Nicaragua and the IMF

Press Release: IMF Executive Board Completes Fifth and Sixth Reviews Under Nicaragua's PRGF Arrangement, Approves Disbursement Amounting to US$20 Million
September 8, 2004

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Nicaragua—Letter of Intent, Supplementary Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Managua, August 12, 2004

Use the free Adobe Acrobat Reader to view the SMEFP Tables (183k PDF file)

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.

Mr. Rodrigo de Rato
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. de Rato:

1. We are attaching the Supplementary Memorandum of Economic and Financial Policies (SMEFP) and a revised Technical Memorandum of Understanding that reviews economic developments and policy implementation through end-May 2004 under the PRGF arrangement approved in December 2002, and sets out specific objectives and targets for the period June-December 2004. Based on the good track record and policies adopted, we request completion of the fifth and sixth reviews under the PRGF arrangement and the establishment of corresponding performance criteria (PCs) for end-September and end-December 2004 and a structural PC for October 15, 2004 (paragraph 4 below). We also present the following requests for: (i) a waiver for the nonobservance of the December 2003 quantitative PC on CPS savings (paragraph 2 below); (ii) a waiver for the nonobservance of the mid-May 2004 structural PC on granting legal protection to staff of the superintendency of banks; (iii) a replacement of the performance criterion on CPS savings, starting in September 2004 (paragraph 3 below); (iv) the completion of the financing assurance review (paragraph 5 below); and (v) a set of prior actions for the completion of the fifth and sixth reviews (paragraph 6 below).

2. Nicaragua's economic performance through May 2004 continues to be consistent with the program. Macroeconomic policies have been in line with the PRGF arrangement, and progress has been made on the structural agenda. Consequently, all quantitative and structural PCs for end-December 2003 were met, with one exception, and all end-March 2004 quantitative PCs were also met. However, a mid-May structural PC was not observed. The end-December 2003 target for combined public sector (CPS) savings was missed by a minor amount (0.2 percent of GDP), reflecting a tax shortfall, which was only partially offset by a lower quasi-fiscal deficit. The government has taken corrective measures to address the revenue shortfall and, thus, fiscal targets for the balance of 2004 remain unchanged. We have strengthened resolutions of the superintendency of banks and central bank to cover explicitly the legal expenses of staff sued in the course of their official duties. We have also requested technical assistance from the Fund to help draft legislation to strengthen legal protection for bank supervisors.

3. Reflecting the continued concern over the high public debt burden, and the priority given to returning Nicaragua's debt dynamics to a sustainable path, we request the replacement of the PC on CPS savings with two new PCs—one on the overall balance of the CPS (after grants), and one on the overall balance of the central government (after grants).

4. New PCs for end-September and end-December 2004, which were indicative in the past review, are being requested. We are also requesting establishment of a new structural PC for October 15, 2004 on submission to the assembly of a draft Fiscal Responsibility Law. Following HIPC completion, and the associated accounting methodology changes, only debt service to multilaterals is recorded in the fiscal accounts at full value, with relief shown as exceptional financing. Debt service to other creditors, following recent stock operations, is shown after all relief.

5. The request for completion of the financing assurances review is based on satisfactory assurances of external financing evidenced by the recent successful Paris Club negotiation, the clearance of arrears on indemnity bonds, and our intent to use the IDA Debt Reduction Facility to resolve the commercial debt problem.

6. A set of prior actions is proposed for completion of the fifth and sixth reviews that includes inter alia implementation of a budget modification in line with the fiscal program, as well as fiscal measures to achieve the targeted revenue gains and expenditure savings (specifics are provided in Table 2 of the SMEFP).

7. Based on two years of experience with implementation of the PRSP, as well as the results of a growth seminar held in Nicaragua earlier this year, we have strengthened the PRSP. We have completed a first draft of an enhanced PRSP which is now being discussed within the government and the civil society before its final adoption.

8. We are committed to continue good faith negotiations with all non-Paris Club official and private creditors to seek debt relief at least comparable to that granted by Paris Club creditors under the enhanced HIPC Initiative.

9. We are confident that the policies and measures set forth in the SMEFP are adequate to achieve the program's objectives under the PRGF arrangement. Nonetheless, we stand ready to take, in consultation with the Fund, further measures that may be needed for the successful implementation of the program. To this end, we will continue consulting with the Fund on relevant economic and financial policies, and provide the Fund with the 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 SMEFP and will report on the progress of the program periodically.

10. We propose that for the remainder of the second year of the arrangement, the Fund carry out program reviews by November 2004 and January 2005, based on the observance, respectively, of end-June 2004, and end-September 2004 quantitative and structural performance criteria established in Tables 1 and 2 of the attached memorandum.

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

    Sincerely yours,

Mario B. Alonso I.   Eduardo Luis Montiel
Central Bank of Nicaragua
  Minister of Finance

Supplementary Memorandum of Economic and Financial Policies

1. The government of Nicaragua reaffirms its commitment to the strategy embodied in the Poverty Reduction Strategy Paper (PRSP), as updated in the 2003 PRSP progress report, and the program supported by the Poverty Reduction and Growth Facility (PRGF). This memorandum supplements the Memorandum of Economic and Financial Policies of November 19, 2002, and the associated supplements,1 and outlines the key next steps envisaged in implementing our program.

2. Economic growth and inflation in 2003 were broadly in line with the program targets. Real GDP grew by 2.3 percent, and it is projected to expand by 3.7 percent in 2004. Inflation was 6½ percent, slightly above the program target of 6 percent, due to a jump in prices for perishable goods and petroleum products in November-December. NIR accumulation surpassed the end-December performance criterion (PC) by US$33 million (0.8 percent of GDP), despite a delay in the sale of the government's shares in ENITEL (telecommunica-tions company). As a result of the sustained implementation of prudent economic policies, interest rates (and the spread between domestic and foreign rates, in dollar terms) have been trending downward, declining by about 200 basis points since January 2002.

3. Policy implementation has been broadly consistent with the program and all structural and quantitative performance criteria (PCs) for end-December 2003 were observed, with one exception, and all end-March 2004 PCs were observed. In December, the floor on combined public sector (CPS) savings was missed by 0.2 percent of GDP, reflecting a tax revenue shortfall (described below), which was only partially offset by a lower quasi-fiscal deficit. This shortfall has now been corrected, and the end-March CPS savings target was met. In line with the financial sector reform agenda, in December 2003 we submitted to the assembly a draft law to grant legal protection to bank supervisors.

4. The 2003 fiscal program did not perform as envisaged in December due to tax revenue shortfalls and higher-than-programmed capital spending. Tax revenues fell short of the program projections by 0.4 percent of GDP, mainly on account of lower receipts for income taxes and the value added tax (VAT). Proceeds from the income tax were affected by legal challenges and taxpayer resistance to the minimum income tax (1 percent of gross assets), while net VAT receipts fell short of projections, largely due to tax rebates arising from former zero-rated products.2

5. Higher capital spending in the CPS (0.6 percent of GDP), fully financed by concessional external resources (grants or loans from multilateral organizations), resulted in most indicative fiscal targets for end-December being missed. The majority of the increased spending was directed to anti-poverty programs, which increased to 11.4 percent of GDP and exceeded the program target by 0.4 percent of GDP.

Macroeconomic framework for 2004

6. Our key economic objectives in the macroeconomic framework for 2004 are as follows:

Key Macroeconomic Objectives
(In percent of GDP, unless otherwise indicated)
  Rev. Prog.

Real GDP growth (in percent) 2.3       3.7
Consumer prices (end period) 6.6       7.0
Gross international reserves (in millions of US$) 504.2   553.2
Change in augmented BCN reserve position (in millions of US$) 89.0     97.3
Combined public sector deficit, after grants -4.4      -1.7

Sources: Central Bank of Nicaragua (BCN) and Ministry of Finance.

Fiscal policy

7. We remain fully committed to the medium-term fiscal strategy outlined in the PRGF-supported program. For 2004, our fiscal program targets a CPS deficit (after grants) of 1.7 percent of GDP. After adjusting for HIPC debt relief, CPS savings for 2004 is projected at 2.4 percent of GDP. To meet these targets, we are taking both revenue and expenditure measures.

Fiscal Indicators
(In percent of GDP)
  Prog. Prel.   Rev. Prog.

Combined public sector deficit, after grants -3.8 -4.4   -1.7
Combined public sector deficit, before grants -8.9 -9.7   -7.0
Combined public sector savings   0.2   0.0     2.4
Combined public sector primary savings   6.7   6.3     7.0
Combined public sector primary expenditure 24.5 25.1   24.7
Tax revenues of the central government 16.3 15.8   16.5
Total poverty-reducing spending 11.0 11.4   11.4

Sources: Central Bank of Nicaragua; and Ministry of Finance.

8. On the revenue side, the tax base for the application of the VAT to soft drinks was raised and we expect the assembly to approve a new tax on gambling activities by September 2004. Tariffs on water services will be adjusted by 10 percent effective in December 2004, in line with the current rules on tariff indexation. The tax office agreed with the main public enterprises the elimination before end-2004 of their 2003 tax arrears (C$14 million), of which about half has already been collected. In addition, the revenue overperformance of the first-half of 2004, is largely financing the increase in expenditures approved by the assembly (see below). The government is firmly committed to oppose any extension of tax benefits or granting any form of tax relief to the private or public sectors without compensatory measures that protect tax revenues, to limit the use of the accelerated depreciation scheme solely to exporters, and to maintain a database on forgone revenues arising from existing tax exemptions and exonerations.

9. On the expenditure side, we have made some fiscally-neutral changes to the 2004 budget. We will require municipalities to use a portion of their 2004 transfers from the central administration to partially reduce their payment arrears to the social security institute (INSS). Expenditures of INIFOM, IDR, FISE and INVUR will be reduced by C$37 million during 2004. In addition, the budget reform eliminated most vacancies in the central administration (except for education, health and police), and included minor budget reductions in other areas. At the same time, to maintain social peace and support for the program, we have modified the 2004 budget to allow for higher salaries for teachers (C$122 million, equivalent to 0.2 percent of GDP),3 for transfers to universities (C$140 million, equivalent to 0.2 percent of GDP),4 subsidies to public transportation (C$40 million, equivalent to 0.06 percent of GDP),5 and other small projects (C$69 million, equivalent to 0.1 percent of GDP).

10. We are facing additional expenditures of about 0.2 percent of GDP due to higher oil prices than originally envisaged in the program, reflecting higher costs in oil consumption (0.1 percent of GDP) and public investment projects (0.1 percent of GDP). We are compensating the higher current oil-related expenditures by reducing public fuel and electricity consumption (a recent presidential directive was issued to this effect). However, to protect priority projects, we will finance the additional investment costs with highly concessional financing from the World Bank and IDB.

Corrective Actions in 2004

Revenue measures

  • Collect overdue VAT from MTI.

  • Change VAT tax base from wholesale to retail value for soft drinks.

  • Collect net income tax arrears from nonconsolidated state enterprises.

  • New tax on gambling operations.

Expenditure measures

  • Slow the pace of capital spending, with emphasis on nonpoverty spending.

  • Implement capital spending cuts in the central government to compensate partially for higher transfers to municipalities.

  • Require municipalities to use transferred revenues to partially reduce arrears to INSS.

  • Selected cuts in the ministry of education's general budget partially offsetting the increase in teachers' salaries.

  • Eliminate most vacancies in central administration.

Other measures

  • Strengthen arrears collections in ENACAL and ENTRESA.

11. We are also strengthening the quality of public expenditures, including through the work of the Public Expenditure Commission (PEC). By end-September, we will initiate a thorough assessment of the main investment projects to determine their social rate of return, and prioritize the use of scarce resources. The PEC will also make specific recommendations for improving the classification of current and capital spending and propose a new definition for poverty reducing spending. For the next review, we will prepare revised series of current and capital expenditures back to 2003. Following the agreement with the World Bank under the PRSC, the PEC will analyze public expenditures and make recommendations to improve their effectiveness in an annual public expenditure review. The PRSP progress report will include a forward-looking discussion of the annual public investment program (PIP) and the government's priorities in capital spending. If necessary, we will adjust public expenditures in order to preserve macroeconomic stability, in line with the priorities established above.

12. We have expanded the mandate of the PEC to include monthly reporting and monitoring of current and capital expenditures, by institution, in order to provide an early warning system for any expenditure deviation in the future. We will improve the control and tracking system of public spending, including by transferring responsibility for the payment to suppliers and contractors from the numerous executing agencies to the ministry of finance. If tied foreign financing of capital spending is lower than the amounts in the table below, we will postpone capital spending by an equivalent amount, while making every effort to protect poverty-reducing spending.

External Financing of the Nonfinancial Public Sector
(In millions of U.S. dollars, cumulative)
  Prel.   QI  QII  QIII  QIV Total

Tied resources 335.6   70.4 178.1 235.0 286.4 286.4
Loans 223.5   54.1 126.2 154.2 175.2 175.2
IDB/World Bank 169.7   46.4 109.5 127.5 141.0 141.0
Others   53.8     7.7   16.7   26.7   34.2   34.2
Grants1 112.1   16.3   51.9   80.8 111.2 111.2

Source: Central Bank of Nicaragua.
1No tied grants were received from the IDB or World Bank in 2003, and none are expected in 2004.

Main Responsibilities of the PEC

The main responsibilities of the PEC for 2004 are:

  • Make recommendations for prioritizing capital spending, based on the expected impact on growth and poverty reduction.

  • Analyze the classification of capital and current spending at the project level and make recommendations to improve it.

  • Analyze public expenditure allocations and make recommendations to improve effectiveness of public expenditure in an annual Public Expenditure Review.

  • Define efficiency indicators for education and health expenditures, along with the Ministerio de Educación (MECD) and Ministerio de Salud (MINSA). Report these indicators in the quarterly Informe de Ejecución del Presupuesto.

  • Propose a new definition for poverty expenditures to be used in the second generation PRSP.

PEC recommendations will be published by September 2004, with a view to incorporating them in the 2005 budget.

13. We are preparing a Poverty and Social Impact Analysis (PSIA) of the PIP with assistance from the World Bank. The PSIA seeks to (i) assess the procedures for selecting the activities included in the PIP to accelerate growth and reduce poverty; (ii) evaluate the regional distribution of investment spending; and (iii) improve the efficiency and targeting of public investment. The PSIA was completed in April 2004 and will be reviewed shortly with the World Bank.

14. We continue to move forward with several other reforms that are underway to support medium-term fiscal sustainability. These include:

  • Tax administration. The internal tax office (DGI) is implementing an action plan, which is summarized in the table below. Specifically, the DGI has updated the large taxpayer database, centralized large taxpayer operations into one unit, and assigned the most experienced auditors to this unit. In addition, the DGI is preparing a strategic plan to improve its information technology systems, which should help in cross-checking data and hence in improving collections. We welcome the appointment of a Fund resident tax advisor who is assisting in the implementation of the tax office's action plan.

  • Tax code. We revised the draft tax code, which sets out the rights and obligations of tax officials and taxpayers and establishes sanctions for tax violations. The recommendations of Fund staff have been incorporated and the draft tax code is now being discussed by the national assembly.

  • Law on administrative career for customs and tax offices. This draft, submitted to the assembly in November 2003, is intended to strengthen human resource management in the tax collection agencies by establishing hiring, promotion, and retirement criteria.

  • Decentralization. The July 2003 transfers law calls for increasing revenue transfers to municipalities starting in 2004, but does not simultaneously devolve commensurate spending responsibilities. In consultation with World Bank and Fund staff, we have established an action plan, described in the box below, which would improve the definition of municipal responsibilities, redefine the role of selected central administration agencies that carry out spending in municipalities, and strengthen the legal framework for decentralization. Our broad objective is to ensure a prudent and fiscally-neutral decentralization process in order to protect macroeconomic stability and improve the effectiveness of public spending. Thus, beginning in 2004 municipalities will be required to use a portion of their transfers, which amount to C$407 million, to fulfill their obligations with INSS. By end-August, in consultation with the World Bank, we will complete a study with the objective of identifying which expenditures can be transferred to municipalities from the central government in order to achieve full fiscal neutrality, as well as improved expenditure efficiency. Each year, beginning in 2005, expenditures equivalent to one-third of the revenue transfers will be shifted to municipalities, such that by 2007, full fiscal neutrality will be achieved.

  • Law on fiscal responsibility and law on financial administration (LFA). We will submit to the assembly, by October 15, 2004, proposals for a fiscal responsibility law (FRL) and a law on financial administration (LFA). The FRL which will include fiscal rules for the central government and municipalities, and explicit transparency requirements to underpin the credibility of such rules. The LFA will strengthen budgetary and accounting procedures. Assembly approval of both laws is expected by December 2004.

Internal Tax Administration's Action Plan for 2004
Key Actions Expected Date of Implementation

1. Strengthen the tax office's large taxpayers unit by updating its database, establishing new procedures to monitor nonfilers and delinquent taxpayers, and improving the effectiveness of audits. Done
2. Approve the law of casinos. End-September
3. Reorganize the DGI and redefine assignments to each core functional department (tax collection, audit, and tax enforcement). End-August
4. Present a three-year strategic IT plan. End-September
5. Establish procedures to systematically exchange taxpayer-related information among the DGI, DGA, INSS, and other public institutions. End-September
6. Reduce stop filing rates in all local offices to less than 20 percent (from 60 percent at end-March 2004). End-December
7.  Reduce stock of tax arrears from 3.5 percent of total DGI revenue collection (at end-2003) to less than 2 percent of total DGI revenue collection. End-December
8.  Make substantial progress in developing a data warehouse to support tax audit and tax enforcement work. End-December
9.  Assess the feasibility of setting up a tax collection system via financial institutions. End-December

Action Plan to Strengthen Decentralization

Definition of municipal responsibilities. We have appointed a special advisor, who will recommend alternatives to reorganize intergovernmental relationships with the goals of fiscal neutrality, efficiency, transparency, clarity, and equity. The special advisor will also devise a timetable and management process for devolving expenditures and responsibilities to municipalities. A presidential decree will be issued modifying the regulations of the Law of Municipalities in a fiscally sustainable manner, consistent with the conditionality under the World Bank's PRSC. By September 2004, we will create and staff a unit at the ministry of finance to monitor the decentralization process. This unit will be responsible for collecting data on municipal operations.

Roles of central government agencies. The roles and the financing of IDR, INIFOM, FISE, INVUR and other institutions involved in municipal issues, will also be redefined following the recommendations of the special advisor with the goal of ensuring efficiency and fiscal neutrality.

Transfer of responsibilities to municipalities. By January 2007, all transfers to municipalities will be fully matched by corresponding spending responsibilities.

  • Pension reform. Following the findings of the inter-institutional pension reform committee, which identified the transition cost of moving from a pay-as-you-go to a capitalization system, and to ensure macroeconomic stability, we are reassessing, in close consultation with the WB, our overall reform strategy for the system.

  • Debt management. In December 2003, the assembly approved the public debt law that establishes the procedures for public sector borrowing and created a technical debt committee, which is entrusted with the formulation of an annual public debt strategy. We have issued the implementing regulations, which include clear limits on public guarantees and subnational borrowing. The ministry of finance, in coordination with the central bank, has begun issuing short-term treasury bills with the purpose of establishing a domestic market for such bills. The U.S. Treasury and the WB are providing technical assistance to the ministry of finance to strengthen its debt management capabilities. We are working with the World Bank's recently-approved DRF to settle outstanding claims by private creditors. We have cleared arrears on BPIs accrued since last year. We remain committed to maintain a prudent external borrowing policy, in line with the assumptions made at the time of HIPC completion.

  • Civil service reform. A new civil service law was approved by the assembly in November 2003 and published in December 2003. Implementation of the civil service reform will be gradual, starting in July 2004 and will be completed by June 2007. Together with the WB, we are estimating the cost of civil service reform, which will be included in the annual budget, starting in 2005. In consultation with Fund staff, we will ensure that the cost of civil service reform is consistent with the agreed macroeconomic framework.

15. We will continue improving the efficiency of public enterprises. We are targeting an operational surplus of 0.2 percent of GDP for 2004. The water and sewerage company (ENACAL) is strengthening its collections of overdue accounts, including through the planned outsourcing of billing and collection. In December 2003, the assembly approved changes to the legal framework of ENACAL, including granting additional legal powers for the collection of arrears (such as cutting off water services to delinquent customers). In addition, tariffs will be revised, as noted above. With respect to the power sector, we are implementing the roadmap agreed in 2003 with WB and the IDB, including steps to improve financial and operational efficiency, making government subsidies more transparent, and improving the sector's policy, regulatory, and legal frameworks.

16. In view of the weak financial situation of some public enterprises, as evidenced by their inability to fulfill their tax obligations, we are analyzing various options to address this problem, including, inter alia, privatization, leasing, and concessions of selected enterprises.

Monetary and exchange rate policy

17. Monetary policy in 2004 will remain guided by the objectives of maintaining low inflation, reducing domestic debt, and strengthening the external position of the central bank. Specifically, the program targets a further buildup of US$20 million of NIR and a net repayment of central bank domestic debt of US$77 million (in addition to a reduction of central government domestic debt of US$36.7 million).

18. Exchange rate policy during 2004 will continue to be guided by the crawling peg arrangement. The annual rate of crawl vis-à-vis the U.S. dollar has been lowered to 5 percent (from 6 percent in 2003).

Financial sector policies

19. Further strengthening of the financial sector remains high on our agenda. In this context:

  • We recognize that for the purpose of providing a sound legal framework for banking supervision in Nicaragua, strengthening legal protection for staff of the superintendency of banks (SB) and the central bank (BCN) is an urgent priority. Therefore, new resolutions of the SB and BCN have been approved that covers explicitly legal expenses of staff sued for actions taken in the course of their official duties, through the establishment of a new budgetary item in the SB budget starting in 2005 for the sole purposes of covering these legal expenses.

  • We are enhancing prudential norms and supervision in line with Basel Core Principles. The SB has approved norms to limit risk derived from maturity mismatches (November 2003) and currency mismatches (December 2003).

  • We are working to overhaul the legal framework for the financial sector in line with international best practices. MFD technical assistance missions made specific recommendations to upgrade the legal framework, with particular emphasis on the bank resolution strategy. We intend to submit to the assembly the draft laws by end-September 2004. In addition, we have reviewed the recommendations of the FSAP in consultation with the PRGF review missions, which will serve as the basis to strengthen our financial sector reform agenda.

  • New on-site technical and administrative procedures for banking supervision were approved in January 2004, in line with MFD recommendations.

National Development Plan

20. We have started to implement our National Development Plan (NDP), which already incorporates comments of civil society groups, business organizations, local governments, and the international community. We give high priority to maintaining macroeconomic stability, prioritizing public investment projects and efficiently executing them, and accelerating key institutional reforms, including judicial reform and decentralization. In this regard, we are strengthening our poverty-reduction strategy and will include key elements of our NDP in an enhanced PRSP (to be published in September 2004).

21. As part of this process, we carried out a growth workshop that was attended by leaders of the business, political, civil, and international communities. The importance that the government attaches to economic growth and poverty reduction was evidenced by the high-level participation in the workshop, including President Bolaños, members of his economic cabinet, and other assembly members. Participants contributed useful insights on ways to accelerate broad-based economic growth, including by addressing the obstacles to growth, and building a national consensus around prudent policies and structural reforms.

22. We continue to pursue key structural reforms envisaged in the program. The remaining government shares in the telecommunications company (ENITEL) were sold in January 2004, and the proceeds (US$49.6 million) have been received. We are pushing ahead with our efforts to improve governance and fight corruption. We are working on a law that should make the electoral process less prone to political influence, by making it more technical and professional. Also, as part of our judicial reform agenda, we are working on a draft Real Estate Registry Law and a new Public Property Registry that would guarantee property rights of landowners. We are also taking the required steps for the implementation of the new civil service law. In addition, with the support of the World Bank and the IDB, we are further strengthening public procurement practices and the comptroller's office.

23. Last year, the government presented its general proposal for judicial reform and launched a national consultation process. In February 2004, after finishing this consultation process, the executive branch sent to the national assembly a new judicial career law, which aims to depoliticize the judiciary. The draft law proposes separating jurisdictional functions from administrative and financial functions, as well as modernizing personnel evaluation procedures. The whole process intends to delimit and separate the functions of the administration of justice with those of selecting judges, thereby contributing to the independence of judges and strengthening governance.

Safeguards assessment and program implementation

24. We have implemented all of the recommendations of the initial safeguards assessment, and agreed to an action plan for implementation of the second assessment, including the adoption of international accounting practices by end-2004.

25. Implementation of the second annual program supported by the PRGF arrangement will continue to be monitored through quarterly reviews, performance criteria, and benchmarks. Tables 1 and 2 present the quantitative and structural PCs for March, June, September, and December 2004, as well as the proposed prior actions and structural benchmarks. We continue to be firmly committed to the success of the program and stand ready to implement additional measures, as needed, to achieve its objectives.

1Dated June 3, 2003, October 2, 2003, and December 22, 2003
2The zero-VAT rate was in effect for 53 products between September 2002 and May 2003.
3It was necessary to address pressing needs in the education sector.
4In response to a ruling by the supreme court calling for a transfer to universities equivalent to 6 percent of budget expenditures.
5Targeted to cushion the impact of higher oil prices on the poor.


Nicaragua—Technical Memorandum of Understanding

1. This technical memorandum incorporates all previous understandings between the Nicaraguan authorities and the Fund relating to the monitoring of the Poverty Reduction and Growth Facility (PRGF) arrangement into one document. For 2004, the quantitative performance criteria and indicative targets will be defined as cumulative flows from January 1, 2004.

Fiscal Targets

2. Coverage of fiscal accounts

    (a) Nonfinancial public sector (NFPS) includes the central government (CG), the Nicaraguan social security institute (INSS), the municipality of Managua (ALMA), and two public sector enterprises: ENTRESA (electricity transmission) and ENACAL (water and sewerage company).1,2

    (b) Combined public sector (CPS) includes the nonfinancial public sector (NFPS) and the operating result (quasi-fiscal balance) of the Central Bank of Nicaragua (BCN).

3. Interest on the domestic debt is registered on a cash basis.3 For 2004 and beyond, the targets for public savings, the overall balance, and net domestic financing (NDF) of the CPS are based entirely on cash interest payments.

4. Interest on the external debt presents cash payments for all creditors and HIPC flow assistance for multilateral creditors.

5. Total primary expenditure of the CG is defined as the sum of wages and salaries, other goods and services, current and capital transfers, capital expenditure, and net lending.

6. The CG overall balance after grants is defined as total revenues of the CG minus total expenditures of the CG plus total foreign grants to the CG.

7. Adjusters. The target for the overall balance (after grants) of the CG will be adjusted upwards (up to US$ 56.5 million for the whole year) in the event of additional project disbursements from the World Bank and/or IDB in excess of those presented in Table 1.

Table 1. Cumulative Project Disbursements by IDB and IDA for Nicaragua
(In millions of U.S. dollars)
Quarter Expected Disbursements

   QI   44.5
   QII 102.4
   QIII 116.2
   QIV 125.4

8. Savings of the CPS is defined as the difference between current revenue and current expenditure of the nonfinancial public sector, plus the operating result of the BCN.

9. Adjusters: The floor of the CPS savings will be adjusted: (a) upward (unlimited) in the event of additional revenues associated with delays in the implementation of the privately managed pension funds, assumed to take place on August 1, 2005; and (b) downward in the event of lower revenues because implementation of the privately managed pension funds occurs before August 1, 2005.

10. Overall balance (after grants) of the CPS is defined as total revenues minus total expenditures of the nonfinancial public sector, plus the operating result (quasi-fiscal balance) of the Central Bank of Nicaragua (BCN), plus total foreign grants to the nonfinancial public sector.

11. Adjusters: The target for the overall balance of the CPS (after grants) will be adjusted: (a) downward (unlimited) in the event of additional revenues associated with delays in the implementation of the privately managed pension funds, assumed to take place on August 1, 2005; (b) upward in the event of lower revenues because implementation of the privately managed pension funds occurs before August 1, 2005; (c) upward (up to US$56.5 million for the whole year) in the event of additional project disbursements from the World Bank and/or IDB in excess of those presented in Table 1.

12. Net domestic financing (NDF) of the CPS. For 2004, NDF of the CPS comprises the operating result of the BCN and the change from their respective stocks at the end of the previous year of the sum of (a) the outstanding stock of debt of the NFPS to the domestic financial system (BCN, commercial banks, and the Fondo Nicaragüense de Inversiones (FNI)) net of deposits (including arrears that correspond to obligations considered eligible for refinancing or rescheduling, or other debt reduction mechanisms) with the foreign currency part of the net debt to the banking system converted into córdobas at the program exchange rate (C$15.9 per U.S. dollar for 2004); (b) the outstanding stock of domestically-issued public sector debt held by private residents and nonresidents with the foreign currency part converted into córdobas at the program exchange rate (C$15.9 per U.S. dollar for 2004); (c) the outstanding stock of suppliers' credits; and (d) the outstanding stock of floating debt.

13. Adjusters: The ceiling on the cumulative NDF of the CPS will be adjusted: (a) upward by up to US$35 million, US$15 million, US$15 million, and US$15 million, in the first quarter of 2004, the second quarter of 2004, the third quarter of 2004, and the fourth quarter of 2004, respectively, in the event of lower disbursements of balance of payments support and/or privatization receipts than the amounts shown in Table 4; (b) downward (unlimited) in the event of higher disbursements of balance of payments support and/or privatization receipts than the amounts shown in Table 4; (c) downward (unlimited) in the event of additional revenues associated with delays in the implementation of the privately managed pension funds; and (d) upward in the event of lower revenues because implementation of the privately managed pension funds occurs before August 2005. This assumes a two-month lag between collection of contributions by privately managed pension funds and their transfer to the government.

14. Reporting: The BCN will send to the IMF monthly electronic information on the detailed operations of the CPS. The monthly information will be provided no later than five weeks after the end of each month.

15. Reporting by Ministry of Finance: The Ministry of Finance will transmit to the IMF monthly information on exonerations and exemptions by type of tax. The monthly information will be sent no later than five weeks after the end of each month.

16. Transition of the fiscal accounts from cash to accrual accounting. We are committed to the following timetable for the transition of the CG accounts from cash to accrual accounting.

Table 2. Timetable for the Transition of CG Accounts from Cash to Accrual Accounting
Measures Date of Implementation

1. Undertake a study to determine how to apply accrual accounting principles to the budget.4 June 2004
2. Formalize the accrual accounting criteria to be utilized in the 2005 budget. August 2004
3. Train staff in budget office on the new accrual accounting guidelines. August 2004
4. Implement accrual accounting criteria starting with the 2005 budget. January 2005

Monetary Targets

17. Net international reserves (NIR) of the BCN. For program purposes, NIR is defined as the difference between the (a) gross foreign assets of the BCN that are readily available; and (b) short-term reserve liabilities of the BCN (including purchases and credits from the IMF), plus arrears on foreign debt service, plus foreign currency reserve requirement deposits of commercial banks at the BCN.

18. Readily available foreign assets of the BCN exclude those that are pledged or otherwise encumbered, including, but not limited to, reserve assets used as collateral or guarantee for a third-party external liability.

19. Net domestic assets (NDA) of the BCN are defined as the difference between the change in the stock of currency issued and net international reserves, valued at the program exchange rate.

20. Net repayment of the domestic debt of the BCN and the CG. For program purposes, it is defined as the difference between new placements and redemptions of: (i) the BCN CENIs, TEIs, standardized letras and any other BCN paper held by institutions outside the CG; and (ii) the CG's treasury bonds, BPIs, and any other obligations owed to institutions or individuals outside the CG, except the BCN. It also includes all domestically placed paper held by residents and nonresidents. This amount will be converted into U.S. dollars at the program exchange rates (of C$15.9 per U.S. dollar for 2004).

21. Adjusters. The net repayment of the domestic debt of the BCN and the CG will be adjusted: (a) downward by up US$35 million, US$15 million, US$15 million, and US$15 million in the first quarter of 2004, the second quarter of 2004, the third quarter of 2004, and the fourth quarter of 2004, respectively, in the event of lower disbursements of balance of payments support and/or privatization receipts than the amounts shown in Table 4; (b) upward (unlimited) in the event of higher disbursements of balance of payments support and/or privatization receipts than the amounts shown in Table 4; and (c) downward to the extent that the NIR target is exceeded.

22. Reporting. The BCN will send to the IMF (a) daily electronic mail containing information of daily accounts of the BCN (stocks and flows) within two days of the end of the last working day; (b) monthly electronic mail with information of monthly accounts of the BCN, commercial banks and FNI (stocks and flows), within four weeks of the end of the month; and (c) quarterly accounts of the BCN, commercial banks, and FNI (stocks and flows) within five weeks of the end of the quarter.

Structural Measures

23. The procedures established in the new banking supervision inspection manual will be complemented by inspection guidelines for specific areas of banking supervision in line with MFD recommendations. In order to enforce supervisory action, penalties, and regulatory actions for noncompliance with regulatory norms, regulations will be made consistent with the updated legal framework, especially concerning consolidated supervision and remedial measures in the context of new banking resolution framework. In addition, other complementary regulations should be approved, including on fines (as anticipated in Article 150 of the Banking Law); on guidelines for corrective measures (including civil penalties); on fit and proper criteria; and on major acquisitions. Finally, to improve the quality of reporting, accounting rules should be updated and "balance sheet evergreening" (for example arising from the treatment of restructured coffee loans) should be phased out within a reasonable period.

24. The fiscal responsibility law (FRL) should include, but is not limited to, the following key elements: (1) to set forth a regime aimed at achieving long-term fiscal sustainability by (i) limiting growth of real current primary expenditure, and (ii) decreasing total public debt (domestic and external), and (2) to establish an independent body or agency, which does not have direct responsibility in implementing the FRL, charged with the authority of monitoring implementation, and imposing sanctions in case of nonobservance, of the FRL.

25. The tax code should include, but not be limited to, the following key elements: (i) the procedure for the enforced collection of tax liabilities should be amended in the draft tax code so that this is possible through administrative procedures (i.e., handled through the tax administration) instead of only through judicial procedures (which requires prior court approval), as is currently the case; (ii) the tax administration should not be authorized to forgive the payment of interest and penalties (i.e., no tax amnesties based on administrative actions); (iii) if the tax administration does not issue a ruling on a case initiated by the taxpayer within the statutory time frame, the tax administration's "silence" should be interpreted as a negative answer to the inquiry. The taxpayer would then have the option of either appealing that tacit ruling, or waiting until the ruling is actually issued; (iv) under the principle of "legality," the code should specify that only by "law" (not by decree) can the basis be established for: (a) the "taxable acts," (b) the calculation of the tax liability, (c) the tax rate, and (d) the taxpayer.

26. The changes to the legal framework, which are in line with Basle Core Principles for effective banking supervision, will (a) introduce legal protection for supervisors (Principle 1); (b) establish a mechanism to review and reject any proposals to transfer significant ownership in existing banks to other parties (Principle 4); (c) grant supervisors the ability to do supervision on a consolidated basis (Principle 20); and (d) grant supervisors adequate supervisory measures to bring about timely corrective action when, among other reasons, banks fail to meet prudential requirements (Principle 22). In addition, the revised legal framework will eliminate the superintendency's restrictions on sharing information with similar institutions in other countries; and remove secrecy on bank assets.

27. Issuance of a resolution by the board of directors of the superintendency of banks (SB) should include, but not be limited to, the following main elements: (i) the establishment of a specific budgetary item in the SB's budget starting in the 2005 for the coverage of legal expenses (attorney fees and other costs (costas)) arising from lawsuits for actions taken in the course of performing their official duties; (ii) the provision of a mechanism under which in the event of insufficiency of resources in the original budgetary allocation, the SB is authorized to request and the Board to approve the allocation of the necessary additional funds under a supplement item of the BS's budget for the coverage of the above-mentioned excess of expenses, and (iii) the granting to the Superintendent of authority to issue implementing regulations to ensure that the process of hiring attorneys that will provide legal defense shall be made under market conditions. Finally, new legislation will be prepared to set up a banking resolution framework that would provide adequate incentives and safeguards for an effective and transparent resolution mechanism.

28. To strengthen the large taxpayers' unit (LTU) will be understood to mean consolidate the administration of all large taxpayers into one office, apply clear selection criteria to ensure only the large taxpayers are administered by the LTU, and significantly strengthen LTU audit, starting by assigning the most experienced auditors to the unit. In addition, it will be understood to mean that the percentage of stop filers cannot exceed 2 percent of all registered large taxpayers, and that tax arrears will not exceed 2 percent of total revenues collected by the DGI.

29. To implement effective procedures to monitor stop filers and delinquent taxpayers in all local offices will be understood to mean reduce the average number of stop filers in all local tax offices to below 20 percent at the end of December 2004. In addition, the control of delinquent taxpayers will be understood to mean a reduction in the stock of tax arrears to less than 2 percent of total DGI revenue collection at the end of December 2004.

30. Improvement of the classification of capital and current expenditures will be understood to mean to examine the classification of investment between current and capital of at least 50 percent of the externally financed projects included in the 2005 budget.

31. The unit that will be created in the ministry of finance to report on decentralization will collect quarterly data on municipal operations.

32. Pension reform study should estimate the alternative fiscal costs of various sensitivity analyses that include parametric reforms (increase of retirement age, minimum number of contributions, minimum pension, replacement rate, etc.), the estimation of the compensation bond, and the different parameters used in the estimation of the transition costs.

Safeguards Assessment

33. To address the vulnerabilities identified during the safeguards assessment of the BCN completed in August 2003, we propose the following timetable:

Table 3. Timetable for the Implementation of Safeguards Assessment Recommendations
Measures Expected
Date of

1. International Accounting Standards (IAS)    

Disclose the differences between IAS and the BCN accounting practices:

DoneIn progress
    (i) in the 2002 financial statements. October 2003  
    (ii) in the 2003 financial statements. End-June 2004   
  b. Full adoption of IAS (beginning with the 2004 financial statements).


— Initiate migration to IAS. July 2004 Awaiting recommendations from external auditors
— Complete migration of IAS. End-December 2004  
2. Adopt a Board resolution to appoint external auditors for three-year terms. The appointments should continue to be on an open competitive bidding basis by international auditing firms with expertise in International Standards on Auditing and IAS, in accordance with national legislation. End-October 2003 Done
3.  Submit amendment of the BCN Law to the assembly to enhance the specificity of existing provisions for the removal of BCN Board members from office. Mid-May 2004 Done

To adopt IAS, the BCN hired a new external auditor in April 2004 for a three-year period and established a program to ensure adequate training for the staff of the accounting department and identify the necessary changes to the central bank law. The auditor will perform the reconciliation of the 2003 financial statements and will start the transition in June from Nicaraguan accounting standards to IAS by the end of the year.

External Sector Targets

34. Borrowing on nonconcessional terms. For the purpose of the ceiling on the contracting of nonconcessional external debt of the NFPS and the BCN, external debt limits apply to the contracting or guaranteeing of nonconcessional external debt by the public sector5 and the BCN or any other agencies on their behalf. This limit applies not only to debt as defined in Point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted by the IMF on August 24, 2000, but also to commitments contracted or guaranteed for which value has not been received. External debt includes all current liabilities with a nonresident party, which are created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, at some future point(s) in time to discharge the principal and/or interest liabilities under the contract. This definition includes loans, suppliers' credits, and leases (operational and financial leases). The ceiling on contracting of nonconcessional external debt applies both to medium-and long-term debt defined as debt with maturity of one year or longer, as well as to short-term debt, defined as debt with maturity of less than one year. For program purposes, BCN instruments placed in the domestic market held by nonresidents, will be excluded from the ceiling on the contracting of nonconcessional external debt and included in the net repayment of the domestic debt of the BCN target.

35. Excluded from the ceiling on debt with a maturity of less than one year are import-related credits and BCN reserve liabilities. Borrowing from the Fund is excluded from the ceiling (maturities up to one year).

36. Concessionality will be based on a currency-specific discount rate based on the 10-year average of the OECD's commercial interest reference rates (CIRR) for loans or leases with maturities greater than 15 years and on the six-month average CIRR for loans or leases maturing in less than 15 years. Maturity will be determined on the basis of the original loan contract. Under this definition of concessionality, only debt with a grant element equivalent to 35 percent or more will be excluded from the debt limits.

37. New loan reporting: A loan-by-loan accounting of all new loans contracted or guaranteed by the public sector, including detailed information on the amounts, currencies, and terms and conditions, as well as relevant supporting materials, will be transmitted on a quarterly basis within four weeks of the end of each quarter by the BCN.

38. External payments arrears. External payments arrears are defined as overdue debt service obligations arising from external debt contracted or guaranteed by the public sector, except on external debt subject to rescheduling or restructuring. For purposes of this performance criterion, liabilities arising from the Bonds for the Payment of Indemnification ("Indemnity Bonds") are excluded.

39. External arrears reporting: The accounting of nonreschedulable external arrears by creditor (if any), with detailed explanations, will be transmitted by the BCN on a monthly basis within four weeks of the end of each month.

40. Domestic arrears reporting: The accounting of domestic arrears by creditor (if any), with detailed explanations, will be transmitted by the BCN on a monthly basis within four weeks of the end of each month.

Other Definitions

41. Privatization receipts are defined as payments received by the government in connection with the sale of state assets net of any fee. The programmed amounts consistent with this definition are shown in Table 4. Privatization revenues in foreign exchange are those recorded as such in the balance of payments.

42. Balance of payments support. Official external untied financial assistance is defined as loans and grants provided by foreign official entities that are received by the government for unrestricted budgetary use. The amounts assumed in the program consistent with this definition are shown in Table 4.

43. Accounting of HIPC assistance. For the purposes of fiscal targets, HIPC assistance from multilateral creditors is categorized as grants. Only cash payments to other creditors are shown.

Table 4. Cumulative Program Financing(In millions of U.S. dollars)
      Privatization BOP Support Asset Recovery1

Cumulative from October 2002
    QIV 11 35   4
    QI 11 35   6
    QII 11 76   5
    QIII 12 76 29
    QIV2   3 95 29
Cumulative from January 2004
    Q I2 50 35   0
    Q II 51 50   0
    Q III 51 65   0
    Q IV 61 80   0

1Corresponds to the receipts of asset recovery net of the administration cost. This cost should not exceed US$5.6 million. Includes US$11 million received in BPI (face value), which for program purposes are recorded at market value (36 percent of the face value).
2From December 2003 through June 2004, adjusters will be calculated using the information shown in Table 4 of the TMU contained in EBS/03/177, December 2003.

1Starting in 2005, all operations of the electricity holding company (ENEL), the telecommunications regulatory agency (TELCOR), and the port company (ENAP) will be included in the program. The definition of the CPS overall balance is being expanded to include these enterprises. By September 2004, the expanded CPS overall balance will be included as an indicative target. Starting in 2005, the expanded CPS overall balance will be included as a PC. As complete and timely information becomes available for other public sector entities, the government intends to expand the definition of the public sector.
2With technical assistance from the international financial institutions, we intend to expand the definition of the nonfinancial public sector to include municipalities. A specific action plan will be devised at the next review.
3The BCN and the CG are taking steps to improve their debt statistics in order to be able to calculate all interest on an accrual basis, as recommended GFS manual.
4Study is ongoing and is expected to be concluded by end-August.
5As regards external sector targets, the public sector comprises the nonfinancial public sector as defined under fiscal targets, as well as all other public sector entities and enterprises including, the airport, the lottery, CORNAP, and ENAP.