Nicaragua and the IMF

Press Release: IMF Completes First and Second Reviews of Nicaragua's PRGF-Supported Program, Approves US$19.8 Million Disbursement
June 19, 2003

Country's Policy Intentions Documents

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NicaraguaLetter of Intent, Supplementary Memorandum of Economic and Financial Policies, and Supplementary Technical Memorandum of Understanding

Managua, Nicaragua
June 3, 2003

The following item is a Letter of Intent of the government of Nicaragua, which describes the policies that Nicaragua intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Nicaragua, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Use the free Adobe Acrobat Reader to view the Tables 1-2 (131k PDF file).

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

1. Attached you will find the Supplementary Memorandum of Economic and Financial Policies (MEFP) that reviews economic developments and policy implementation through March 2003 under the PRGF arrangement approved in December 2002, and sets out specific objectives and targets for June-December 2003. Based on the good track record and the policies adopted, we request the completion of the first and second reviews under the PRGF and the approval of the revised performance criteria for June 2003 and September 2003 that reflect the strong performance under the program. We also request waivers for the nonobservance of two performance criteria (PCs).

2. Nicaragua's economic performance through March 2003 has been consistent with the program. Macroeconomic policies have been in line with the PRGF, and progress was made in key structural areas. As a result, all quantitative and structural PCs for end-December 2002 and end-March 2003 were met, with two exceptions that were subsequently corrected. The structural PC related to the approval of the 2003 budget was not met in December 2002, but a presidential veto led to a modified budget in February 2003 and brought it back in line with the program. In March 2003, the quantitative PC for the net domestic financing of the consolidated public sector was exceeded by only a small amount (about US$ 2 million), which is fully explained by delays in disbursements of balance of payments support that had been expected for March but were received in the second quarter of 2003.

3. It is worth mentioning that as a prior action for the completion of the first and second reviews, we secured approval by the National Assembly (assembly) of a tax reform package in April 2003, two months earlier than envisaged in the program. The package is designed to significantly improve the efficiency and equity of the tax system, while raising tax revenues by at least 1.7 percent of GDP on an annual basis. In addition, structural benchmarks have been added with the aim of strengthening the quality of public spending and improving bank resolution procedures.

4. The Government of Nicaragua believes that the policies and measures set forth in the MEFP are adequate to achieve the objectives of the reform program supported by the PRGF Arrangement. However, we stand ready to take, in consultation with the Fund, additional measures that may be appropriate for the achievement of the program's objectives. We will continue consulting with the Fund on relevant economic and financial policies, and providing the Fund all necessary data on a timely basis for monitoring purposes. Consistent with our intention to keep the public informed about our policies and objectives, the government will publish the MEFP and will report periodically on progress under the program.

5. We propose that the IMF carry out reviews under the program in September 2003 and December 2003 based on the observance, respectively, end-June 2003 and end-September 2003, quantitative and structural performance criteria established in Tables 1 and 2 of the attached memorandum.

6. We assure you that the government of Nicaragua remains fully committed to the implementation of the program.

Sincerely yours,

Mario B. Alonso I.
Central Bank of Nicaragua
Eduardo Montealegre Rivas
Minister of Finance

Supplementary Memorandum of Economic and Financial Policies

1. The PRGF arrangement approved last December supports the government's economic and financial program, which we began to implement soon after taking office in January 2002. We remain firmly committed to the strategy embodied in our Poverty Reduction Strategy Paper (PRSP), as updated in the 2002 PRSP first progress report, and the program supported by the PRGF. This memorandum supplements our letter and memorandum of economic and financial policies of November 19, 2002, and outlines the key next steps that we envisage in implementing this program.

2. Economic performance has been consistent with the program and all performance criteria (PCs) for end-December 2002 (first review test date) and end-March 2003 (second review test date) were met, with the exception of one structural and one quantitative PC that were subsequently corrected. Real GDP growth in 2002 was 1 percent, and 12-month inflation declined to 4 percent. Between 2001 and 2002, the combined public sector deficit before grants fell from 21 percent of GDP to 16.4 percent of GDP, while the deficit after grants fell from 14.3 percent of GDP to 8.6 percent of GDP. Poverty-reducing spending increased to 15.4 percent of GDP in 2002, slightly short of the 15.6 percent of GDP target.

3. The fiscal program for 2003 targets a reduction in the combined public sector deficit (after grants) to 6.3 percent of GDP. While the end-December 2002 PC related to the 2003 budget was not observed due to changes made by the assembly to the proposal submitted by the Executive Branch, a presidential veto led in February 2003 to a revised budget that brought the fiscal program back on track. The revised budget allowed 0.3 percent of GDP higher spending than originally envisaged (mainly on salaries for health and education), but the deficit and savings targets of the program were preserved through additional taxes on automobiles, cigarettes, and commercial banks. During the first quarter of 2003 fiscal performance was better than envisaged under the program, and only the PC on domestic financing of the combined public sector for March 2003 was not met by a small amount (about US$2 million). This is fully explained by shortfalls in balance of payments support (beyond the adjustments allowed under the program) that had been programed for March and was received in the second quarter of 2003.

4. We have intensified our efforts to broaden domestic support for our economic program. Of particular importance was the agreement reached in March 2003 with a qualified majority of the NA, which was instrumental to reduce social tensions and obtain support for the tax reform. As part of the agreement, public spending is to increase by 0.7 percent of GDP in 2003, of which 0.4 percent of GDP is current spending and 0.3 percent of GDP capital outlays (about 0.2 percent of GDP in poverty reducing programs). To preserve the fiscal deficit target (6.3 percent of GDP in 2003) it was also agreed to approve a larger-than-initially envisaged tax reform.

5. The tax reform package submitted by the executive and approved by the assembly in April (prior action) aims to improve substantially the efficiency and equity of the system, while raising revenues of 1.2 percent of GDP in 2003 (C$500 million) and 1.7 percent of GDP on an annual basis (C$700 million). This compares with an expected yield of 0.5 per-cent of GDP in 2003 (1 percent of GDP on an annual basis) initially envisaged under the program. The implementing regulations (prior action) were recently approved, with the reform coming into effect on June 3, 2003. Its main components include the elimination of the zero VAT rate (except for exports), while allowing VAT exemptions for the basic-goods basket of 53 items and on raw, intermediate, and other materials physically incorporated into eight basic products; the net reduction of other exemptions on domestic and imported goods; the implementation of a minimum income tax for corporations and sole proprietors via withholding of 1 percent of asset value (0.6 percent of deposits for banks); and a substantial simplification in the excise tax rate structure.

6. Strengthening tax administration is a key priority for 2003 and will be an important focus of discussions with the staff to complete the third review. In this connection, we will adopt and begin implementation of action plans to strengthen the customs and internal tax agencies by end-September 2003. To support these efforts, which will aim at increasing tax revenues by a cumulative 0.6 percent of GDP by 2005, we are requesting additional TA from the Fund.

7. Primary spending of the consolidated public sector is expected to reach a level of 36.3 percent of GDP in 2003 (about 1 percent higher than in the original program), while poverty reducing spending would increase to 16.1 percent of GDP (0.3 percent of GDP higher than programmed). Current and capital spending would increase by 0.7 percent of GDP and 0.4 percent of GDP in relation to the program, respectively (largely reflecting the expenditure revisions of February and April outlined above), but still remain below the 2002 levels.

8. In the long run, increases in spending not directed at poverty reduction or enhanced growth opportunities, even when fully financed by tax revenue, cannot be viewed as a sustainable strategy to address social pressures. For this reason, we view the improvement in the effectiveness of public spending for poverty reduction as critical to our long-run development goals. To this end a high-level commission will be created in consultation with the World Bank to assess fiscal spending and make recommendations to enhance its effectiveness in generating economic growth and reducing poverty in line with the PRSP. The commission is to be established and its terms of reference prepared by mid-June 2003 (structural benchmark), and will make concrete recommendations by mid-September 2003 (structural benchmark) in time for the preparation of the 2004 budget.

9. The asset recovery plan is being implemented on schedule through a firm hired in December 2002 with international experience in asset management. The bidding process was launched in April 2003, and the auctions are expected to take place before end-June 2003. The authorities will not withdraw any of the assets from the auctions. A special scheme that allows coffee-related debt to be repaid using government bonds at face value ended in May 2003; the total amount of debts eligible for this scheme was less than US$31 million (about 7 percent of assets to be sold); and there will be no such similar schemes for other sectors.

10. Monetary policy in 2003 will remain guided by the objective of strengthening the position of the central bank in the context of low-inflation and the crawling peg exchange rate system (with an annual rate of crawl vis-à-vis the U.S. dollar of 6 percent). As part of the strategy to reduce economic vulnerabilities and achieve interest savings, the government plans to further reduce the central bank's domestic debt by US$15 million in 2003, including through buybacks of central bank securities.

11. Strengthening the banking system remains high on the government's agenda. The government will continue to strictly enforce compliance with the regulatory framework, including the capital adequacy requirement. By end-September 2003, new prudential norms limiting liquidity risks will be approved; and the superintendency of banks will start implementing comprehensive regular on-site inspections for all banks (as allowed by the current legislation). By September 2003, a new unit will be set up at FOGADE, the public deposit insurance agency, to manage and liquidate assets in the event of bank failures and legislation will be submitted to the assembly to bring the regulatory framework of the banking system in line with Basel Core Principles. We have requested participation in the IMF's Financial Sector Assessment Program (FSAP) as soon as possible, which will contribute to our policy dialogue on these issues.

12. We continue to pursue the important other structural reforms envisaged in the program. In particular, we remain committed to judicial reform and to seeking the approval of the Law on Public Indebtedness. Regarding the former, we are working on a proposal, which will be completed and made public by September 2003. This proposal will take into account the work done by last year's Presidential commission on this subject and by the Supreme Court with bilateral assistance. Subsequently, a national consultation process will be launched with the end-product being draft legislation to be submitted to the NA.

13. Following the recommendations of the Fund's Stage One Safeguards Assessment of the BCN, the central bank recently sent to the Fund the internal audit report on the reconciliation of international reserves and wrote-off long-overdue outstanding loans to central government/agencies.

14. Efforts are continuing to improve our statistical database. A new GDP series for the period 1994-2000 was officially adopted in late March 2003 and published in mid-May 2003, entailing a 70-percent upward revision based on more accurate survey-based data sources; preliminary GDP estimates for 2001-02 under the new methodology will be ready by June 2003. The revised national accounts will be incorporated into the macroeconomic framework of our PRGF-supported program in the context of the third review. Work is ongoing (with technical assistance from the IMF) to improve the database and sectorization of banking sector accounts, which by end-June 2003 will result in a major improvement in the consistency between the monetary and fiscal sector statistics, and in the quality of data on credit for the private sector. Work to improve balance of payments statistics is also ongoing, but we would like to receive further technical assistance to strengthen these efforts.

15. Implementation of the first annual program supported by the PRGF arrangement will continue to be monitored through quarterly reviews, performance criteria and benchmarks (Tables 1 and 2). The government continues to be firmly committed to the success of the program and stands ready to implement additional measures, as needed, to achieve its objectives.

Supplementary Technical Memorandum of Understanding

The Technical Memorandum of Understanding (TMU) attached to the Memorandum of Economic and Financial Policies of November 19, 2002 remains in effect, except as modified by this Supplementary TMU. Tables 1 and 2 below replace the previous tables 1 and 3 of the TMU attached to the Memorandum of Economic and Financial Policies of November 19, 2002.

A. Fiscal Targets

Interest on the domestic debt, includes interest on a due basis, except for the cost of CENIS issued for bank resolution, which are shown on accrual basis. The following table presents the projected interest cost of bank resolutions based on program assumptions, which include a debt buyback of US$20 million during the third quarter of 2003. The interest table is for illustrative purposes only; program performance will be evaluated using actual data.

Table 1. Financial Cost of Bank Resolution1
(In millions of cordobas)

  Accrual Due Adjustment

2002 1,042    299    743
2003    905    938    -33
2004    343 2,224 -1,881

1Corresponds to the interest and dollar-indexation cost associated with the issuance of CENIS due to the bank resolution implemented in 2000-01.

B. Monetary Targets

Net Repayment of the Domestic Debt of the Central Bank

Adjusters: The net repayment of the domestic debt of the central bank will be adjusted: (i) upward (unlimited) in the second quarter in the event of higher asset recovery proceeds than the amounts shown in Table 2; and (ii) upward/downward by up to US$15 million in the third quarter in the event of higher/lower asset recovery proceeds than the amounts shown in Table 2.

Table 2. Nicaragua: Cumulative Program Financing
(In millions of U.S. dollars)
  Privatization BOP Support Asset Recovery

Q4 11   35   4  
Q1 11   35   5  
Q2 13   75   19  
Q3 43   83   49  
Q4 53   103   49  

Source: Fund staff estimates and projections.