Public Information Notice No. 99/93

Public Information Notice: IMF Concludes Article IV Consultation with Nicaragua

September 27, 1999

On September 15, 1999, the Executive Board concluded the Article IV consultation with Nicaragua¹ and approved the second annual arrangement under the Enhanced Structural Adjustment Facility in the amount of SDR 33.6 million (see Press Release No. 99/44).

Background

Over the past several years, Nicaragua has made substantial progress toward macroeconomic stabilization, external viability, and the restoration of a market-based economy. From 1994 to 1998, economic growth averaged 4½ percent a year (1½  percent in per capita terms), private sector investment expanded markedly, inflation remained near single digits, and the unemployment rate declined from about 18 percent to 13 percent.

Policy implementation strengthened in 1998 under the ESAF-supported program. The fiscal position improved more than envisaged, credit policy was tightened, and progress was made in reforming the financial system, streamlining the public sector, and setting the legal framework for the privatization of public enterprises. In October 1998, Hurricane Mitch caused significant damage in Nicaragua, in terms of displacement of families and destruction of infrastructure and agricultural production. Because of the strong performance of output in the first nine months of the year and rapid growth in nonagricultural sectors, real GDP growth for 1998 as a whole was 4 percent; however, food supply disruptions raised the 12-month inflation rate to 18.5 percent in December 1998. The external current account deficit rose in 1998, because of losses of exports and the increase in imports following the hurricane. The deficit was covered by higher official and private capital inflows, and net international reserves (NIR) remained virtually unchanged from end-1997 to end-1998.

During 1999, policies have been broadly in line with the program, and preliminary indicators point to an economic upturn, with real GDP growth accelerating to a rate of 6.3 percent in 1999, and unemployment declining to around 10.5 percent. The 12-month rate of inflation fell to 12 percent in August 1999. Further progress has been made on the structural front with advances in the streamlining of government employment, the separation of the health and pension accounts of the social security system, and the transfer to the private sector of the management of the state oil distribution company. However, the privatization of the telephone company (ENITEL) suffered a setback early this year because of a deterioration in its financial position. To address this problem, the government increased its control of the enterprise; the privatization process is being reactivated with the advice of the World Bank and an international advisory bank, and an action plan to strengthen ENITEL's finances is being implemented.

The government's program for 1999-2001 provides for speeding up the reconstruction effort and expanding social programs while furthering progress toward fiscal consolidation and external sustainability. The program targets the reduction in inflation to single digits; the strengthening of the NIR position, with gross reserves reaching the equivalent of 3.5 months of imports by end-2001; and a renewed emphasis on structural reforms and governance improvements. Real GDP is projected to grow by an average of 6.5 percent a year in 1999-2001.

In the fiscal area, the program seeks to mobilize domestic and external resources toward priority spending sectors while improving the public finances on a sustained basis. The combined public sector deficit is to be limited to 13.6 percent of GDP in 1999, and to decline to 8.2 percent in 2001, while public sector saving would be strengthened. The deficits are to be covered with concessional external financing. The structural agenda focuses on consolidating the reform program in the financial sector and the social security system, the privatization of public utilities, and governance improvements. The main elements of the poverty alleviation and social policies are the reforms of the public health and education systems, the strengthening of social safety net, and the promotion of rural development.

Executive Board Assessment

Executive Directors expressed satisfaction with Nicaragua's policy implementation during 1998 and to date in 1999, which had been broadly in line with the ESAF-supported program. Notwithstanding the adverse effects of Hurricane Mitch, economic performance had strengthened in 1999 as output growth accelerated, inflation declined, and unemployment continued to fall. Directors supported the authorities' medium-term economic program covering the period 1999-2001, which aimed at accelerating the reconstruction effort and improving social conditions, while making further progress toward fiscal and external sustainability. In this regard, they stressed the need to reduce Nicaragua's substantial macroeconomic imbalances, accelerate structural reform, and improve governance.

Directors emphasized the need, and welcomed the authorities' intention, to consolidate the fiscal position over the medium term. They stressed the importance of ensuring adequate growth in revenues to meet rising expenditure needs, notably by strengthening tax and customs administration and phasing out the remaining exemptions in the tax code. Directors welcomed the corrective revenue measures taken early this year to partly offset the shortfall in revenues stemming from the reduction in import duties, and encouraged the authorities to be prepared to take additional measures, if needed, to achieve their fiscal objectives.

Regarding fiscal expenditures, Directors welcomed the authorities' intention to limit, as much as possible, outlays on wages, government consumption, transfers, and, in particular, military outlays in order to allow for higher spending in the social and other priority sectors. In the interest of good governance, as well as to allay donors' concerns in this area, Directors stressed the importance of carefully monitoring reconstruction and social projects, and ensuring that all public contracts are awarded on the basis of fully transparent public bidding procedures.

Directors agreed that credit policy needs to be tight to achieve the program targets on inflation and the external sector. While recognizing the progress made in reducing the stock of central bank short-term exchange rate indexed instruments (CENIS) in 1998, they cautioned that the still-high level of CENIS represented a source of vulnerability, and urged the authorities to take every opportunity to reduce them further. Directors noted that a well-functioning financial system is vital to sustaining high economic growth. In this light, they welcomed the authorities' efforts to enhance prudential norms, as well as the submission of draft legislation on strengthening the central bank, the banking system, and the Superintendency of Banks.

Directors generally supported the authorities' decision to slow the pace of crawl of the exchange rate, and to introduce an exchange rate band in the near term as a transitional step in improving the monetary framework. They emphasized the importance of consistent implementation of sound financial policies for the new system to sustain the reduction in inflation, and to pave the way for a more flexible market-determined exchange rate regime. Prudent policies on public sector spending, and further gains in productivity through structural reforms and the improvement of human capital will be critical for the continued strengthening of Nicaragua's external competitiveness.

Directors commended the authorities' actions to strengthen social policies. They considered that improvements in the health and education systems, expansion of the social safety net, and promotion of rural development were crucial elements in the strategy to reduce poverty and enhance human capital. They welcomed the planned evaluation of social programs based on the World Bank-sponsored Living Standards Measurement Survey, which would take into account the possible assistance under the HIPC Initiative. Directors suggested that quantitative indicators be developed to monitor progress in the social sectors.

Directors highlighted the importance of the authorities' structural agenda for 1999-2001. They stressed the need for a careful implementation of the social security reform, to be undertaken with assistance from the World Bank and the Inter-American Development Bank, and encouraged the authorities to move forcefully with the privatization program in the telecommunications and energy sectors. Directors strongly emphasized the need to continue improving governance and to build on the progress made toward greater transparency in government activities. They urged the authorities to adhere to the Stockholm declaration that attaches utmost importance to transparency and efficient use of funds from international assistance. Directors endorsed the authorities' intention to seek prompt legislative approval of the new public sector procurement law, and encouraged them to pursue vigorously their plans for accelerating the resolution of property rights claims, and strengthening the judiciary system. They pointed to the need for broad domestic support for Nicaragua's program, and were encouraged by the government-sponsored discussions between various political parties as a means of fostering public support for policies. Regarding other structural measures, Directors emphasized the need to strengthen the financial position of the public enterprises through cost containment and appropriate adjustments in tariffs.

Directors were of the view that implementation of the authorities' policies will enhance the basis for Nicaragua's sustained, high quality growth over the medium term. They observed, however, that based on the debt sustainability analysis prepared by the staffs of the Fund and the Bank, Nicaragua's external debt will remain at unsustainable levels, which could become an impediment to growth and poverty reduction. Directors therefore fully endorsed Nicaragua's eligibility for assistance under the HIPC Initiative.