 15 years ago when Costa Rica provided electricity to Nicaragua and, through the Central American Compensation Chamber, the Costa Rican Central Bank paid Costa Rican exporters for products sold to Nicaragua, but the Nicaraguan Central Bank never canceled this debt.

Domestic debt has increased in recent years as well, reaching 30% of GDP. It is mainly composed of Negotiable Investment Certificates (CENIS) and Indemnization Payments Bonds (BPI). To reduce fiscal fragility, new CENIS have longer maturity periods. The ESAF program expects no increment in domestic debt through CENIS, whose outstanding balance is around US$200 million. The outstanding balance of BPI is above US$500 million, but with different types of maturities. The monetary authority is trying to standardize this debt paper to promote its sale in the secondary market.

Economic Policies

In February of 1998, the Nicaraguan Government agreed to a three year ESAF program that would improve their macroeconomic situation and provide eligibility to the HIPC initiative. The implementation of economic policies was consistent with the ESAF until Hurricane Mitch. After Mitch, policies had to be adapted to the new circumstances and the program was modified with increasing capital expenditure to reconstruct the basic infrastructure that would allow the economy to continue operating. As explained in the first chapter, the recovery of the economy experienced during 1999 was partly due to the increase in capital expenditure related to the reconstruction efforts. But, at the same time to prevent inflationary pressures, the cautious monetary policy compensated for the capital inflows, and a reduction in reserve requirements was allowed to facilitate liquidity to the market in order to meet reconstruction demands.

Some adjustments were made to the Law that Governs Commercial and Tax Justice in order to increase revenues given the expected reduction related to agreements with Central American Countries to reduce duties. To further increase revenues and simplify the tax structure, taxes on cigarettes and liquor were increased while some taxes on beef and minerals were eliminated in March. Income tax was modified and reduced from 30% to 25% for the tax bracket of over C$300,000 per year, a measure that benefitted a few. Some additional measures are expected to improve customs administration.

Important measures were undertaken in bank supervision to address illegal transactions observed in Banco del Sur. The liquidation of Banco del Sur was ordered by the Superintendency. Deposits of Banco del Sur were transferred to BANCENTRO and depositors were assured of no losses, since deposits were backed by the liquidation of the Bank´s assets and by Central Bank bonds with a three year maturity. To avoid future similar cases, capital requirements were increased from 8% to 10%, and all banks should fulfill the requirement before next August.

The Government is also strengthening the financial legal framework accordingly they recently sent three proposals to Congress: a general banking law, another for the Superintendency and the third being an organic law for the Central Bank.

On the structural side, progress was achieved in reduction of public employment, by reducing the number of employees by 700 of the 1200 programmed for reduction in 1999. The social security system started its reform by separating health accounts from pension accounts. Pension system will implement individual capitalization accounts administered by the private sector. At the same time, retirement age and contribution rates are expected to be increased. Nicaragua signed a contract awarding a private firm the administration of the state-owned oil distribution company (PETRONIC) for 10 years.

Functions in the state electric company ENEL were divided into generation, transmission and distribution and is in the process of being privatized in stages. The first stage involves the privatization of the distribution portion, by allowing employees to acquire up to 5% of its shares, by offering them the opportunity to buy 4% and granting them 1%. By next May the Goverment expects to have the distribution system in private hands. Generation is the second stage that may be privatized by a similar process. The Goverment expects to finalize this stage by next August and follow it with the privatization of the transmission system.

Efforts to privatized the telecommunications company, ENITEL, are underway. The efforts have experienced some delays related to the company´s unclear financial statements. To improve its attractiveness, the Government is reducing employment levels by 500, increasing its tariffs and will assume US$48 million of ENITEL debts. The Government expects to sell, before next May, 40% of the shares.

Last June, the Congress approved a Law to provide fiscal incentives to tourism investments through generous tax breaks. The intention is to emulate the success of the Costa Rican model that help tourism become the primary generator of foreign exchange before the INTEL investment. The law will provide 10 year tax exemptions of 80% of income derived from hotel investment and 100% on income from investments in tourist attraction activities, in addition to full property tax exemptions.

Outlook

The economic recovery of Nicaragua is expected to continue. Good economic performance together with some condonations of external debt could allow increasing investment in the social sectors that should improve future economic growth. This scenario requires continued support from the international community which in turn is expecting more transparency in the government programs and clearer rules for attracting private investment.

Under such scenario, it is possible to achieve the targets of the Government's Economic and Financial Policy memorandum that projects that GDP will continue growing at a rate of at least 6% per year during the next three years, inflation will continue to be in the single digit range, and the public deficit will be reduced to a third of its current level by 2001.

Activities of the Bank

The Bank's support after Mitch maintains the same objective as before, to sustain economic development with equity. This objective is pursued through the implementation of the following instruments: maintain macroeconomic stability and consolidate structural reforms to achieve a market oriented economy; continue actions towards restructuring external debt; develop human capital; reducing poverty; and improve natural resource management.

During 1998, the Bank approved loans for US$220.5 million. Bank financing focused on financial sector reforms and on the development of the electricity sector, aiming at privatizing distribution and generation. The Bank supported health sector reforms as well. The approved loans include a Private Sector Department loan to finance an electricity generating plant.

During 1999 the Bank approved six loans, totaling US$94.0 million that include: preparation of an education sector reform, strengthening social policies, local development, modernizing revenue agencies (tax and custom administration), modernizing drinking water and sewage systems and rehabilitating the Panamericana highway.

Future Bank activity include loans and technical cooperation to: (i) promote a second phase of modernization of the state by strengthening procurement, and modernizing the judicial system and the Managua Municipality; (ii) social sector assistance, including local development support, a housing program, support to vulnerable population, strengthening institutional capacity of social sector executing agencies, and a tertiary education program. Assistance has been devoted to improve rural roads and natural resource management as well.

The Bank Group will support privatization and concession of public services (ports, airports, education). The Bank will support the financial sector as well, by providing long term financing and technical support to strengthen financial supervision. This activities will strongly supported by the Multilateral Investment Fund (MIF), the Private Sector Department (PRI) and the Inter-American Investment Corporation (IIC).

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