Nicaragua and the IMF
Enhanced Structural Adjustment Facility
Economic Policy Framework Paper for 1999–2001
Prepared by the Nicaraguan Authorities in Collaboration with
the Staffs of the International Monetary Fund and the World Bank
August 23, 1999 Use the free Adobe Acrobat Reader to view Tables 1-5 (PDF, 49k).
1. Since peace was re-established and democracy restored in 1990, substantial progress has been made in reducing macroeconomic imbalances and transforming Nicaragua's economy toward a market-based system. During the 1991-96 period, financial policies were strengthened, price controls eliminated, and the foreign exchange and trade systems liberalized. A program of public asset divestment was implemented, and public employment and military outlays were cut substantially. Private banks resumed operations and a superintendency of banks was created. However, macroeconomic conditions remained fragile and poverty widespread. In addition, policy implementation weakened and the process of reform lost momentum in the period leading up to the presidential elections at the end of 1996.
2. The change of administration in early 1997 provided an opportunity for Nicaragua to invigorate the stabilization and structural reform process aimed at achieving sustainable economic growth and improving social conditions. In 1997 fiscal policy was strengthened and private investment increased sharply. A new tax and trade reform law broadened the tax base, improved equity and transparency of the tax system, and introduced a schedule of reductions in the number, spread and levels of import tariffs. A new property law facilitated the settlement of property rights claims and acceleration of the issue of property titles. In late 1997 the government adopted a medium-term economic and structural reform program for 1998-00, which was supported by the three-year Enhanced Structural Adjustment Facility (ESAF) in March 1998. This paper briefly reviews policy implementation in 1998, and outlines the government objectives and policies for the period 1999-01. It also assesses the likely external financing requirements in that period, together with available sources of such financing.
3. Economic performance continued to improve in 1998 despite the destruction by Hurricane Mitch, which resulted in a physical damage estimated by the government at US$1.3 billion (mainly infrastructure, housing and agriculture). The nonagricultural sectors grew strongly and real GDP growth slowed to 4 percent compared with 5 percent in 1997. In the first half of 1999, economic activity accelerated with a strong growth of domestic demand driven by a surge in reconstruction related activities. Domestic investment rose (from 26 percent of GDP in 1995-96 to 33 percent in 1997-98 and further to 37 percent in 1999) financed by large aid flows, higher private capital inflows, and improved national saving. The 12-month rate of inflation rose to 18.5 percent in December 1998 reflecting a sharp increase in food prices in the aftermath of the hurricane, but it fell to 10 percent in July 1999.
4. Policy implementation in 1998 was in line with the government's program. Public finances improved more than envisaged because revenues strengthened, expenditure growth was contained and the finances of public enterprise improved. Despite revenue losses and accelerated spending in the wake of the hurricane, the overall deficit of the combined public sector fell to 7 percent of GDP in 1998 from 9.7 percent in 1997, and public sector savings rose to 5.6 percent of GDP from 4 percent in the same period. Credit policy was tightened and, together with the improved fiscal performance, permitted the planned reduction in the stock of central bank short-term exchange rate indexed liabilities (CENIS). In the first semester of 1999, the fiscal deficit rose above the program projections mostly because of a strong increase in reconstruction outlays. These outlays more than offset a slow pace in the execution of other programs. Net international reserves (NIR) remained unchanged from end-1997 to end-1998; at the end of 1998 the stock of NIR, adjusted for shortfalls in external financing, was in line with the program. As the required structural measures were implemented, the disbursements were made in the first half of 1999 and NIR strengthened.
5. Important progress has been made in implementing structural reforms. In 1998 the Assembly approved laws permitting divestment of the electricity generation and distribution units, and leasing to private sector the units of the water and sewerage system; an improved law for the privatization of the telephone company, ENITEL; and a law that strengthens the judiciary system. In the financial sector, the largest state-owned bank, the National Development Bank (BANADES), was liquidated in June 1998, and the second largest state bank, the Commercial and Industrial Bank of Nicaragua (BANIC), was awarded to a private investors group in January 1999. New bank prudential norms were issued in the second half of 1998 that require banks to raise capital to 10 percent of risk-adjusted assets by mid-2000, increase provisioning for nonperforming loans, and set limits on loan concentration and lending to related parties. The reforms and streamlining of the government were intensified. Retrenchment through the program of voluntary exit was accelerated; the Law on Organization, Functions, and Procedures of the Executive was approved in June 1998, leading to the elimination of three ministries and, by June 1999, a 25 percent reduction in the number of high ranking officials throughout the government.
6. Privatization of the telephone company (ENITEL) has been postponed because the prequalified potential investors withdrew in early 1999 from the process following disclosure of weaker-than-expected financial results and external debt position of the enterprise. To reactivate the process, the loan was canceled and the government is implementing a program (developed with the assistance of the International Development Association (IDA) and the International Finance Corporation (IFC) to improve ENITEL's finances and bring the enterprise to the point of sale by January 2000.
7. The social policies have been strengthened. In education, under a reform program supported by IDA and the Inter-American Development Bank (IDB) during 1997-98, the administrative and managerial capacity of the ministry of education has been improved; and progress was made in school decentralization, and the provision of teacher incentives and the supply of curricula-revised textbooks to primary school students. In the health sector, an integrated model of primary health care and a new system for providing medical supplies have been introduced. The resolution of a prolonged strike of medical staff in 1998 helped improve contracting methods and introduce a new incentive system for the retention of high quality staff. Track record in implementing social policies and the improvement in social indicators are discussed in the preliminary HIPC document.
8. Progress in improving social conditions suffered due to destruction by the hurricane:
9. Nicaragua received substantial external debt relief through restructuring and debt-reduction agreements with official and private bilateral creditors and the Central American Bank for Economic Integration (CABEI) in 1995-98. However, Nicaragua 's public external debt remains unsustainable (estimated at US$6 billion, or 280 percent of GDP), and scheduled external debt-service obligations in 1998 were the equivalent of 32 percent of exports of goods and nonfactor services. Achieving a sustainable debt position will require maintaining sound macroeconomic and structural policies, prudent external borrowing, and assistance under the HIPC Initiative.
10. The main objectives of the government's economic program for 1999-01 are to improve social conditions and alleviate poverty, while advancing toward macroeconomic stability. The program includes comprehensive structural reforms to create conditions for sustained high rates of economic growth by increasing efficiency and fostering savings and private investment.
11. Real GDP is projected to grow by an average of about
6½ percent a year (3½ percent in per capita terms) on the basis of a
sharp increase in reconstruction related activities and the strength of agricultural and
nontraditional exports. Most of Nicaragua's short-term growth potential lies in agriculture and
sustainable use of other natural resources, and the government's development strategy attaches
highest priority to rural development through revitalization of nontraditional agricultural exports.
Unemployment is estimated to decline to about 7-8 percent over the next two years; and
social indicators are projected to continue to improve. The program's macroeconomic objectives
include a decline in inflation to 10 percent by end-1999, and to single digits in 2000-01; a
strong increase in net official reserves, with gross reserves reaching the equivalent of
3.5 months of imports by end-2001.
12. The fiscal program aims at putting the public finances on a sustainable path taking into account the reconstruction program and the projected external financing and debt relief. The combined public sector deficit would be limited to 13.6 percent of GDP in 1999 and is projected to decline to 8.3 percent of GDP in 2001, while public savings will be strengthened. Public sector investment would peak in 1999 at about 18.4 percent of GDP and is projected to decline in relation to GDP as reconstruction is completed. Transparency of the public sector operations is being improved by further broadening of the budget coverage to include all extrabudgetary revenue and expenditure operations.
13. The tax reform passed in 1997 helped raise central government revenue from 22.8 percent of GDP in 1996 to 26.2 percent in 1998. Cumulative reductions in import tariffs are adversely affecting customs revenue in 1999. These negative effects are partly offset by the increase in the rate of excises on cigarettes, beer, and liquor approved in March 1999. Collection of domestic taxes improved considerably since 1997 through better administration and enforcement, and customs administration is expected to improve through a program to be implemented with assistance of the IDB starting later this year.
Public expenditure policy
14. The program envisages a tight control of government consumption, transfers, and the wage bill. To this effect, the ongoing civil service restructuring and reduction program will continue to 2001. In addition, the government plans to further reduce military personnel, and the resulting savings would be used to strengthen the civil police. The government will continue to shift current expenditures toward social expenditure, particularly health and education, and will emphasize programs to alleviate poverty. Owing to such efforts and additional financing made available to the Supplementary Social Fund (SSF), overall social expenditure is programmed to increase to more than 15 percent of GDP in 2000-01.
15. Capital outlays include the reconstruction program amounting to about US$190 million annually (about 8 percent of GDP). Private sector participation in the provision of infrastructure services (energy, telecommunications, ports, and roads) is expected to increase substantially as privatization gains momentum in 2000. The public investment program will give priority to investment in the social sectors and in basic infrastructure and will aim at greater sustainability in the services provided. The institutional capacity for the selection, formulation, evaluation, execution, and follow up of investment projects will be upgraded, so that the public investment program better reflects the short- and medium-term implementation capacity of the government, and ensures more efficient allocation of resources.
16. The strengthening of the financial position of the state enterprises through revenue increases and cost containment is an important component of the fiscal program. The electricity tariffs have been adjusted to cover marginal costs in 1999, and the regulatory agency (INE) will issue regulations by January 2000 on future tariff adjustments that will attain full recovery of the long-term marginal costs. The state water and sewerage company (ENACAL) continues to increase its tariffs by 1.5 percent a month until reaching marginal cost identified in a recent study undertaken with technical assistance from the IDB.
Monetary and credit policies
17. Credit policy will continue to pursue the achievement of the inflation and external objectives of the program. The central bank of Nicaragua (BCN) continues to monitor closely developments in domestic demand. Provided price pressures remain in check, the BCN will resume the net redemption of its U.S. dollar-indexed liabilities (CENIS) to further reduce this source of vulnerability. As the growth in the financial sector liabilities and bank credit to the private sector increased strongly in 1999, the authorities are placing increased importance to protecting the quality of credit through a vigilant bank supervision.
External sector policies
18. The external current account deficit (estimated at 33 percent of GDP in 1998) is projected to remain above 30 percent of GDP in 1999-00, before declining over the medium term. Export volume is projected to recover starting in 1999, and to grow at about 6 percent a year on average during the next decade. The growth of import volume is expected to remain strong in 1999-00 as a result of the reconstruction efforts, before slowing down to a pace in line with real GDP. The terms of trade are projected to deteriorate in 1999 as a result of the drop in international commodity prices, and to recover gradually over the medium term.
Exchange rate system
19. The exchange system was unified in January 1996, with the exchange rate determined by a crawling peg system. In July 1999, the central bank reduced the rate of the crawl from 12 percent to 9 percent a year, as inflationary pressures abated. A further reduction to 6 percent is expected in early 2000; at the same time, the exchange rate would be allowed to fluctuate within a band around the crawl, as a first step toward a more flexible interbank determined exchange rate system.
20. The government is committed to continue the process of eliminating the remaining nontariff restrictions and reducing import duties. For the most part, international trade is free of administrative restrictions, except for a number of products subject to licenses for health, security, and environmental reasons1. Export subsidies in the form of tax benefits for nontraditional exports through negotiable tax certificates (CBT) were phased out in November 1997. A 1.5 percent tax credit for all exports remains in place and firms producing for exports continue to have duty free access to imported machinery, equipment, and intermediary goods through the regimes of either temporary entry or export processing zones. For the vast majority of import items, the maximum tariff was reduced in stages from 30 percent in July 1997 to 10 percent in July 1999. Imports are generally subject to tariff rates of 0, 5, or 10 percent. For 15 items import duties are above the general ceiling and have a more gradual timetable for reduction; including those on milk and milk products (15 percent), beans, corn and rice (20 percent), sugar (55 percent), and chicken parts (40-180 percent). Also, for customs valuation, the authorities use customs reference prices.
External debt management
21. To advance toward external viability, the government's debt management policy will rely on securing grants and highly concessional loans to cover its external financing requirements; borrowing on nonconcessional terms will be strictly limited. The government will actively pursue debt rescheduling agreements with bilateral creditors on terms at least comparable to those granted by Paris Club creditors. In order to enhance the effectiveness of debt management, and with the approval of Law No. 290 in June 1998, the ministry of finance is assuming the core responsibility on debt management, integrating public sector debt within the overall public resource management. Inter-agency coordination (ministry of finance, BCN, technical secretariat of the presidency, and secretariat for external cooperation) is being strengthened through the creation of a technical committee on debt.
22. For the period 1999-01 the government has strengthened its ambitious structural reform program formulated in 1997 by committing to a series of "second generation" reforms that focus on measures to promote national saving and investment. The government plans to reform the public sector, improve governance and public accountability, privatize public utilities, reform social security, and further strengthen the financial system. Policies and targets are shown in Table 1.
Public sector reform
23. The institutional reforms aim at improving quality and efficiency of public services. Implementation of the public sector reform program initiated in 1994 is at an advanced stage (with technical and financial support from IDA, the IDB, USAID, and UNDP). The Law on Organization, Functions and Procedures of the Executive approved in 1998 reduced the number of ministries from 15 to 12 and the number of decentralized entities from 25 to 22. As the ministries and decentralized agencies adjust their organizational structures, the number of government officials ranking department director or higher is expected to be reduced further. Most ministries are to be restructured in accordance with their new functions in 1999-00, and the reform is expected to be completed in 2001.
24. Implementation of the new program for voluntary employment termination, the labor mobility program, which started in October 1997, aims at reducing 4,800 positions by end-1999 (6 percent of the general government employment at end-1996). Implementation is broadly on track as about 3,900 positions were reduced as of June 1999, despite temporary delays caused by an extended strike in the health sector in 1998 and the hurricane. In 1999 about 1,200 positions will be eliminated with the bulk associated with the health sector reform and the implementation of the new organization of the Executive.2
25. To improve efficiency of public investment, the government intends to strengthen the legal status and mandate of the National System of Public Investment (SNIP), empowering the office of the presidency to review and oversee public investment across ministries, and thus provide greater cohesion to the country's development strategy. To this end, a decree will be issued by January 2000 to formalize SNIP and its mandate to evaluate, clear, and monitor implementation of investment projects.
Governance and public accountability
26. Improvements in this area will be pursued through better transparency and accountability in the management of public finances, an accelerated resolution of outstanding property claims, continued modernization and strengthening of the judiciary, and greater decentralization, municipal development and enhanced civil society participation.
27. The government is committed to improving accountability and transparency of the public sector procurement and finances. To this end, the government has submitted to the national assembly a draft procurement law (introducing amendments along the lines recommended by the IMF's Fiscal Affairs Department and the World Bank) that is expected to be approved shortly. Also, all revenue from domestic sources and expenditure, including transfers among public entities are to be put under the centralized cash management of the treasury, and the information system for financial management and audit (SIGFA) is to be implemented in all core government ministries by September 1999. This system will be extended in 2000 to all government entities and its coverage will be broadened to include management and monitoring of human resources, procurement and public investment.
28. The government intends fully to adhere to the Stockholm declaration that attaches utmost importance to transparent and efficient use of funds from international assistance.3 To this end, it is cooperating with donors and will improve the collaboration and coordination with the National Comptroller's Office to ensure that all reconstruction contracting is done through competitive international bidding and that spending is recorded and monitored in accordance with sound accounting practices. Quantitative indicators are being developed to establish more direct relationship between spending and results and facilitate monitoring. To enhance citizen participation in the decision making, the newly established National Council for Economic and Social Development, with representatives of the NGOs, the private sector, and the minority political parties, will advise on priorities and help coordinate projects in the social, infrastructure, agricultural support and environment areas.
29. The government is committed to resolving expeditiously the remaining property claims. A reformed Property Rights Law approved in November 1997 permitted accelerated progress in this area.4 On the basis of available funding (mostly from donors) and improved implementation capacity, the Intendent for Property in the ministry of finance plans to settle claims for about 1,000 properties in 1999 and 1,400 properties in 2000. At the envisaged pace, by the end of 2000, about 80 percent of claims outstanding at the end of 1998 would have been resolved. In addition, the property rights regulation will focus on acceleration of land titling, and the Intendent plans to almost double the number of urban and rural titles issued annually, compared with the annual average for 1992-98. The ministry of agriculture plans to step up the construction and activation of departmental cadastres. The Supreme Court plans to modernize the property registry in Masaya in 1999, as a pilot project that would be expanded throughout the country in 2000-01.
30. A comprehensive program to strengthen and modernize the judiciary, improve legal procedures and enhance the enforcement of contracts and property rights is being implemented since 1995 (with the support of IDA, the IDB, USAID, UNDP, and the European Union).5 The forensic medicine institute was inaugurated in June and the national Center for Property Mediation is expected to open in late 1999. To clarify and simplify administrative procedures and facilitate the resolution of administrative claims, an administrative procedures and dispute settlement law has been submitted to the Assembly and is expected to be approved by end-1999. Further measures planned by the judiciary include the creation of civil defense offices to provide legal services to the poor (by mid-2000), strengthening of the information and statistics systems and a reform of the penal code (in 2000), and a reform of the penitentiary system (in 2000-01).
31. Decentralization will continue to be promoted through the school autonomy program in the education sector, and gradual delegation of powers to the local integrated health care systems (SILAIS) in the health sector. The roles of municipalities and civil society will be enhanced through the contracting out of road maintenance activities to private or communal microenterprises in the transport sector and the application of microplanning approaches emphasizing community participation in provision and maintenance of social infrastructure by FISE.
32. The government will protect environment by taking legislative and executive measures that prohibit encroachment into watersheds, national parks, and indigenous reserves. By end-1999 the national assembly will have approved the proposed law on demarcation of indigenous lands, or a presidential decree will be issued regulating the demarcation of lands in Bosawas and surrounding areas. To rationalize the management of natural resources, a new law on the mining sector will be submitted to the national assembly by September 1999, and new laws on forestry and fishery sectors will be submitted in 2000.
33. To foster private investment, the government plans to make revisions to the foreign investment law and regulations. The revisions (expected to be submitted to the assembly by end-1999) will simplify procedures and eliminate discretionary decisions, thus ensuring a level playing field for domestic and foreign investors. Work on preparation of a new commercial code is expected to start in early 2000, and a reformed code is expected to be submitted to the assembly by December 2000.
34. The government is committed to privatizing or granting long-term concessions for the remaining public enterprises. To resume the privatization process of ENITEL, the government has canceled a contract for a loan on commercial terms (to increase the number of lines), and in accordance with a program supported by IDA/IFC has restructured and raised telephone tariffs (revenue will increase by 10 percent), bringing the rates in line with those of the already reformed systems in the neighboring countries; introduced a program to lower operating costs by 20 percent; and started discussions with CABEI to assume a loan owed by ENITEL. According to the new schedule agreed with IDA/IFC and the international advisory investment bank, final bidding documents for 40 percent of ENITEL assets will be issued in January 2000. As envisaged in Law 293, the government intends to place the remaining shares for sale in the stock exchange.
35. A decree on the division of ENEL into generation, transmission, and distribution units in preparation for privatization was issued in May 1999. A regulation revising the tariff structure and setting the rules for future adjustments is expected to be issued in October 1999. The generation and distribution units will be offered for sale to the private sector by December 1999.
36. With the support of the IDB and KFW of Germany, the government is decentralizing the water and sewerage system and plans to involve the private sector in management. To this end, the recently approved law established a regulatory agency, and created a new operating company (ENACAL). Water and sewerage operations are being split into urban and rural units, and the rural units are being linked to municipalities and put under local management. Larger sub-systems are being prepared for private management concessions. Two sub-systems (Matagalpa and Jinotega) accounting for about 13 percent of the national system are expected to be offered for private management in 1999, and two more units (Leon and Chinandega) accounting for 25–30 percent of the system would be offered by mid-2000 (as autonomous units of the ENACAL system.
37. The major ports need rehabilitation and modernization. To the extent possible, these improvements will be funded by the private sector. A study on reorganization of port services is expected to be completed by the end of 1999, while the state port authority (ENAP) is expected to be converted into a regulatory agency. The government intends to issue terms of reference with the offer of port facilities for sale or long-term concession by March 2000.
38. The government will continue to rehabilitate the road system, especially the major export corridors, by implementing projects supported by IDA and the IDB. The feeder and rural roads also will be improved. The government is working with IDA on the establishment of a road fund that will streamline the contracting out of maintenance to the private sector where feasible. In this process, at least three of the seven state-owned road maintenance units (CERCs) are expected to be privatized by December 1999.
Social security reform
39. The government is committed to a comprehensive social security reform, which is being prepared with technical assistance by the World Bank and the IDB. The reform will entail a tightening of parameters of the existing pension system and introduction of a new system of individually funded accounts managed by the private sector. The first step of dividing the pension from the health insurance accounts was implemented in April 1999. To reduce losses of the existing system, the retirement age will be raised, the contribution rate increased, and the minimum period of contributing lengthened. The reform envisages a compulsory transfer to the new system of contributors younger than age 45, to provide sufficient time horizon for the contributors to generate adequate savings by age 65, and a minimum number of accounts in the new system to generate interest of private managers. Some elements of the reform, related to specifics of the benefits and the cost and financing of the transition to the new system, will need to be defined before implementation. The draft reform bill is expected to be submitted to the Assembly shortly. The parametric changes of the existing system would be introduced following approval of the law, and transition to the new system would start in the last quarter of 2000.
Financial sector reforms
40. The government intends to further promote the development of a sound and competitive financial system. To this end, it plans to complete the privatization of state banks and take important measures to strengthen the financial sector. The law permitting privatization of the remaining state bank (Banco de Crédito Popular) is expected to be approved soon, and the bank would be offered for privatization by the end of 1999. The enforcement of higher prudential standards set in the banking norms revised in the second half of 1998 will ensure that the calendar for compliance is observed.
41. The government has prepared three laws to improve the legislative framework for the financial sector, with support of IDA and IDB sector loans, and technical assistance from the Fund. A revised banking law will set clear rules for entry and exit from the system, permit consolidated supervision of financial groups, and provide clearer base for enforcement of prudential norms, including on-lending to related parties. A new bank superintendency law will clarify the responsibilities of the superintendency and its regulatory council in bank regulation and supervision, and reduce room for discretionality in the enforcement of prudential norms. The proposed revisions of the central bank charter will strengthen central bank autonomy, help clarify financial and accounting relations between the bank and the treasury (leading to central bank recapitalization and elimination of quasi-fiscal operations, and permit open-market operations with treasury bills). The draft laws are expected to be submitted shortly to the assembly.
42. An IDA-supported study to be completed by the end of 1999 will recommend criteria and procedures for bank exit, crisis resolution, a deposit insurance scheme, and the optimal structure of an agency. A program of further steps to strengthen the banking system based on the new laws and the results of this study will be developed by December 1999 and implemented in 2000–01. The program will, inter alia, support the strengthening of the superintendency's personnel and technology.
43. The government's poverty alleviation and social development strategy is based on the poverty profile and analysis carried out with IDA support in 1993-94. The strategy has focused on the four pillars: promoting economic growth with equity, investing in human capital, strengthening the social safety net, and promoting rural development. The social strategy will continue to be implemented, primarily through the health and education reforms that put priority on improving the quality and efficiency of preventive and primary health care and primary education, and investments in social infrastructure in poverty-ridden communities through the Social Investment Fund (FISE). Funds made available through SSF increase financing of current expenditure for the ongoing social programs thus helping accelerate their implementation. A pilot project of a social safety net is being developed and will be implemented in 2000.
44. A redefinition of the role of government and decentralization of management responsibilities also are central to the social sector strategy. The decentralization entails transferring decisions on budget execution (except for payroll) from the ministry of health (MINSA) to the departmental health care units, SILAIS and to municipalities; and on school administration and financial management from the ministry of education (MED) to local councils at the school or municipal levels. The ministries are being transformed from service providers to policy coordinating and regulatory agencies. The FISE programs include support to municipal governments in building their capacity to manage projects and maintain local infrastructure. A technical secretariat under the office of the presidency has been assigned to coordinate setting of priorities and improve effectiveness of social policies. Together with the ministries and other executing agencies (with technical assistance of the IDB and IDA) the secretariat has helped identify a set of quantitative targets for monitoring execution and ensuring accountability for allocated funds starting in 1999 (see Table 1).
Health and nutrition
45. The health policy focuses on strengthening primary and preventive care and epidemiological control by extending the integrated model of public care at the national level. Public expenditure in health is projected to increase from 4 percent of GDP in 1997-98 to about 5½ percent of GDP annually during 1999-01, which would raise the public expenditure on health from the equivalent of US$17 per capita in 1997-98 to about US$27 in 2000-01. The primary health facilities are being reconstructed and coverage expanded; these centers are being provided with essential pharmaceuticals and medical supplies. The government also is improving the availability of reproductive health services and introducing nutritional assistance focused on mothers and young children. School feeding programs in the poorest areas will be extended, and a program of targeted delivery of nutritional supplements to the most needy will be implemented. Primary and secondary level infrastructure is being reconstructed and rehabilitated, and essential secondary level services will also be strengthened. The ministry of health will continue means-based cost recovery practices. The main instruments to implement these policies with program targets and timing are described in the policy matrix.
46. The provision of potable water and basic sanitation aims at reducing water-borne diseases and is an essential complement to the health and nutrition strategies. The government plans to continue improving and expanding water systems and services in urban areas and, with the help of FISE, to accelerate the expansion of water services in dispersed rural communities. The government has set quantified targets for improvements in coverage of these services. The projects include assistance to strengthen local capacity to plan, operate, and maintain these systems once installed.
47. The principal objective of the reform program to 2001 is to raise the primary school completion rates by improving the coverage, quality, and relevance of primary education, rehabilitating education infrastructure, and improving student and teacher incentives. Public expenditure in education was about 5 percent of GDP in 1997-98 and is projected at about 6 percent of GDP a year in 1999–01. However, with improved allocation of funds, the nonsalary current expenditures per student would almost double in the same period. The administrative structure on the sector will also be improved (with support of IDA and IDB projects), and resource allocation per student across schools will be made more equitable. Quality improvements are expected from intensifying teacher training and evaluation, improved curricula, more and better text books, and increased number of school days. Incentives for students to remain in schools include the provision of school materials and essential clothing as well as school nutrition programs. The government will also continue to expand its pre-school program and improve secondary education.
Poverty alleviation programs
48. The main instrument for directly assisting the poorest communities in the 1990s has been the provision of basic social infrastructure through the FISE projects. Since late 1998 this has been complemented by the SSF supported programs, mainly in education and health. Beginning in early 2000, the SSF will introduce a pilot project of a targeted social safety net, which the government is designing with the assistance of the IDB. FISE projects are generated by the demand from communities and their targeting is based on a poverty map; the implementation is coordinated with relevant ministries, municipalities, and NGOs. In 1999-01 the projects will focus on: (i) replacement and repair of primary schools and basic health facilities; and (ii) sanitary infrastructure, including the rehabilitation and installation of safe water systems, sewerage, and latrines in rural and marginal urban areas.
49. The promotion of rural development aimed at raising productivity of small farmers is critical to achieving sustained growth and alleviating poverty. This objective is pursued by removing distortions in the land markets and access to credit, developing infrastructure, and helping improve technology and preserve the environment. The above-mentioned measures to accelerate land titling and modernize cadastres should remove insecurity of land tenure for small farmers. To increase agricultural yields and improve human capital, the National Agricultural Technology Institute (INTA) will continue to expand coverage of agricultural extension services, and to implement its basic grains, crop diversification, and seed improvement programs.
50. To remove distortions that hinder access of small farmers to financial intermediation, the government is providing temporary incentives to banks to open branches in rural areas, taking steps to regulate (set prudential standards and minimum reporting requirements) the nonbank intermediaries, and preparing a revision of norms on bank guarantees to permit movable property to serve as collateral. Loans to small farmers (Fondo de Crédito Rural), which carry below-market interest rate, is limited to financing with foreign grants (about US$9 million in 1999), with transfers recorded as expenditure in the budget. Technical assistance is provided to small farmers in the preparation of projects to be submitted with the loan application.
51. Over the past several years, extensive technical assistance has been provided by the IMF, IDA, the IDB, UNDP, and USAID in the areas of macroeconomic and social policies, public sector and institutional reforms, and the methodology and compilation of statistics in a number of different areas. During 1999–01 technical assistance is expected to continue in these areas, with special emphasis on: (i) public sector reform, including the institutional reform, the investment program, privatization, and the strengthening of tax and customs administration; (ii) financial sector, including the supervisory functions of the superintendency of banks, central bank functions and operations, development of capital markets and reform of the pension system; (iii) social policies, including health, education, and poverty alleviation programs; and (iv) statistics, including public finance, balance of payments and price statistics, and national accounts estimates. A list of identified technical assistance plans is attached in Table 2.
52. Economic policies of the program aim at strengthening national savings to help maintain the level of domestic investment and gradually reduce Nicaragua's dependence on official external flows. However, the external financing requirements remain large over the next several years because of the country 's still low export base and high debt service obligations.
53. Gross capital inflows from official sources amounted to about US$450 million (21 percent of GDP) in 1998, as envisaged, and 40 percent was in the form of grants. Balance of payments support was, however, lower than expected. Gross inflows are projected to reach US$600 million in 1999, and about US$450 million annually in 2000-01, associated with the large reconstruction effort following the destruction caused by Hurricane Mitch. Subsequently, gross official inflows are expected to decline gradually. Net private sector capital inflows, excluding transfers but including direct investment, are projected to increase from US$220 million in 1998, to about US$340 million in 2001; afterwards, these inflows would stabilize at about US$420 million a year.
54. The residual financing gap, estimated at US$2.1 billion in 1999 (mainly reflecting the assumed clearing of arrears to non-Paris Club creditors), is projected to drop to US$70 million in 2000. These financing gaps could be filled by a flow rescheduling by non-Paris Club creditors on terms at least comparable to terms granted by Paris Club in 1998. However, after assuming a stock-of-debt operation on Naples terms by all bilateral creditors in 2001, sizable financing gaps would remain throughout the medium term.
55. The latest debt sustainability analysis prepared jointly by the Nicaraguan authorities, the IMF, the World Bank, and the IDB, on the basis of a loan-by-loan data on debt outstanding at end-1998, and in the context of a 20-year macroeconomic and balance of payments framework, suggests that Nicaragua would be eligible for assistance under the HIPC Initiative. A decision point under the Initiative could possibly be reached by the end of 1999 or early 2000. The additional debt relief that may be available under the Initiative would allow a reduction in Nicaragua's debt burden to sustainable levels and a normalization of relations with all creditors. The relief would also provide crucial resources for Nicaragua to strengthen essential social services.