## _cr13377

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---

### Implementation of Past IMF Policy Advice — Background and Structural Developments
- Since the global financial crisis Nicaragua has made significant progress toward restoring sustainable growth, consolidating the fiscal position, and keeping inflation under control.
- Main drivers of progress: sustaining prudent policies amid the global financial crisis, commodity price shocks, and natural disasters.
- Remaining challenges: second lowest per capita income in the Western Hemisphere and poor other social indicators; need for higher growth to reduce poverty while addressing fiscal and external vulnerabilities.
- Government medium-term economic strategy: Programa Economico-Financiero 2013-16 (aims at equitable growth, financial stability, and poverty reduction).
- Planned structural/investment developments:
  - Private investment increased in wind, geothermal, and biomass electricity generation, largely eliminating blackouts and improving system stability.
  - New energy projects expected to be completed by 2018 would further boost electricity production without significantly increasing oil imports.
  - Government signed concession for an inter-oceanic canal; tentative estimated value nearly 4 times the 2012 GDP. Feasibility studies expected to be completed in 2014; costs expected to be incurred by the foreign investor.
  - Improvements to national accounts methodology and data resulted in an upward adjustment of nominal GDP of about 30 percent.
    - Per capita GDP for 2012 is now estimated at US$1,762 (US$1,313 before the change).
    - Revision uses improved source surveys, statistical procedures, and a new base year (2006).
    - Fiscal and external sector ratios to GDP are significantly lower than reported in the 2012 Article IV consultation report.

### Recent economic developments and key indicators
- Real GDP growth:
  - 2012: 5.2 percent.
  - First half of 2013: 5 percent (yoy).
- Inflation:
  - Headline inflation increased to 7.4 percent (yoy) in September 2013.
  - Core inflation at 5.9 percent.
- Fiscal:
  - Combined public sector deficit: 0.7 percent of GDP in 2012.
  - Deficit expected to widen to 1.4 percent of GDP in 2013 largely due to rising capital expenditure in public enterprises.
  - Public debt ratio projected to decline to about 42 percent of GDP in 2013 (from 45 percent of GDP in 2011).
- Financial sector:
  - Domestic credit by August 2013 increased by about 23 percent (yoy); 2012 annual increase was 26 percent.
  - Consumer sector credit expansion: 43 percent.
  - Deposits increased by nearly 10 percent.
  - Capital adequacy ratio of the banking system as of August 2013: 13 percent (regulatory norm: 10 percent; peak in 2010: 16.6 percent).
- External sector:
  - Current account deficit for 2011–13 estimated around 13 percent of GDP.
  - External private and public debt projected about 74 percent of GDP at end-2013.
  - First half of 2013: maquila net exports increased by 6.5 percent.
  - By August 2013, remittances increased by 7.3 percent (yoy).
  - As of end-October 2013, gross international reserves: US$1.9 billion, or equivalent to 3½ months of imports (broadly unchanged from end-2012).
- Structural reforms/actions taken:
  - Tax reform approved December 2012 eliminated VAT exemptions on some items consumed by higher income households; estimated revenue impact in 2013: 0.2 percent of GDP.
  - Electricity tariffs increased by 12.8 percent in April 2013, narrowing the gap between indicative and actual tariffs to 3 percent.
  - Regulatory changes enabled anti-theft measures to be strengthened.

### Outlook and risks
- Baseline projections under current policies:
  - Growth projected to decline to 4.2 percent in 2013 (from 5.2 percent in 2012), then converge to long-term trend of 4 percent.
  - Inflation projected to increase to 6.9 percent by end-2013 (compared to 6.6 percent at end-2012), consistent with the 5 percent rate of crawl of the exchange rate and international prices.
  - External current account deficit projected to widen marginally to 13.2 percent of GDP in 2013, then contract to about 11 percent of GDP over the medium term.
- Key downside risks:
  - Slower than expected economic recovery in the United States and Europe.
  - Higher oil prices.
  - Unanticipated changes to terms or levels in the oil collaboration scheme with Venezuela could generate additional pressures on the external position.
- Agreed policy priorities:
  - Prudent fiscal policies to reduce vulnerabilities.
  - Address large external current account deficits driven by oil import dependency (12 percent of GDP) and reliance on financing from Venezuela.
  - Recognize external inflows including FDI and official sources, and the oil collaboration scheme with Venezuela as important for financing deficits and maintaining reserve buffers.
  - Monitor high dollarization and rapid private credit expansion.

### Fiscal policy discussions and recommendations
- General stance:
  - Present policy stance broadly appropriate; with the output gap closing no policy change needed for 2014.
  - Maintaining present deficit level consistent with further lowering public debt ratios over the medium term.
  - Draft 2014 budget submitted in October features revenues rising as a ratio of GDP and deficit of combined public sector broadly unchanged at 1.2 percent of GDP.
- Specific fiscal measures and targets:
  - Budget to incorporate in 2014 the wage bonus (0.4 percent of GDP), previously funded with grants from a private entity (CARUNA), without increasing deficits by restraining other current expenditure and using higher tax revenues.
  - Combined public sector deficits need to remain at about 1-1 ½ percent of GDP to reduce public debt ratios, consistent with the Debt Sustainability Analysis.
  - To strengthen fiscal sustainability: strengthen revenue performance, reform the pension system, and rationalize expenditures.
    - Authorities intend to fully implement the tax reform approved in December 2012.
    - Pension reform proposal includes step increases in employers’ contributions, modification of benefits eligibility to ensure financial viability over the next 15 years, a program of reduced pensions for certain retirees, and resolution of government debt to the social security system.
  - Electricity and other subsidies need rationalization through better targeting; financial position of public enterprises to be strengthened to avoid intra-sector arrears.
  - Authorities agreed to review system of energy and other subsidies; key law on electricity subsidies to be updated by 2015.
- Transparency:
  - Staff supported increasing transparency of public sector operations.
  - Economic cooperation with Venezuela financed flows about 7¼ percent of GDP in 2012, managed through a private entity; stock of associated debt reached 21 percent of GDP at end-2012.
  - Staff welcomed increase in electricity tariffs and argued for more transparency in energy subsidies provided through VAT refunds and extra-budgetary channels.
  - Authorities committed to continue expanding provision of information on international cooperation.

### Monetary and external sector policy discussions
- Monetary policy stance:
  - Given high dollarization and rigidity of exchange regime, monetary policy appropriately focuses on the external position; central bank operations anchored by objectives for stock of international reserves.
  - Staff supported authorities’ objective to increase gross international reserves and maintain them above the equivalent of three months of imports.
- Exchange rate regime:
  - Authorities view crawling peg as beneficial for anchoring inflation expectations and maintaining broad financial stability.
  - Staff noted the present rate of crawl (5 percent) has set a relatively high floor for domestic inflation (domestic inflation generally higher than regional peers) and may contribute to rising dollarization.
  - Authorities agreed and welcomed technical assistance to develop a long-term strategy to reduce incentives for dollarization and explore alternative exchange rate regime options.
- External vulnerabilities and contingency planning:
  - Authorities acknowledged external vulnerabilities but noted no significant misalignment of the exchange rate and reserves above benchmarks.
  - Recognized risks: large external current account deficits, oil import dependency, high external debt, exposure to changes in oil collaboration with Venezuela.
  - Authorities agreed on merit of developing a contingency plan to deal with external shocks (including additional financing and measures to compress expenditure).
  - Committed to continue negotiations to complete bilateral debt reduction agreements with non-Paris Club creditors.

### Banking sector risks, monitoring, and supervisory recommendations
- Staff recommendation: close monitoring of commercial bank credit to the private sector due to rapid expansion in banking system exposure in context of high dollarization, particularly in the consumer loan sector.
- Specific monitoring and prudential actions urged:
  - Close monitoring of banks' foreign exchange positions.
  - Close monitoring of credit quality.
  - Stress tests based on exchange rate and other shocks.
- Authorities’ position:
  - Broadly concurred; noted credit expansion represented a rebound and was slowing during the year.
  - Pointed to relatively strong capital adequacy indicators and stability of deposits, including those linked to oil-collaboration scheme with Venezuela (about 8 percent of total deposits).
  - Agreed on increased vigilance; committed to strengthen supervision framework and continue providing transfers to the central bank to reduce its operational losses.
- Additional recommendations:
  - Staff supports continued recapitalization of the central bank.
  - Staff encouraged improvement of the AML/CFT framework in line with the action plan agreed with the Financial Action Task Force.

### Structural reform agenda to boost medium-term growth
- Shared diagnosis:
  - Achieving higher medium-term growth requires substantial investments in infrastructure and progress in reforming labor and product markets and education.
  - Target medium-term annual output growth to raise incomes and reduce poverty: about 5–6 percent.
  - Total factor productivity growth averaged negative -0.2 percent of GDP per year during 2001–11.
- Key reform areas and recommendations:
  - Electricity sector:
    - Nicaragua highly dependent on oil imports (12 percent of GDP); electricity subsidies about 1½ percent of GDP.
    - Authorities’ strategy: expand access to electricity nationwide, reduce distribution losses, and shift generation toward renewable energy sources.
    - Staff recommended targeting electricity subsidies to lowest income groups using a transparent mechanism that insulates the budget from international price shocks; strengthen financial position of public enterprises; avoid intra-public sector arrears.
    - Staff recommended dissemination of full information on financial flows and economic benefits of oil collaboration with Venezuela.
  - Labor and product markets and education:
    - Reduce incentives to informality (ease access to social security schemes, simplify tax filing, improve business licensing procedures) and better match education system skills with labor market demand.
  - Public finances and fiscal strategy:
    - Sustained fiscal consolidation as main anchor.
    - Broaden revenue base by fully implementing elimination of tax exemptions from 2012 reform, rationalize public expenditures, and reform the pension system.
    - Renewed efforts to conclude negotiations on public debt reduction with remaining non-Paris Club official creditors.
  - Infrastructure and private investment:
    - Mobilize infrastructure investments; rationalize public spending and strengthen framework for private investment.

### Box 3 — Oil Collaboration with Venezuela (mechanics and allocations)
- Genesis and institutional roles:
  - Agreement between Presidents Ortega and Chavez in April 2007.
  - PDVSA supplies petroleum and is financial agent; ALBANISA (PDVSA 51%, PETRONIC 49%) imports and sells oil in Nicaragua and acts as PDVSA’s agent for FDI; CARUNA receives on behalf of PDVSA 50 percent of the oil bill (FOB) as a long-term loan; ALBALINISA (75% ALBANISA / 25% PDVSA) handles in-kind repayments.
- Loan terms (exact):
  - payable over 25 years
  - with a 2-year grace period
  - 2 percent interest
  - grant element of 30 percent
- Flow and allocation:
  - ALBANISA pays 100 percent of oil bill to PDVSA within 90 days; PDVSA transfers 50 percent of the oil bill (FOB) to CARUNA as a loan with the terms above.
  - CARUNA allocates 38 percent of funds to quasi-fiscal operations (subsidies and transfers for electricity and transport, and public sector wage bonuses) and 62 percent to for-profit projects.
  - In-kind repayments allowed only through ALBALINISA exports to Venezuela (primary products like cattle, beef, sugar, coffee, and beans).

### Annex I — External Sustainability, Competitiveness, Reserves, and DSA key findings
- Exchange rate and competitiveness:
  - CGER-based methodologies suggest the exchange rate is overvalued by about 4.9 percent (simple average of three CGER-based methodologies).
  - Range of CGER estimates: between 1.8 percent and 7.8 percent.
  - Medium-term external current account deficit projected to decline as energy matrix changes reduce oil import dependence, but remain large at about 12 percent of GDP (on average in 2014–18).
- Net International Investment Position:
  - Net IIP as of end-2012: -123.7 percent of GDP.
- Reserve adequacy:
  - Gross international reserves expected to reach US$2.0 billion or equivalent to 3.5 months of imports (excluding maquila) and 110 percent of broad money by end-2013.
  - IMF 2011 Optimal Reserve Metric for Low-Income Countries: optimal reserve stood at 3.2 months of imports (excluding maquila).
- Debt Sustainability Analysis — key messages:
  - Risk of external public debt distress remains moderate.
  - Present value debt ratios have declined following recent reform of the discount rate.
  - Need to continue borrowing mostly on concessional terms and build fiscal buffers over the next decade; reduce oil dependency; continue debt relief negotiations; remain alert to contingent liability risks.
- DSA assumptions and projections:
  - Growth slows from 5.2 percent in 2012 to potential rate of 4 percent by 2014.
  - Baseline assumes pension reform implemented in 2013; without it social security deficits emerge by 2015, reaching about 1-1.5 percent of GDP by 2023 and nearly 3.5 percent of GDP by 2033.
  - Capital expenditures programmed to increase about 1½ percent of GDP relative to 2012.
  - PV of the PPG external public debt-to-GDP (plus remittances) ratio declines from 22½ percent in 2013 to 12 percent by 2033.
  - PV of total public debt-to-GDP projected to decline to 20.4 percent of GDP by 2033 (from 34.4 percent in 2013).
- Stress tests and scenarios:
  - Under current discount rate (5 percent), standard alternative scenarios and stress tests do not breach policy-dependent indicative thresholds.
  - Exchange rate depreciation stress test: standardized one-time 30 percent nominal depreciation in 2014 increases PV public debt-to-GDP from 34 percent in 2013 to 47 percent in 2014.
  - Contingent liability scenario (absorption of private external debt by public sector) would raise PV public external debt-to-GDP to 41.7 percent in 2014 (compared to 24.6 percent baseline) and public debt-to-GDP to 67.8 percent in 2014 (compared to 40.6 percent baseline), breaching indicative thresholds.
- Private external debt:
  - Private external debt rose from 22 percent of GDP in 2007 to 42 percent of GDP in 2012.
  - Under DSA assumptions ALBA-related flows decline smoothly through 2033; private external debt projected to peak in 2020 at about 56 percent of GDP (in PV terms) and decline thereafter.
  - Venezuela represents 94 percent of Nicaragua’s FOB oil imports; 50 percent of this oil bill is financed with the loan terms noted above (25 years, 2-year grace, 2% interest), implying a grant element of 37 percent at a 5 percent discount rate.
- Selected quantitative indicators and facts cited:
  - Oil-collaboration scheme deposits: about 8 percent of total deposits.
  - Contingency credit line secured in 2013: US$200 million with the Central American Bank for Economic Integration.
  - At end-2012, debt to non-Paris Club creditors still subject to relief: US$1.5 billion (14 ½ percent of GDP).
  - Total factor productivity growth, 2001–11 average: -0.2 percent of GDP per year.
  - Electricity sector subsidies: about 1½ percent of GDP.
  - Nominal GDP adjustment from base-year change: upward by about 30 percent.

### Fiscal projections, policy prescriptions, and operational recommendations
- Fiscal projections and assumptions:
  - Primary deficits (after grants) expected to average less than ½ percent of GDP in the first 10 years of the projection period and about ¼ percent of GDP in the following 10 years.
  - Issuance of BPIs expected at US$21 million annually through 2018.
- Policy recommendations:
  - Maintain fiscal discipline; support 2014 draft budget stance (incorporating wage bonus) while strengthening fiscal buffers and lowering public debt ratios.
  - Broaden the revenue base by fully implementing 2012 tax reform and rationalizing public expenditures.
  - Reform the pension system to ensure financial viability while reinforcing the social safety net.
  - Continue efforts to conclude debt relief negotiations with non-Paris Club official creditors and encourage participation in the HIPC Initiative.
  - Monetary policy to contain inflation, keep real exchange rate broadly in line with fundamentals, and maintain reserves above benchmarks.
  - Closely monitor rapid private sector credit growth; strengthen bank supervision and recapitalize the central bank.
  - Advance structural reforms to lower informality, improve education/training, reduce oil dependence, and strengthen private investment and infrastructure.
  - Increase transparency and full disclosure of oil import financing agreement with Venezuela; develop contingency plans for external vulnerabilities.
- Operational recommendation:
  - Staff recommends the next Article IV Consultation take place on the standard 12-month cycle.

*Source: IMF staff report (contents of _cr13377).*

### 1.   Implementation of Past IMF Policy Advice ___________________________________________________  13

### 1.   Implementation of Past IMF Policy Advice

### Background
- Since the global financial crisis Nicaragua has made significant progress toward restoring sustainable growth, consolidating the fiscal position, and keeping inflation under control.
- Main drivers of progress: sustaining prudent policies amid the global financial crisis, commodity price shocks, and natural disasters.
- Remaining challenges: second lowest per capita income in the Western Hemisphere and poor other social indicators; need for higher growth to reduce poverty while addressing fiscal and external vulnerabilities.
- Government medium-term economic strategy aims at achieving equitable growth, financial stability, and poverty reduction (Programa Economico-Financiero 2013-16).
- Strategy balances an ambitious investment and social spending agenda with fiscal sustainability; plans to reduce fiscal and external vulnerabilities by lowering public debt ratios and lessening dependence on oil imports.
- Political cycle note: general elections in 2016 provides space to implement new structural reforms with broad consultations.

### Structural and investment developments
- Private investment has increased in wind, geothermal, and biomass electricity generation, largely eliminating blackouts and improving system stability.
- New energy projects expected to be completed by 2018 would further boost electricity production without significantly increasing oil imports.
- Government signed concession for an inter-oceanic canal; tentative estimated value nearly 4 times the 2012 GDP. Feasibility studies expected to be completed in 2014; costs expected to be incurred by the foreign investor.
- Improvements to national accounts methodology and data resulted in an upward adjustment of nominal GDP of about 30 percent.
  - Per capita GDP for 2012 is now estimated at US$1,762 (US$1,313 before the change).
  - Revision uses improved source surveys, statistical procedures, and a new base year (2006).
  - Fiscal and external sector ratios to GDP are significantly lower than reported in the 2012 Article IV consultation report.

### Recent economic developments (A)
- Real GDP growth:
  - 2012: 5.2 percent.
  - First half of 2013: 5 percent (yoy).
- Inflation:
  - Headline inflation increased to 7.4 percent (yoy) in September 2013.
  - Core inflation at 5.9 percent.
- Fiscal:
  - Combined public sector deficit: 0.7 percent of GDP in 2012.
  - Deficit expected to widen to 1.4 percent of GDP in 2013 largely due to rising capital expenditure in public enterprises.
  - Public debt ratio projected to decline to about 42 percent of GDP in 2013 (from 45 percent of GDP in 2011).
- Financial sector:
  - Domestic credit by August 2013 increased by about 23 percent (yoy); 2012 annual increase was 26 percent.
  - Consumer sector credit expansion: 43 percent.
  - Deposits increased by nearly 10 percent.
  - Capital adequacy ratio of the banking system as of August 2013: 13 percent (regulatory norm: 10 percent; peak in 2010: 16.6 percent).
- External sector:
  - Current account deficit for 2011–13 estimated around 13 percent of GDP.
  - External private and public debt projected about 74 percent of GDP at end-2013.
  - First half of 2013: maquila net exports increased by 6.5 percent.
  - By August 2013, remittances increased by 7.3 percent (yoy).
  - As of end-October 2013, gross international reserves: US$1.9 billion, or equivalent to 3½ months of imports (broadly unchanged from end-2012).
- Structural reforms:
  - Tax reform approved December 2012 eliminated VAT exemptions on some items consumed by higher income households, changed personal income tax thresholds, and included a plan for further rationalization of tax exemptions over the medium term.
    - Estimated revenue impact in 2013: 0.2 percent of GDP.
  - Electricity tariffs increased by 12.8 percent in April 2013, narrowing the gap between indicative and actual tariffs to 3 percent.
  - Regulatory changes enabled anti-theft measures to be strengthened.

### Outlook and risks (B)
- Baseline projections under current policies:
  - Growth projected to decline to 4.2 percent in 2013 (from 5.2 percent in 2012), then converge to long-term trend of 4 percent.
  - Inflation projected to increase to 6.9 percent by end-2013 (compared to 6.6 percent at end-2012), consistent with the 5 percent rate of crawl of the exchange rate and international prices.
  - External current account deficit projected to widen marginally to 13.2 percent of GDP in 2013, then contract to about 11 percent of GDP over the medium term.
- Key downside risks:
  - Slower than expected economic recovery in the United States and Europe.
  - Higher oil prices.
  - Unanticipated changes to terms or levels in the oil collaboration scheme with Venezuela could generate additional pressures on the external position.
- Authorities agreed with staff that:
  - Prudent fiscal policies needed to be sustained to reduce vulnerabilities.
  - Large external current account deficits are a key medium-term vulnerability, reflecting high oil import dependency (12 percent of GDP) and reliance on financing from Venezuela.
  - External inflows including FDI and official sources, as well as the oil collaboration scheme with Venezuela, were considered sufficiently stable to finance deficits and maintain reserves buffers.
  - High dollarization and rapid increase in private credit could pose risks.

### Policy discussions — Fiscal policies (A)
- General stance:
  - Present policy stance broadly appropriate; with the output gap closing no policy change needed for 2014.
  - Maintaining present deficit level consistent with further lowering public debt ratios over the medium term.
  - Draft 2014 budget submitted in October features revenues rising as a ratio of GDP and deficit of combined public sector broadly unchanged at 1.2 percent of GDP.
- Specific fiscal measures and targets:
  - Budget to begin incorporating in 2014 the wage bonus (0.4 percent of GDP), previously funded with grants from a private entity (CARUNA) originating from oil collaboration with Venezuela, without increasing deficits by restraining other current expenditure and using higher tax revenues.
  - Combined public sector deficits need to remain at about 1-1 ½ percent of GDP to reduce public debt ratios, consistent with the Debt Sustainability Analysis.
  - To strengthen fiscal sustainability: strengthen revenue performance, reform the pension system, and rationalize expenditures.
    - Authorities intend to fully implement the tax reform approved in December 2012.
    - Pension reform proposal includes step increases in employers’ contributions, modification of benefits eligibility to ensure financial viability over the next 15 years, a program of reduced pensions for certain retirees, and resolution of government debt to the social security system.
  - Electricity and other subsidies need rationalization through better targeting; financial position of public enterprises to be strengthened to avoid intra-sector arrears.
  - Authorities agreed to review system of energy and other subsidies; key law on electricity subsidies to be updated by 2015.
- Transparency:
  - Staff supported increasing transparency of public sector operations.
  - Noted economic cooperation with Venezuela had financed flows about 7¼ percent of GDP in 2012, managed through a private entity; stock of associated debt reached 21 percent of GDP at end-2012.
  - Staff welcomed increase in electricity tariffs and argued for more transparency in energy subsidies provided through VAT refunds and extra-budgetary channels.
  - Authorities committed to continue expanding provision of information on international cooperation.

### Policy discussions — Monetary and external sector policies (B)
- Monetary policy stance:
  - Given high dollarization and rigidity of exchange regime, monetary policy appropriately focuses on the external position; central bank operations anchored by objectives for stock of international reserves.
  - Staff supported authorities’ objective to increase gross international reserves and maintain them above the equivalent of three months of imports.
- Exchange rate regime:
  - Authorities view crawling peg as beneficial for anchoring inflation expectations and maintaining broad financial stability.
  - Staff noted the present rate of crawl (5 percent) has set a relatively high floor for domestic inflation (domestic inflation generally higher than regional peers) and may contribute to rising dollarization.
  - Authorities agreed with staff assessment and would welcome technical assistance to develop a long-term strategy to reduce incentives for dollarization and explore alternative exchange rate regime options.
- External vulnerabilities and contingency planning:
  - Authorities acknowledged considerable external vulnerabilities but noted no significant misalignment of the exchange rate (Annex 1) and reserves above benchmarks.
  - Recognized risks: large external current account deficits, oil import dependency, high external debt, exposure to changes in oil collaboration with Venezuela.
  - Authorities considered probability of these risks low but agreed on the merit of developing a contingency plan to deal with external shocks (including additional financing and measures to compress expenditure).
  - Committed to continue negotiations to complete bilateral debt reduction agreements with non-Paris Club creditors.

*Source: IMF staff report excerpt titled "1.   Implementation of Past IMF Policy Advice."*

### 20.      Staff recommended close monitoring of commercial bank credit to the private sector.

### _cr13377 - 20.      Staff recommended close monitoring of commercial bank credit to the private sector.

### Banking sector risks and monitoring
- Staff recommended close monitoring of commercial bank credit to the private sector, highlighting risks from a rapid expansion in the banking system’s exposure to the private sector in the context of high dollarization, particularly in the consumer loan sector.
- Staff cautioned that this rapid expansion could pose risks and urged:
  - Close monitoring of banks' foreign exchange positions.
  - Close monitoring of credit quality.
  - Stress tests based on exchange rate and other shocks.
- Authorities’ position:
  - Broadly concurred with staff’s assessment.
  - Noted the recent credit expansion represented a rebound from the contraction after the global recession and was slowing in the course of the year.
  - Pointed to relatively strong capital adequacy indicators and the stability of deposits, including those linked to the oil-collaboration scheme with Venezuela (about 8 percent of total deposits).
  - Agreed that increased vigilance over credit quality and stress tests were warranted.
  - Committed to strengthen the supervision framework based on evaluation of risks.
  - Committed to continue providing transfers to the central bank to reduce its operational losses; staff supported this intention.
- Additional recommendations and actions:
  - Staff supports the authorities’ commitment to continue recapitalizing the central bank.
  - Staff encouraged the authorities to improve the AML/CFT framework in line with the action plan agreed with the Financial Action Task Force to address remaining strategic deficiencies.

### Structural reforms to boost medium-term growth
- Shared diagnosis:
  - Achieving higher growth over the medium term requires substantial investments in infrastructure and significant progress in reforming labor and product markets and education.
  - Nicaragua needs a broad program of structural reforms to boost annual output growth to about 5–6 percent to significantly raise income levels and reduce poverty.
  - Indicators suggest Nicaragua is behind peers in key governance and doing business indicators and there are significant inefficiencies; total factor productivity growth averaged negative -0.2 percent of GDP per year during 2001–11.
- Key reform areas and staff recommendations:
  - Electricity sector:
    - Nicaragua is highly dependent on oil imports (12 percent of GDP), a key input to electricity generation.
    - Large distribution losses, consumer subsidies, and below-cost tariff require subsidies to the electricity sector of about 1½ percent of GDP.
    - Authorities’ strategy: expand access to electricity nationwide, reduce distribution losses, and lower electricity costs by shifting generation toward renewable energy sources.
    - Expected outcomes: efficiency gains and cost reductions, in part due to falling oil prices, would help eliminate the electricity tariff gap; review tariff policy in view of social objectives and public resource availability.
    - Staff recommended targeting electricity subsidies to the lowest income groups and providing them through a mechanism that is transparent and insulates the budget from shocks to international prices.
    - Staff recommended strengthening the financial position of public enterprises and avoiding intra-public sector arrears.
    - Staff welcomed increased provision to the public of information on international cooperation and recommended dissemination of full information on financial flows and economic benefits of oil collaboration with Venezuela.
  - Labor and product markets and education:
    - High informality inhibits integration of small firms into the formal sector and limits incentives for business expansion and productivity improvements.
    - Low education levels constrain growth in higher productivity areas.
    - Recommended measures: reduce incentives to informality (ease access to social security schemes, simplify tax filing, improve business licensing procedures) and better match education system skills with labor market demand.
  - Public finances and fiscal strategy:
    - Sustained fiscal consolidation should be the main anchor of macroeconomic strategy.
    - Draft budget for 2014 appropriately maintains the fiscal stance of the current year; incorporation of the wage bonus (“bono solidario”) financed by rising revenue yields and adjustments in other expenditures is welcomed.
    - Staff supports the medium-term objective to lower public debt ratios to gain fiscal space for shocks and countercyclical policy.
    - Recommended to broaden the revenue base by fully implementing elimination of tax exemptions envisaged in the 2012 reform, rationalize public expenditures, and reform the pension system to ensure financial viability.
    - Recommended renewed efforts to conclude negotiations on public debt reduction with remaining non-Paris Club official creditors.
  - Infrastructure and private investment:
    - Staff welcomed authorities’ intention to mobilize infrastructure investments and advance structural reform agenda to boost productive capacity.
    - Recommended reforms to rationalize public spending and strengthen the framework for private investment.

### Other vulnerabilities, outlook, and policy mix
- Staff appraisal and risks:
  - Nicaragua’s recent macroeconomic performance has been favorable; authorities deserve credit for fiscal discipline and prudent monetary management.
  - Economy faces vulnerabilities from high public and private debt and exposure to external shocks.
  - Near-term risks considered moderate under staff’s baseline projections; growth expected to slow to long-term trend and inflation to remain anchored by the exchange rate crawling peg regime.
  - External risks include slower-than-expected recoveries in the United States and Europe, higher oil prices, and potential changes to the oil collaboration scheme with Venezuela.
- External and monetary policy recommendations:
  - Reduce external vulnerabilities by diversifying the generation matrix away from oil imports.
  - Develop contingency plans to address vulnerabilities from high oil imports and potential volatility in financing large external current account deficits.
  - Monetary policy should keep inflation under control to maintain a real exchange rate broadly in line with fundamentals and ensure international reserves coverage stays above international benchmarks.
- Fiscal transparency and data:
  - Staff welcomes commitment to rationalize public expenditure and increase transparency of public sector operations.
  - Recommended reform of subsidy policies in electricity and other sectors; targeted, transparent subsidy mechanisms to insulate the budget from international price shocks.
  - Data provided to the Fund are broadly adequate for surveillance; recent revision to national accounts improved reporting on real sector developments.
  - Coverage and timelines of public financial accounts could be further improved; incompatible methodologies in compiling budgetary data from “above” and “below” the line contribute to delays in reconciled revenue, expenditure, and financing accounts.
- Operational recommendation:
  - Staff recommends that the next Article IV Consultation take place on the standard 12-month cycle.

### Selected quantitative indicators and facts cited
- Oil-collaboration scheme deposits: about 8 percent of total deposits.
- Contingency credit line secured in 2013: US$200 million with the Central American Bank for Economic Integration.
- At end-2012, debt to non-Paris Club creditors still subject to relief: US$1.5 billion (14 ½ percent of GDP).
- Target medium-term annual output growth to raise incomes and reduce poverty: about 5–6 percent.
- Total factor productivity growth, 2001–11 average: -0.2 percent of GDP per year.
- Oil imports dependency: 12 percent of GDP.
- Electricity sector subsidies: about 1½ percent of GDP.
- GDP per capita after new national accounts (2012): US$1,762 (US$1,313 before the change).
- Nominal GDP adjustment from base-year change: upward by about 30 percent.

*Source: IMF staff report (contents of _cr13377).*

### Box 3.  Nicaragua: Oil Collaboration with Venezuela

### Box 3.  Nicaragua: Oil Collaboration with Venezuela

### Overview and genesis
- Nicaragua’s oil collaboration with Venezuela was agreed by Presidents Ortega and Chavez in April 2007.
- The collaboration is based on a broad framework for oil import-related financing as well as other financing (e.g., FDI) and debt servicing schemes (through in-kind repayments).

### Institutional participants and roles
- PDVSA: Venezuelan state-owned oil company; Venezuela’s representative under the agreement. It supplies petroleum and is a financial agent for FDI and other arrangements in Nicaragua.
- ALBANISA (ALBA de Nicaragua): Created in 2008; ownership: PDVSA (51 percent) and PETRONIC (a Nicaraguan state-owned company; 49 percent). ALBANISA imports oil from PDVSA and sells it in Nicaragua at market prices. It also serves as Venezuela’s agent in FDI in various sectors in Nicaragua’s economy.
- CARUNA (Caja Rural Nacional): A privately owned Nicaraguan financial cooperative that receives on behalf of PDVSA 50 percent of the oil bill (FOB) in the form of a long-term loan.
- ALBALINISA (ALBA Alimentos de Nicaragua): A joint venture between ALBANISA and PDVSA (75% Albanisa, 25% PDVSA) that purchases primary products from domestic private firms and re-sells these to retail chains in Venezuela; it is the sole route for in-kind repayments.

### Mechanics of the scheme
- Under the agreement, 100 percent of the oil bill is paid by ALBANISA to PDVSA within 90 days.
- On behalf of PDVSA, 50 percent of the oil bill (FOB) is then transferred to CARUNA in the form of a long-term loan with the following exact terms:
  - payable over 25 years
  - with a 2-year grace period
  - 2 percent interest
  - grant element of 30 percent
- Payments to PDVSA for oil or the debt service on oil financing can be made in-cash or in-kind.
  - In-kind repayments can take place only through exports of goods by ALBALINISA to Venezuela.
  - ALBALINISA purchases primary products (e.g., cattle, beef, sugar, coffee, and beans) from domestic private firms and re-sells these to retail chains in Venezuela.

### Allocation and use of funds from CARUNA
- Under the oil collaboration scheme, 38 percent of the funds received by CARUNA are used for quasi-fiscal operations (examples provided: subsidies and transfers for electricity and transport, and public sector wage bonuses).
- The remaining 62 percent is used to finance for-profit projects.

### Flow summary (as presented)
- Oil imports from PDVSA → ALBANISA.
- ALBANISA pays 100 percent of oil bill to PDVSA within 90 days.
- PDVSA (on whose behalf) transfers 50 percent of the oil bill (FOB) to CARUNA as a loan (25-yrs, 2-yrs grace, 2% interest, grant element of 30%).
- CARUNA allocates:
  - 38% → social programs (quasi-fiscal operations)
  - 62% → for-profit projects (private sector)
- In-kind repayment channel: ALBALINISA (75% Albanisa / 25% PDVSA) exports goods (examples: beef, sugar, coffee, cattle) to Venezuela, enabling in-kind loan repayment.

*Source: IMF staff presentation in Box 3. Nicaragua: Oil Collaboration with Venezuela.*

### ANNEX I. Nicaragua: External Sustainability and External

### ANNEX I. Nicaragua: External Sustainability and External Competitiveness Assessment

### I. Exchange Rate and Competitiveness — Summary Findings
- CGER-based methodologies (macroeconomic balance, external sustainability, ERER) suggest the exchange rate is overvalued by about 4.9 percent (simple average of the three CGER-based methodologies).
- Range of CGER estimates: between 1.8 percent and 7.8 percent.
- Methodological uncertainties and sensitivity to staff macroframework and estimates of trade elasticities are noted.
- Other indicators: export market shares have moderately improved; weak business environment, governance and corruption perceptions continue to weigh on external competitiveness.
- Medium-term external current account deficit is projected to decline as changing energy matrix reduces oil import dependence, but will remain large at about 12 percent of GDP (on average in 2014–18).
- Persistent vulnerability from external current account deficits and associated external financing needs is expected to remain.

### I.A. CGER Assessment — Detailed Results
- Historical context:
  - Average external current account deficits during 2003–12: about 14.3 percent of GDP.
  - Current account deficit for 2013 expected to widen to 13.2 percent of GDP, from 12.9 percent of GDP in 2012, due to lower external demand, continued FDI-related imports, and temporary import of machinery for the energy sector.
  - Key drivers of the current account deficit: FDI, fiscal balances, global spillovers via remittances and exports, oil imports, and real growth.

- Macroeconomic balance approach:
  - Current account norm for Nicaragua estimated at -10.5 percent of GDP considering projected medium-term fundamentals through 2018.
  - Underlying current deficit after adjusting for temporary factors (temporary import of machinery for energy sector estimated at 0.4 percent of GDP) is estimated at 11.6 of GDP.
  - Comparison of norm and underlying current account using elasticities yields an overvaluation estimate of 5.2 percent.

- External sustainability approach:
  - Net International Investment Position as of end-2012: -123.7 percent of GDP.
  - External current account deficit of 9.9 percent would stabilize the net IIP.
  - Given the underlying current account deficit of 11.6 percent of GDP, resulting overvaluation estimated at 7.8 percent.

- Equilibrium real exchange rate approach (ERER):
  - ERER estimated as function of terms of trade, government consumption, relative productivity (computed as GDP per working population), and remittance and FDI inflows.
  - ERER approach suggests a modest overvaluation of 1.8 percent.

### I.B. Other Assessment — Competitiveness Indicators
- Market share and exports:
  - Moderate increase in exports volume and in the share of exports in trading partners’ non-oil imports since 2009.
  - Net maquila trade and manufacturing exports increased market shares.

- Business environment, governance, and global competitiveness:
  - World Bank Doing Business Indicators: Nicaragua continues to rank lowest among its regional peers.
  - Relative weaknesses identified: regulatory processes, paying taxes, starting a business, construction permits, and perceived corruption.
  - Favorable factors: personal safety and low business costs of crime and violence relative to regional peers.
  - Global competitiveness index shows similar results.
- Caution: Doing Business indicators should be interpreted with caution due to limited number of respondents, limited geographical coverage, and standardized assumptions.

### II. International Investment Position
- Net IIP deterioration:
  - Net international investment position deteriorated from -95 percent of GDP in 2007 to -124 percent of GDP in 2012.
  - Deterioration driven largely by rapid increase in liabilities; asset position improved marginally.

- Reserve-related and balance metrics presented in figures (no numeric extraction beyond IIP percent figures in text).

### III. Reserve Adequacy
- Gross international reserves expected to reach US$2.0 billion or equivalent to 3.5 months of imports (excluding maquila) and 110 percent of broad money by end-2013 (based on preliminary information).
- Reserves adequacy based on traditional measures:
  - Reserves projected to be above benchmarks such as broad money, short-term debt, and three months of imports (excluding maquila).
  - Using the risk-weighted measure, reserves are expected to stay above the adequacy threshold of 100–150 over the medium-term.
- IMF 2011 Optimal Reserve Metric for Low-Income Countries: optimal reserve stood at 3.2 months of imports (excluding maquila).

### Debt Sustainability Analysis (DSA) — Key Messages and Recommendations
- IMF and World Bank 2013 DSA indicates Nicaragua’s risk of external public debt distress remains moderate.
- Present value debt ratios have declined following the recent reform of the discount rate; an alternative scenario points to vulnerabilities from contingent liabilities (e.g., if private debt is taken over by the public sector).
- Public debt assessment:
  - Debt levels are high, but debt dynamics are sustainable, subject to contingent liability risks.
- DSA underscores the need to:
  - Continue borrowing mostly on concessional terms.
  - Build up fiscal buffers over the next decade to lower debt ratios and strengthen capacity to respond to shocks.
  - Reduce oil dependency.
  - Continue efforts to conclude ongoing debt relief negotiations.
  - Remain alert to contingent liability risks.

### DSA Background, Changes Since 2010, and Classification
- This is the third joint Bank-Fund DSA for Nicaragua under the LIC Debt Sustainability Framework since 2007.
- Four changes included relative to the 2010 DSA:
  - Nominal GDP revised upwards by about 30 percent due to new national accounts data (base year 2006).
  - Nicaragua reclassified in 2011 as a medium performer (instead of a strong performer) based on its 3–year average CPIA rating; current 3–year average (2010–12) CPIA rating is 3.68.
  - Discount rate revised upward from 4 percent (in the 2010 DSA) to 5 percent (3 percent in the 2011 DSA) following a Board decision.
  - This DSA includes remittances in the baseline scenario (Nicaragua is considered a large remittances country given remittances-to-GDP of 10.3 percent and remittances-to-exports of goods and services of 26.6 percent during 2003–12).

### Debt Portfolio — Current Structure and Developments
- Public and publicly-guaranteed (PPG) external debt ratios have declined since earlier relief and restructurings, but external debt relief negotiations have progressed slowly.
- At end-2012:
  - Debt to non-Paris Club bilateral creditors still subject to relief: US$1.5 billion (equivalent to 14½ percent of GDP and 35 percent of total outstanding external debt). This excludes Taiwan, which is in the process of being resolved.
  - Of ten countries holding claims still subject to relief, only Taiwan receives debt-service payments as that debt was incurred after the cutoff date and an agreement has recently been reached.
  - Bilateral and multilateral debt relief from Spain, Slovak Republic, FIDA, and Nordic Funds totaling US$32 million granted since the 2010 DSA.
  - Nicaragua’s PPG external debt (including debt still subject to relief) is almost equally divided between the central government and the central bank. Most PPG external debt is owed to multilateral institutions or to non-Paris Club official creditors.
- Domestic debt:
  - Ratio of domestic debt fell from 29 percent of GDP in 2002–03 to about 11 percent in 2012, reflecting debt buyback operations.
  - Most domestic debt is indexed to the U.S. dollar but serviced in córdobas.
  - Property settlement bonds (BPIs) are the largest component of domestic debt; BPIs represent 49 percent of total domestic debt and their stock fell from 15 to 5 percent of GDP between 2005 and 2012.
  - New issues of BPIs averaged US$75 million in 2003–06 and were down to US$21 million in 2012.

- Private external debt and ALBA:
  - Private external debt rose from 22 percent of GDP in 2007 to 42 percent of GDP in 2012.
  - A large share of this rise is due to the ALBA oil collaboration.

### Macroeconomic Assumptions Underlying the DSA Baseline
- Growth assumptions:
  - Growth slows from 5.2 percent in 2012 to potential rate of 4 percent by 2014 (same medium-term growth assumption as 2010 DSA).
  - Projections assume continuation of prudent macroeconomic management and reforms supporting the change in the electricity generation matrix.
  - Non-interest external current account is programmed to improve in the first 10 years of the projection period (2013–22) broadly in line with a relative decline in the oil bill.

- External assumptions:
  - Relative decline in dependence on oil imports and a lower (non-interest) external current account deficit reflecting programmed non-fossil electricity generation projects. No significant changes in external imbalances assumed after 2023 (more conservative than 2010 DSA).
  - Export-to-GDP ratios remain broadly stable at about 50–53 percent of GDP.
  - Import-to-GDP ratios decline mildly from 73 percent to 68 percent in 2013–33, largely reflecting declining oil import dependence and lower FDI.
  - Completion of negotiations with non-Paris Club bilateral creditors on HIPC-equivalent terms assumed, generating debt relief of 9.4 percent of GDP (in stock terms as of end-2012 or US$983 million). Most of this debt is currently not serviced.
  - Net official external assistance expected to decline from 10 percent of GDP (average 2007–12) to about 3 percent for 2027–33; exposure to multilateral development banks projected to grow.
  - FDI assumed to remain about 1¼ percent of GDP below the level recorded in 2010–12 as recent foreign investment in the energy sector is expected to decline (projected levels are also below those in 2010 DSA by about 1½-2 percent of GDP).
  - ALBA-related flows assumed to decline smoothly through 2033; ALBA oil collaboration assumed to continue to be channeled through the private sector.

*Source: ANNEX I. Nicaragua: External Sustainability and External Competitiveness Assessment (IMF staff report excerpts).*

### 9.      On the fiscal side, the baseline scenario assumes that:

### 9.      On the fiscal side, the baseline scenario assumes that:

### Fiscal assumptions and projections
- Fiscal management remains prudent, consistent with achievements since 2010.
- Primary deficits (after grants) are expected to average less than ½ percent of GDP in the first 10 years of the projection period (this is broadly similar to the level observed in 2010–12) and about ¼ percent of GDP in the following 10 years.
- The baseline assumes a pension reform is implemented in 2013, which is key to keeping debt sustainable. In the absence of such a reform:
  - the social security system would begin incurring deficits by 2015;
  - deficits would reach about 1-1.5 percent of GDP by 2023;
  - deficits could rise to nearly 3.5 percent of GDP by 2033.
- Capital expenditures are programmed to increase over the medium-term by about 1½ percent of GDP relative to their 2012 level reflecting increased investment in infrastructure.
- Issuance of BPIs is expected to remain at the level observed in 2012 through 2018, in line with the annual projection in the 2010 DSA (US$21 million).

### External public debt sustainability — Baseline scenario (with remittances)
- All present value (PV) external debt stock indicators remain below policy dependent indicative thresholds and are expected to decline over the 20–year projection period.
- PV of the PPG external public debt-to-GDP (plus remittances) ratio:
  - declines from 22½ percent in 2013 to 12 percent by 2033.
  - This is well below the 36 percent threshold.
- PV of external public debt as a share of exports (plus remittances) remains below indicative thresholds throughout the projection period, reflecting Nicaragua’s relative openness.
- Projected PPG external debt service ratios:
  - projected to average 2 percent of exports plus remittances (or about 5 percent of revenues) during 2013–17.
  - This reflects strong fiscal performance and relatively high concessionality of existing and new public external debt, despite assumed small erosion in concessionality terms of new borrowing.

### Alternative scenarios and stress tests (external)
- Under the current discount rate policy (set at 5 percent), none of the standard alternative scenarios and stress tests breach the policy dependent indicative thresholds.
- Historical scenario:
  - PV of the PPG external-debt-to-GDP ratio is projected to grow but would remain by 2033 below the policy dependent threshold.
- Non concessional financing scenario:
  - assumes interest through 2033 is 2 percentage points higher than in the baseline;
  - all debt ratios deteriorate but stay below the threshold.
- Exchange rate depreciation stress test:
  - standardized one-time 30 percent nominal depreciation in 2014;
  - all debt ratios deteriorate but stay below the indicative thresholds.
- Scenario without remittances:
  - average remittances during 2008–12 were the equivalent of 10 percent GDP and 23 percent exports of goods and services;
  - results without remittances point to conclusions similar to the baseline with remittances.

### Private external debt
- The PV of private external debt is well above the indicative thresholds used for public external debt.
- DSA projections assume:
  - the ALBA oil collaboration continues through 2033;
  - these resources continue to be channeled to the private sector with financial terms similar to current terms;
  - Venezuela-related oil bills will decline in relative terms as savings from renewable energy sources materialize.
- Under these assumptions, private external debt:
  - is projected to peak in 2020 at about 56 percent of GDP (in PV terms) and decline steadily thereafter.
- Notes on composition and terms:
  - Venezuela represents 94 percent of Nicaragua’s FOB oil imports;
  - 50 percent of this oil bill is financed with a loan that has a maturity of 25 years, a grace period of 2 years, and an interest rate of 2 percent;
  - this implies the equivalent of a grant element of 37 percent when using a discount rate of 5 percent.

### Public debt sustainability — baseline and stresses
- Total public debt ratios are high but continue to decline under the baseline (with remittances).
- PV of total public debt-to-GDP:
  - projected to decline to 20.4 percent of GDP by 2033 (from 34.4 percent in 2013).
- Total public debt-service-to-revenue ratios:
  - expected to decline from 13.0 to 4.8 percent between 2013 and 2033.
- Availability of concessional external financing limits reliance on domestic debt; projection assumes level of dollarization does not change.
- Exchange rate shock stress test:
  - a 30 percent depreciation would increase the PV of public debt-to-GDP ratio from 34 percent in 2013 to 47 percent in 2014 and decline only gradually thereafter;
  - total public debt ratios-to-revenues would increase from 126 percent (in PV terms) to 175 percent.
- Contingent liabilities (e.g., property confiscations and social security deficits) add to public debt vulnerabilities.

### Alternative scenario: absorption of private debt by public sector
- Scenario assumptions:
  - nearly two thirds of private external debt are assumed by the public sector in 2014;
  - no additional debt will be generated from future oil imports;
  - concessional terms apply to this new public debt (specifically, 1.8 percent interest rate, 5 years grace period, 30 years maturity; at 5 percent discount rate, this yields 36 percent grant element).
- Impact of this contingent liability scenario:
  - PV of public external debt-to-GDP ratio would rise to 41.7 percent in 2014 (compared to 24.6 percent under the baseline).
  - Public debt-to-GDP ratio would rise to 67.8 percent in 2014 (compared to 40.6 percent under the baseline).
  - In both cases, the indicative thresholds for the PV of debt-to-GDP ratios would be breached.

### Other stress tests (public)
- Other stress tests show, with few exceptions, only temporary deterioration in debt and debt-service ratios. These include:
  - a 10 percent of GDP increase in other debt-creating flows in 2013;
  - GDP growth at its historical average minus one standard deviation in 2013–14;
  - a scenario combining the latter with a primary balance at its historical average minus one standard deviation in 2013–14.
- The most concerning stress test is the depreciation shock; it takes about a decade to recover from such a shock. In all cases, PV ratios remain below their thresholds except when private debt is absorbed by the public sector as noted above.

### Debt distress classification and conclusions
- Staff view: Nicaragua should be considered at moderate risk of external debt distress.
- DSA on public debt: public debt is high, but debt dynamics are sustainable under baseline assumptions.
- Assessment assumes continuation of prudent macroeconomic management and the electricity generation transformation.
- Rapid increase in private external debt (including debt from the oil collaboration with Venezuela) requires continuous monitoring and the government’s continued commitment not to extend public guarantees on this debt.

### Authorities’ response and requests
- The authorities concurred with the thrust of the analysis, findings, and key conclusions.
- They agreed on the need to keep pace of key reforms, including the social security reform.
- They recognized the imperative to continue efforts to conclude ongoing negotiations with non-Paris Club creditors under the HIPC Initiative.
- The authorities requested support of the IMF and the World Bank in encouraging creditors who had not yet reached agreement on debt relief for Nicaragua to participate in the Initiative.
- The authorities noted they had obtained similar results in their own DSA and requested that staff share the final detailed DSA output.

*Source: _cr13377 - 9.      On the fiscal side, the baseline scenario assumes that:*

### conclusions of the 2013 DSA are similar to those presented in the 2010 DSA; the 2013 DSA also benefits from the

### _cr13377 - conclusions of the 2013 DSA are similar to those presented in the 2010 DSA; the 2013 DSA also benefits from the

### Debt sustainability findings (external and public)
- Conclusions of the 2013 DSA are similar to those presented in the 2010 DSA and benefit from the recent change in the discount rate.
- PV of external debt (selected projection points): 66.2, 67.9, 70.3, 72.4, 74.0, 75.2, 75.9, 72.5, 64.4 (values as presented in the table).
- PV of PPG external debt (percent of exports): 24.6, 24.7, 24.6, 24.7, 24.7, 24.2, 23.7, 21.0, 13.6 (values as presented).
- PV of PPG external debt (in Millions of U.S. dollars): 2,520; 2,713; 2,869; 3,046; 3,220; 3,362; 3,492; 4,133; 4,731 (selected table entries).
- PV of PPG external debt (in percent of GDP + remittances): 22.6, 22.6, 22.5, 22.5, 22.4, 22.1, 21.7, 19.2, 12.5 (values as presented).
- Debt service-to-exports ratio (in percent, selected historical/projection values): 17.3; 16.1; 12.4; 13.2; 14.2; 14.9; 15.2; 16.4; 14.6; 14.8; 11.9 (table entries).
- PPG debt service-to-exports ratio (in percent, selected): 4.1; 2.6; 2.3; 2.2; 2.3; 2.4; 2.8; 2.6; 2.4; 1.6; 0.7.
- PPG debt service-to-revenue ratio (in percent, selected): 7.7; 4.9; 4.6; 4.3; 4.5; 4.6; 5.4; 4.9; 4.5; 3.1; 1.4.

### Projections and key statistics (selected)
- Baseline projections cover 2013–2033 (multiple figures and tables).
- External debt (nominal) historical entries (selected): 70.6; 71.6; 73.8; 75.8; 78.4; 80.7; 82.8; 84.3; 85.1; 81.9; 72.4 (table format).
- o/w public and publicly guaranteed (PPG) external debt historical entries (selected): 35.0; 33.0; 32.2; 32.6; 32.7; 32.9; 33.4; 33.3; 32.9; 30.5; 21.6.
- Change in external debt (a) historical/projection entries (selected): 6.1; 1.1; 2.2; 2.0; 2.5; 2.4; 2.1; 1.5; 0.8; -1.3; -2.2.
- Identified net debt-creating flows (b) sample entries: 1.3; -1.3; -0.7; 4.1; 3.9; 3.4; 3.3; 2.7; 2.0; -0.1; -1.1.
- Non-interest current account deficit (selected): 8.6; 11.1; 10.5; 10.2; 2.9; 10.3; 9.5; 9.2; 9.1; 8.6; 8.0; 6.1; 6.1; 7.1.
- Exports (selected): 43.5; 49.0; 50.8; 50.3; 50.5; 50.7; 50.9; 51.0; 51.1; 51.5.
- Imports (selected): 64.2; 72.3; 73.4; 72.5; 72.1; 71.5; 71.2; 70.6; 70.1; 68.0.
- Net current transfers (negative = inflow) (selected): -16.5; -15.2; -14.5; -17.6; 1.8; -13.1; -13.3; -13.3; -12.9; -12.4; -12.2; -11.5; -12.1; -11.0.
- Gross workers' remittances (Millions of U.S. dollars) (selected): 823; 912; 1,014; 1,095; 1,197; 1,312; 1,378; 1,425; 1,529; 2,074; 3,931.
- Total gross financing need (Millions of U.S. dollars) (selected): 1,147; 1,231; 1,392; 1,756; 2,153; 2,225; 2,285; 2,317; 2,052; 2,123; 4,315.
- Non-interest current account deficit that stabilizes debt ratio (selected): 2.5; 10.1; 8.2; 8.3; 7.0; 6.9; 7.0; 7.1; 7.1; 7.5; 8.3.

### Sensitivity analysis and stress tests
- The most extreme stress test is defined as the test that yields the highest ratio in 2023; different indicators identify different most-extreme shocks (One-time depreciation shock and Terms shock appear frequently).
- Table 2 and Table 3 present sensitivity results for PV of debt-to-GDP+remittances, PV of debt-to-exports+remittances, PV of debt-to-revenue, and debt service ratios under:
  - Alternative Scenarios (A1: key variables at historical averages; A2: new public sector loans on less favorable terms).
  - Bound Tests (B1–B6 including Real GDP growth shock, Export value shock, US dollar GDP deflator shock, Net non-debt creating flows shock, combination B1–B4, and one-time 30 percent nominal depreciation).
- Selected numerical outcomes (examples from tables):
  - PV of debt-to-GDP+remittances ratio baseline and scenarios: baseline values include 41; 40; 41; 40; 40; 39; 34; 22 (table entries across horizons).
  - PV of debt-to-exports+remittances ratio baseline and scenarios: baseline values include 97; 95; 94; 93; 91; 86; 79; 51; 1 (table entries).
  - PV of debt-to-revenue ratio baseline and scenarios: baseline values include 97; 95; 94; 93; 90; 88; 79; 51; (table entries).
  - Debt service-to-revenue and debt service-to-exports+remittances ratios presented across scenarios and bounds (tables include many numeric entries reproduced in the source).

### Fiscal and macro outlook, vulnerabilities, and indicators
- Near-term macro outlook (Executive Board press release summary):
  - Real GDP grew by an average of 5¼ percent during 2011–12.
  - Annual average inflation was 7¼ percent during 2011–12.
  - Real GDP expected to grow by 4¼ percent in 2013 and stabilize at 4 percent over the medium term.
  - Inflation projected to remain at about 7 percent.
- Fiscal accounts and public debt:
  - Combined public sector ran a deficit of ¾ percent of GDP in the year referenced (previous year), projected deficit in 2013 of 1½ percent of GDP.
  - Public debt-to-GDP projected to decline to about 42 percent in 2013 from 50 percent in 2010.
- External sector vulnerabilities:
  - External current account deficit projected to be about 13 percent of GDP in 2013.
  - Gross international reserves projected to increase to nearly US$2 billion (equivalent to 3½ months of imports).
  - External financing reliant on strong capital inflows (FDI and oil-related financing from Venezuela).
- Financial sector and credit:
  - Banking system average adequacy ratio was 13 percent as of August 2013 (regulatory norm 10 percent).
  - Nonperforming loans have declined from their 2009 peak.
  - Bank credit to the private sector increased by 23 percent (yoy) as of August 2013, following 26 percent in 2012; credit expansion strongest in the personal loan sector.
- Selected social and economic indicators (2009–13 table excerpts):
  - GDP growth (percent): -2.2 (2009); 3.6 (2010); 5.4 (2011); 5.2 (2012); 4.2 (2013 Proj.).
  - GDP (nominal, US$ million): 8,155 (2009); 8,587 (2010); 9,636 (2011); 10,506 (2012).
  - Consumer price inflation (period average): 3.7 (2009); 5.5 (2010); 8.1 (2011); 7.2 (2012); 7.4 (2013 Proj.).
  - Current account (percent of GDP): -9.5 (2009); -10.0 (2010); -13.2 (2011); -12.9 (2012); -13.2 (2013 Proj.).
  - Gross reserves (US$ million): 1,575; 1,800; 1,892; 1,887; 1,977 (2009–2013 entries).
  - Public sector debt: 50.2 (2009); 50.1 (2010); 45.4 (2011); 43.2 (2012); 42.4 (2013 Proj.).
  - Private sector external debt: 23.0; 33.0; 36.7; 39.0; 41.8 (2009–2013 entries).

### IMF relations, technical assistance, and program context
- Membership status: Joined March 14, 1946; Article VIII.
- Quota: 130.00 (SDR Million) = 100.00 percent.
- SDR Department net cumulative allocation: 124.54 (SDR Million) = 100.00 percent; holdings 97.95 = 78.65 percent.
- Outstanding Purchases and Loans: ECF Arrangements 101.88 = 78.37 percent (SDR Million/%Quota).
- Latest financial arrangements listed include ECF arrangements with approval and expiration dates (historical entries).
- Projected payments to Fund (SDR Million, selected): Principal 2.58; 14.42; 19.18; 20.90; 15.60 (multi-year entries).
- HIPC and MDRI entries:
  - Assistance committed by all creditors (US$ Million) under HIPC Enhanced Framework: 3,308.00; IMF assistance (US$ million) 82.20 (SDR equivalent 63.54).
  - MDRI-eligible debt (SDR Million): 140.48; financed by MDRI Trust 91.79; Remaining HIPC resources 48.70.
- Exchange rate arrangement: crawling peg with monthly crawl set at an annual rate of 5 percent since December 2004; official market exchange rate as of November 7, 2013 was C$25.1496 per U.S. dollar. Nicaragua has accepted obligations of Article VIII, Sections 2, 3, and 4.
- Technical assistance (selected since 2011): extensive FAD, MCM, STA missions and topics (Public Financial Management; Customs; Tax Administration; Monetary and Foreign Exchange Policy; Debt Management Strategy; Stress Testing; Balance of Payments Statistics BPM6; Producer Price Index; etc.). Resident Representative Mr. Juan Zalduendo assumed the position in March 2013.
- Relations with the Inter-American Development Bank: IDB sovereign loan portfolio commitments and disbursement details listed (total commitment US$702.3 million; undisbursed balance US$471.15 million as of October 21, 2013). IDB FSO lending blend and annual allocations are provided (allocation values include US$80.2 million, US$162.0 million, US$170.2 million, US$171.2 million, US$191.5 million for various years).

### Policy recommendations and Executive Board assessment
- Fiscal policy:
  - Fiscal discipline should remain the cornerstone of macroeconomic policy.
  - Support for the 2014 draft budget stance that incorporates a wage bonus while remaining consistent with medium-term goals of strengthening fiscal buffers and lowering public debt ratios.
  - Broaden the revenue base by fully implementing the 2012 tax reform and rationalizing public expenditures.
  - Reform the pension system to ensure financial viability while reinforcing the social safety net.
  - Renewed efforts to conclude debt relief negotiations with non-Paris Club official creditors and encouragement for creditors to deliver HIPC Initiative debt relief.
- Monetary and exchange rate policy:
  - Monetary policy should aim to contain inflation and keep the real exchange rate broadly in line with fundamentals.
  - Maintain external reserves coverage above established international benchmarks.
- Financial sector:
  - Closely monitor rapid private sector credit growth; continue strengthening bank supervision and recapitalizing the central bank.
- Structural reforms:
  - Advance reforms to lower informality in labor markets, improve and expand education and training, reduce dependence on oil imports, and strengthen private investment framework in infrastructure.
  - Continue expanding electricity sector capacity and efficiency; continue reform of subsidy system to reduce fiscal risks.
  - Increase transparency and full disclosure of oil import financing agreement with Venezuela; develop contingency plans to address potential external vulnerabilities.

*Italic: Source — IMF staff report content and associated tables and press release excerpts as supplied in the content unit.*

### 1.      A  tax  reform,  the

### 1.      A  tax  reform,  the

### Tax reform and fiscal impacts
- The “Ley de concertacion tributaria” (Consensus tax law) was approved by the National Assembly in 2012 and entered into full force in January 1st 2013.
- It will increase revenues and improve tax administration, and is consistent with IMF recommendations.
- Nicaragua’s fiscal authorities estimate that tax revenues will increase by an equivalent of 0.21 percent of GDP.
- The evolution of taxes until September 2013: government revenue grew at an inter-annual accumulated rate of 13.6 percent.

### Electricity sector reform and risks
- A financially sound private company recently acquired almost all the country’s electricity distribution facilities.
- The government has approved new legislation and is enforcing measures to reduce technical and non-technical losses (including theft).
- The government is supporting community-based plans to commercially integrate illegal connections.
- Measures are part of the deal with the private company and are supervised by the country’s independent regulator.
- Along with improved maintenance plans and increased infrastructure investment, these actions will strengthen the sector’s performance.
- Oil price dependency still constitutes the main risk, but the electricity industry continues to reduce its dependence on subsidies as tariffs adjustments progressively narrow the gap between the reference price for distributors (close to the cost of generation) and the actual price charged to consumers.
- Footnote details preserved from source:
  - The TSK energy group and the Andalusian Company Melfosur, with which TSK has partnered for several projects, purchased from Gas Natural–Union Fenosa more than 83% of the two biggest distribution utilities in Nicaragua.
  - Non-technical losses in electricity distribution include mainly electricity theft, but also losses due to poor equipment maintenance, calculation errors and accounting mistakes.
  - Recent successful experiences in the cities of Leon and Managua have been implemented with IDB and WB financing.

### Off-budget operations and payroll bonus
- The “solidarity bonus” paid to low-income state employees, formerly an off-budget expenditure financed by Venezuelan cooperation, has been integrated into the 2014 budget.
- The government decided to include the bonus as a permanent payroll benefit to partially reduce accumulated disparities in public sector salaries.
- Footnote details preserved from source:
  - This bonus is a monthly allowance of US$ 20 for each of the approximately 150,000 low-income government employees (those who earn less than US$ 230/month). It costs about US$ 40 million per year or 0.38 percent of GDP.

### Social security reform
- Negotiations between representatives of labor, the private sector and the government are well under way to reach consensus on social security reform based on a proposal presented by the government.
- The objective is ensuring financial sustainability until (at least) 2030.
- Important context: out of 3 million economically active, only 21 percent are affiliated to the national pension system.
- Increasing the number of social security subscribers will contribute to the pension’s system sustainability and also increase the tax base.
- The government has acknowledged a debt of US$ 580 million with the Social Security Institute and will start honoring it in 2014.
- The authorities anticipate that consensus will be attained by the end of the year so that the reform could be enacted by January 2014.
- Footnote preserved from source: The proposal puts forward several options, all of which ensure financial sustainability.

### Economic growth performance and projections
- Nicaragua’s growth remains relatively strong, averaging 5.3 percent in the last two years.
- Quarterly GDP reached an inter-annual growth (y-o-y) of 5.3 percent during the first semester of 2013, mainly driven by construction, industry, and the primary sector.
- The authorities conservatively project 4.8 percent GDP growth for 2013.
- Authorities’ medium term forecast (2014-2017): growth hovers between 4.7 and 5 percent.
- IMF staff projects medium-term growth at 4 percent.
- For 2014 the Central Bank of Nicaragua (CBoN) projects 4.5 percent growth (assuming the continued recovery of the economy in the United States, stable commodity prices, and the normalization of local meat production).
- Exports decreased by 9.3 percent in value terms (y-o-y) until August 2013.
- Exports have more than doubled since 2009, while non-oil imports have increased by 83 percent.
- Netting-out oil imports, the current account deficit dropped from 10 percent of GDP in 2002 to 1.5 percent in 2012.

### Monetary policy and inflation
- Inflation receded in 2012 (partly due to moderation in oil prices) and has remained stable since then.
- Headline inflation is projected at 7.4 percent and core inflation at 6.5 percent by the end of 2013.
- Preservation of the crawling peg and maintenance of an adequate level of international reserves have been priorities for monetary policy.
- The authorities consider the peg arrangement has successfully anchored inflation, while helping to maintain external competitiveness.
- The 5 percent annual crawl provides an undesirable floor to inflation and interest rates, limiting the elbow room for monetary policy.
- Authorities are willing to explore with staff alternative policy options for a gradual transition towards a less dollarized economy in the long run.

### External sector stability and financing
- The current account deficit is still quite high (12.9 of GDP in 2012 and projected at 13.2 percent in 2013), reflecting Nicaragua’s dependence on oil imports.
- It is expected to remain stable and be covered mostly by foreign direct investment.
- International reserve levels are adequate and stable.
- The CBoN considers that the real effective exchange rate is broadly in line with fundamentals.
- In the medium run, changes in the electricity matrix are expected to continue reducing oil imports.

### Fiscal consolidation and public debt
- The Central Government’s consolidation efforts: primary balance has been slightly above equilibrium between 2010 and 2012.
- In 2013, the primary surplus is expected to reach 1.1 percent of GDP.
- The overall balance of the “Combined Public Sector” (after grants) went from equilibrium in 2011 to a 0.7 percent deficit in 2012.
- The deficit is projected to increase to 1.4 percent of GDP in 2013 due to an expansion in capital spending.
- Public debt projections by CBoN: projected to drop from 42 percent of GDP in 2013 to about 35 percent of GDP by 2018.
- Staff projection preserved: a decline from 42.4 to 37.5 percent of GDP between 2013 and 2018 (Table 10 of the staff report).
- Authorities committed to further fiscal consolidation; agreed areas requiring action:
  - implementing social security reform,
  - concluding debt negotiations with non-Paris Club creditors,
  - better targeting electricity subsidies,
  - strengthening the Water Utility Company (ENACAL).

### Financial sector stability
- Staff notes rapid credit expansion could increase financial system vulnerabilities; this remains one of the few areas of disagreement with staff.
- By the end of July, average capital adequacy in the banking system was 3 percent higher than the regulatory requirement.
- NPLs were less than 2 percent of total loans.
- Credit expansion follows a period in which credit virtually did not exist; the pace of credit expansion is moderating while deposits continue to increase.
- CBoN’s favorable assessment is based on capital adequacy, low NPLs, quality of credit, and profitability of commercial banks.

### Productivity and structural constraints
- Low productivity constitutes the main constraint for long-term growth.
- To increase very low agricultural yields and better position the agro-industrial sector in international value-added chains, the government will need to step-up investment in infrastructure and in human capital development.
- The government is striving to strengthen the quality of (and facilitate access to) technical education.
- The Inter-American Development Bank and the World Bank Group are supporting these efforts.

### Concluding remarks and policy engagement
- Nicaragua has achieved considerable progress on the macroeconomic and structural reform fronts.
- Remaining challenges include elevated and persistent poverty levels, a long-standing lag in basic infrastructure and competitiveness, and relatively weak human development indicators.
- Nicaragua is committed to continue implementing coherent macroeconomic and development policies to remove structural hurdles, achieve higher productivity levels and improve income distribution.
- The Government counts on the Fund’s support through policy advice and capacity building tailored to the country’s specific needs and circumstances.

*Source: IMF staff report content from _cr13377 - 1.      A  tax  reform,  the*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13377.pdf_