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Public Information Notice (PIN) No. 02/136
December 12, 2002
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2002 Article IV Consultation with Nicaragua

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On December 4, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Nicaragua.1

Background

After a decade of economic decline, the peaceful transition to a democratic system and adoption of market-based reforms in the early 1990s generated a strong economic recovery. Real GDP grew at an annual average of about 5 percent during the second half of 1990s and inflation was brought under control, helped by a slowing crawl of the exchange rate. Substantial external assistance mitigated the adverse effect on growth caused by the 1998 Hurricane Mitch. Notwithstanding these improvements, this period also saw the emergence of new vulnerabilities, reflecting a difficult political environment and social tensions. Government spending remained high and became inflexible, and the domestic debt of the public sector increased substantially. Meanwhile, bank credit to the private sector was allowed to expand rapidly, under inadequate supervision.

In 2000-01, the economy deteriorated sharply as the vulnerabilities were compounded by external shocks (including a steep decline in the terms of trade) and a widening fiscal deficit. Efforts to arrest the economic deterioration under a staff-monitored program (SMP), covering the second half of 2001, were not successful. The combined public sector deficit (after grants) increased to over 14 percent of GDP in 2001, reflecting large expenditure overruns; governance concerns intensified; and a banking crisis stunted credit flows to the private sector. As a result, real GDP growth, after reaching over 7 percent in 1999 (boosted by Hurricane Mitch-related spending), slowed to an estimated 1 percent in 2002. Exchange rate policy continued to follow a "crawling peg" to the U.S. dollar, and trend inflation remained around 6 percent, reflecting the exchange rate crawl.

The financial position of the central bank deteriorated sharply in 2000-01. In addition to a large loss of reserves (with NIR declining by US$200 million over the two-year period), the central bank's dollar-indexed domestic debt jumped by US$520 million (21 percent of GDP) as it absorbed the cost of resolving four banks that failed in 2000-01. Gross official reserves at end-October 2002 stood at US$362 million (2.7 months of imports of goods and services); excluding reserve requirements on dollar deposits with domestic banks, gross reserves were US$166 million (one month of imports of goods and services).

The new government that took office in January 2002 has moved quickly to address economic imbalances. Government spending was reined in, first through administrative means and then (in July) by a reduction in the budget (by about 1.5 percent of GDP). The assembly also approved the first round of a major tax reform package, yielding about 2.1 percent of GDP. As a result, the combined public sector deficit after grants is projected to narrow significantly in 2002 (to 9.2 percent of GDP). Reflecting improved confidence, interest rates on central bank paper dropped significantly after the November 2001 presidential elections, to about 12 percent by mid-2002; since then, monetary policy has been tightened and interest rates have increased to about 15 percent by October. Despite the absence of balance of payments support, the net position of the central bank (NIR plus the central bank's domestic debt) has remained broadly stable during the first 10 months of the year. Prudential oversight of banks has been stepped up, and all banks have been required to comply with relevant provisioning and capital adequacy rules.

Nicaragua reached the decision point under the HIPC Initiative in December 2000, and it is expected to reach the completion point by end-2003 assuming relevant conditions are met. In 2001-02, Nicaragua received about US$110 million of interim assistance from various multilateral organizations, which has been used to finance poverty-reducing expenditures in the health, education, and social safety net programs. The debt service deferral granted by Paris Club creditors after Hurricane Mitch (1998) expired in March 2001, and since then Nicaragua has been servicing its post-cut-off debt. During 2000-02 Nicaragua negotiated debt reduction agreements with Brazil, Bulgaria, Finland, Guatemala, and Slovakia, in line with the enhanced HIPC Initiative. At end-2001, Holland cancelled its ODA claims on Nicaragua.

Executive Board Assessment

Executive Directors noted with concern that economic performance in Nicaragua had deteriorated significantly in recent years as domestic problems were compounded by external shocks. In particular, a deterioration of the external environment, combined with expansionary fiscal and monetary policies in the run-up to presidential elections and a banking crisis, had resulted in large increases in the fiscal deficit and domestic debt, and a significant decline in official international reserves.

Against this backdrop, Directors welcomed the new government's commitment to correct the economy's key vulnerabilities and create the basis for sustained growth and poverty reduction by addressing the structural rigidities confronting the economy. They were encouraged by the authorities' efforts to date to address the macroeconomic imbalances, strengthen prudential oversight in the banking sector, and undertake strong anti-corruption initiatives, but stressed that further decisive actions in these areas will be needed over the medium-term. Building on the government's strong ownership of the program, it will therefore be important that the authorities continue their efforts to widen ownership and support for reform across the political spectrum and among the population at large.

Directors agreed that sustained fiscal consolidation will be key to the authorities' medium-term strategy and, in particular, their objective of attaining public debt sustainability. Early passage and strict implementation of the 2003 budget, in line with the program, will be an important milestone in this regard. Following the helpful first stage of tax reform, which fell however short of initial objectives, Directors underscored the need for timely adoption of a second round of reforms to achieve the targeted increase in revenues while also making the tax system more equitable, efficient, and transparent. They stressed that eliminating tax exemptions and reducing the list of zero-rated VAT items will be critical to this end. They also looked forward to the planned comprehensive reform of tax administration and partial transfer of pension administration to the private sector, while encouraging careful monitoring of any budgetary implications of pension reform. On the expenditure side, Directors supported the authorities' plan to reduce non-priority primary spending while raising the quality and quantity of poverty-reducing spending. They highlighted, in this context, the importance of carrying on with the implementation of the new mechanism to track and monitor the use of poverty-reducing spending, and also looked forward to the forthcoming Poverty and Social Impact Analysis to help target social programs.

Directors supported the authorities' monetary policy strategy of strengthening international reserves while maintaining low inflation, noting that fiscal adjustment and implementation of the asset recovery plan will be key to helping achieve these objectives. The authorities were also encouraged to further strengthen the independence of the central bank. Directors noted that the crawling peg exchange regime has helped to keep inflation low, and that the current level of external competitiveness is broadly appropriate. While Directors saw no need to consider abandoning the crawling peg in the near future, many Directors considered that over the medium term greater flexibility would help reduce vulnerabilities and facilitate adjustment to shocks and structural change. These Directors, therefore, recommended that the authorities put in place the conditions for moving toward greater flexibility, including appropriate fiscal, monetary and financial sector policies, while carefully taking into account the high degree of dollarization of the economy.

Directors stressed the crucial importance of strengthening bank supervision and strict enforcement of prudential rules, especially on provisioning and minimum capital requirements. They urged the supervisory authorities to react promptly and forcefully to any weaknesses in financial institutions. Directors welcomed the recent selection of a firm to implement asset recoveries, and encouraged the authorities to allow speedy asset disposal without government interference—noting the importance of successful asset recovery for program financing, improving governance, and strengthening the credit culture. Directors commended the authorities' commitment to combat money laundering and the financing of terrorism, and encouraged them to continue their efforts in this area. They also looked forward to the implementation of the recommendations of the safeguard assessment.

Directors were encouraged by the steps taken by the authorities toward achieving public debt sustainability, including their efforts aimed at lowering the stock of nonconcessional domestic debt. They also stressed that long-term debt sustainability beyond debt relief will depend on continued prudent external borrowing based on highly-concessional financing.

Directors welcomed the high priority which the authorities are giving to structural reforms aimed at addressing economic vulnerabilities and removing long-standing barriers to growth. They looked forward to continued efforts to fight corruption and improve accountability in the public and private sectors, and urged the authorities to press ahead with their plans for reforming the judicial system, restructuring the public sector, and continuing the privatization program. Further trade liberalization and regional integration will also be important to underpin growth and external viability.

Directors supported the planned improvements in Nicaragua's economic statistics, including steps to bring monetary statistics and national accounts in line with international standards, and encouraged the authorities to follow up on their intention to join the General Data Dissemination System.


Nicaragua: Selected Economic and Financial Indicators


         

Prel.

 

1997

1998

1999

2000

2001


           

(Annual percentage change; unless otherwise indicated)

 

National income, prices, and unemployment

         

GDP at constant prices

5.1

4.1

7.4

5.9

3.3

Consumer prices (end of period) 1/

7.3

18.5

7.2

6.6

4.7

Consumer prices (period average) 1/

9.2

13.0

11.2

7.4

7.4

Unemployment rate (percent)

14.3

13.2

10.7

9.9

10.5

           

External sector

         

Exports, f.o.b.

23.4

-0.6

-4.9

18.3

-8.1

    Export volume

18.9

2.5

3.2

15.1

7.3

Imports, f.o.b.

30.6

1.9

21.6

-3.0

-1.1

    Import volume

32.2

8.2

18.3

-9.7

3.1

Terms of trade (deterioration -)

9.8

1.9

-12.5

-4.0

-11.2

Nominal effective exchange rate end of period (depreciation -)

-2.0

-11.9

-2.7

2.1

-2.9

Real effective exchange rate end of period (depreciation -)

3.5

2.0

1.6

8.8

-0.6

           

Money and credit

         

Net domestic assets of the central bank 2/

-36.8

27.5

-39.3

22.7

141.7

    Net credit to nonfinancial public sector 2/

132.3

-85.8

-75.6

-36.2

161.7

    Net credit to financial institutions 2/

-22.3

-4.8

-2.6

95.4

-54.0

Currency in circulation

26.8

22.2

29.5

1.2

11.1

Financial system liabilities to private sector

65.6

28.6

22.4

7.3

10.3

Financial system credit to private sector 3/

9.7

45.3

40.0

14.2

-43.5

Money income velocity (GDP/M3)

1.6

1.6

1.5

1.6

1.7

Interest rate on deposits (percent per annum) 4/

11.5

12.4

11.5

11.2

10.5

           

(In percent of GDP)

 

Public sector 5/

         

Combined public sector saving 6/

4.0

5.6

5.4

3.6

-4.4

Combined public sector primary balance (before grants) 6/

-4.2

-0.1

-10.1

-10.0

-11.9

Combined public sector overall balance (before grants) 7/

-9.7

-7.4

-15.7

-15.4

-21.0

Combined public sector overall balance (after grants) 6/ 7/

-4.5

-3.6

-7.0

-8.1

-14.3

Nonfinancial public sector saving

4.5

8.9

7.1

5.1

-2.4

Nonfinancial public sector overall balance (before grants)

-9.2

-4.1

-14.1

-13.9

-19.0

Central bank operational results (deficit -)

-0.5

-3.3

-1.7

-1.5

-2.0

Stock of combined public sector domestic debt

44.0

42.5

35.3

41.0

59.6

           

Savings and investment

         

Gross domestic investment

30.5

33.8

43.3

34.7

30.8

    Public

13.7

13.0

21.1

19.0

16.2

    Private

16.8

20.8

22.2

15.8

14.6

National savings

3.3

2.3

1.4

2.6

-2.8

    Public

4.0

5.6

5.4

3.6

-4.4

    Private

-0.7

-3.3

-4.0

-1.0

1.6

External savings 8/

35.3

33.0

41.7

32.1

33.4

           

External sector

         

External current account balance

-40.0

-38.7

-47.7

-38.3

-38.1

    (Excluding interest obligations)

-29.3

-28.4

-37.5

-27.7

-25.7

Trade balance (deficit -)

-40.4

-39.9

-52.1

-41.2

-40.7

Outstanding external public debt (end of year)

296.7

296.0

289.0

278.0

250.3

           

(In percent of exports of goods and nonfactor services)

 

Contractual interest obligations, before debt relief

53,4

43.5

47.1

45.3

38.5

Gross international reserves (in months of imports)

2.2

2.3

3.3

3.2

2.3

           

Sources: Central Bank of Nicaragua; Ministry of Finance; and IMF staff estimates.

1/ For 2000, staff estimates using the new consumer price index adopted in 2001.

2/ In relation to currency in circulation at the beginning of the year.

3/ Excludes credit held by liquidation boards.

4/ Six-month deposits, end of period.

5/ For 2001 the interest cost of bank resolution on accrual basis is included in the central government operations.

6/ Includes central bank operational balance.

7/ For 2001 HIPC interim debt relief from multilaterals is recorded as grants.

8/ External current account deficit, excluding interest on debt to bilateral creditors that is eligible for debt rescheduling on terms.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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