This statement summarizes the preliminary findings and recommendations of the mission that visited Managua during April 24-May 5 in the context of the 2017 Article IV consultation. The mission is grateful to the authorities for the constructive dialogue and hospitality.
Growth has been robust while inflation remains well anchored. External imbalances improved moderately in 2016 while the fiscal deficit increased marginally. Given heightened uncertainties with respect to the external environment, Nicaragua needs to continue strengthening its policy framework to stave off downside risks and promote sustained and inclusive growth. Policy discussions focused on (i) creating fiscal space to manage risks and promote sustainable growth; (ii) strengthening monetary management, financial stability and the AML/CFT framework; and (iii) improving external resilience and competitiveness.
Recent Developments and outlook
1. Macroeconomic performance in 2016 was solid
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Economic activity remained robust
. Real GDP grew by 4.7 percent in 2016, supported by strong
domestic demand, while inflation remained subdued at 3.1 percent as
of end-2016, owing largely to low food prices. Inflation
expectations remain well anchored by the crawling peg.
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The fiscal deficit increased slightly in 2016
. Revenues increased by over 0.6 percent of GDP in 2016, because of
advances in tax administration and the impact of the full
implementation of the 2012 tax reform. Nevertheless, the deficit of
the consolidated public sector (CPS) widened from 2.2 percent in
2015 to 2.4 percent in 2016 due to election-related spending,
expansion of public investment and a higher Social Security
Institute (INSS) deficit. The CPS debt ratio edged up to 40.1
percent of GDP in 2016 from 39.3 percent in 2015, excluding
state-owned enterprises (SOEs) and municipalities.
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The external position improved moderately from the previous
year
. The current account deficit for 2016 is estimated to have
narrowed to 8.6 percent of GDP, compared with 9 percent in 2015.
The deficit reduction is largely explained by maquila exports,
which have been better captured due to improvements in statistical
compilation. The current account deficit remained financed by
foreign direct investments (FDI) and other long-term inflows. Gross
international reserves remained broadly stable at US$2.3 billion at
end-2016, with coverage of about 4 months of non-maquila imports.
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Monetary and financial conditions remained stable
. Bank soundness indicators as of end-2016 were relatively robust.
However, balance sheet risk from an expansion of bank credit in
dollars to unhedged borrowers is rising in the context of
increasing interest rates, continued dollar strength and higher
reliance on external financing. Consolidated supervision of
regional banks continues to be a challenge and some non-bank
financial institutions, including deposit-taking credit
cooperatives, remain unsupervised.
2. GDP growth is expected to moderate to its potential.
Real GDP growth in 2017 is projected at 4.5 percent, while
inflation is expected to remain contained at about 6 percent,
assuming food and oil prices remain consistent with projections of
the IMF’s World Economic Outlook. The deficit of the CPS is
projected to moderate somewhat, to about 2.2 percent of GDP,
implying a broadly neutral fiscal stance in line with the
authorities’ fiscal anchor. At the same time, however, the deficit
of the INSS is expected to continue increasing up to 0.43 percent
of GDP in 2017. CPS debt, excluding domestic debt of SOEs and
municipalities, is projected at rise further to about 40.6 of GDP.
The current account balance is projected to remain stable at about
8.4 percent of GDP.
3. Risks are tilted to the downside against a background of high
global uncertainties
. In addition to the growing deficits of the INSS, risks include
spillovers related to the decline in Venezuelan oil cooperation and
potential shifts in U.S. trade and migration policies, which might
have global spillovers on exports and remittances.
Policy Recommendations
The key challenge is to reduce economic vulnerabilities while
maintaining policies geared towards strong, sustained, and inclusive
growth. It will be critical to create fiscal buffers to insure against
downside risks, while preserving social and infrastructure investment;
bolstering financial stability by strengthening the macroprudential
framework, boosting liquidity, provisions and capital buffers,
broadening the supervisory perimeter to all deposit-taking
institutions, and effectively implementing the AML/CFT framework;
continue developing central bank’s monetary management capacities and
deepening financial markets; and improve external resilience and
competitiveness.
A. Creating Fiscal Space to Manage Risks and Promote Sustained
Growth
4. The fiscal stance for 2017 is broadly appropriate
.
With the output gap closed and a stable external debt ratio, the
projected CPS deficit of 2.2 percent of GDP represents a broadly
neutral fiscal stance. Adhering to the fiscal anchor of no more
than 2 percent of GDP for the CPS deficit, consistent with debt
sustainability given current financial conditions, would help
increase the transparency and credibility of the fiscal policy
stance. However, Nicaragua is likely to face increased spending
pressures going forward due to reduced financing from Venezuela and
the weakening financial situation of INSS. At the same time, should
the NICA Act pass, financing costs might increase. To insure
against these risks and maintain fiscal sustainability, the mission
recommends building additional fiscal buffers of about 1.6 percent
of GDP over the next two years through revenue mobilization and
improving expenditure composition and efficiency, while
safeguarding pro-growth public investment and strengthening and
better-targeting social safety nets. The mission considers that
implementing these measures would provide sufficient insurance
against the risks described.
5. Ensuring the sustainability of the INSS remains a key priority
. The increase of INSS’s deficits might increase public debt in the
long run, threatening its sustainability. Under current policies,
the INSS will continue to run deficits and deplete its liquid
reserves by 2019, potentially necessitating transfers from the
government. A sustainable outcome could be achieved by a
combination of: (i) streamlining and rationalizing operational and
health costs; (ii) increasing the retirement age; (iii) raising the
minimum contribution period; (iv) increasing employer and employee
contribution rates; (v) revising the pension indexation mechanism;
(vi) reducing benefits; and (vii) assuming some expenditures by the
government (for instance, reduced and special pensions). It is
important that the government, labor unions, and the private sector
arrive at a mutually agreeable solution as a matter of priority, as
delaying the reforms will lead to a worsening of the situation and
increase the costs.
6. Policy efforts should focus on broadening the tax base, further
strengthening tax administration, and improving expenditure
composition and quality.
Additional fiscal consolidation needed to address the challenges
mentioned above could be obtained by eliminating tax expenditures,
rationalizing and better targeting subsidies and implementing the
legislation on international taxation, while strengthening tax
administration. Further, quality of public infrastructure spending
could be enhanced by strengthening public investment management
processes and practices, and improving the efficiency and
governance of the major SOEs. Progress made by the authorities on
the analysis of fiscal risks, including the monitoring of SOEs, is
welcome, and further advances in this area are encouraged.
7. Going beyond insuring against immediate downside risks, the
fiscal stance should strive to improve resilience against
potential external shocks, including climate change and natural
disasters.
Given the fiscal risks related to external uncertainties and
Nicaragua’s vulnerability to climate change and natural disasters,
fiscal policy should aim to be more counter-cyclical—building space
in good times to be able to avoid volatility in expenditure and the
need for abrupt adjustments should tail-risks materialize.
B. Strengthening Monetary Management, Financial Stability and the
AML/CFT Framework
8. Strengthening risk-based supervision and tightening the
macroprudential framework remain a priority.
Higher interest rates, sustained U.S. dollar strength, and possibly
lower remittances, might have a negative impact on banking sector
soundness in the context of large un-hedged dollar assets. The
authorities should continue monitoring and further strengthening
their monetary, regulatory and macroprudential toolkit, including
by conducting regular stress tests, notably to assess systemic
risks, and crafting contingency plans. The mission supports the
authorities’ plans to gradually strengthen regulatory liquidity
ratios, countercyclical provisions and capital requirements.
9. Gaps to the financial supervisory perimeter need to be
addressed
. Effective supervision of the savings and credit cooperatives and
microfinance industry requires further resources, capacity
development and, in some cases, better prudential regulation. All
deposit-taking institutions and institutions with strong
macro-financial links should be subject to effective risk-based
supervision. While consolidated supervision of cross-border banking
groups has improved since the establishment of the Liaison
Committee at the Regional Group of Financial Sector Superintendents
and the commissioning of the regional College of supervisors,
further progress is needed to fully assess the risks of Nicaraguan
banking groups that report consolidated financial statements to the
supervisory authorities of other countries in the region.
10. There is a need to deepen financial markets, strengthen
liquidity management and increase financial inclusiveness
. Deeper financial markets are needed to increase the ability of
financial institutions to manage their risks, and enhance liquidity
management by the central bank. The efforts of the central bank to
strengthen its liquidity management capacity through better
liquidity forecasting and introducing shorter-term liquidity
management tools are welcome developments that will, in time, allow
establishing a short-term monetary reference rate and corridor,
reduce interest rate volatility, and deepen the interbank and
domestic bond markets. In this context, efforts to capitalize the
central bank need to continue. Initiatives to increase financial
inclusion, including by developing a simplified savings account,
facilitating access to payment methods, and developing a national
plan of financial education, are welcome and should be pursued with
a greater sense of urgency, notably in the context of a
comprehensive strategy to enhance inclusive growth, reduce poverty
and strengthen financial stability.
11. Additional efforts are needed to improve the
Anti-Money Laundering/ Combating the Financing of Terrorism
(AML/CFT) regime
. Nicaragua has made significant progress in improving the AML/CFT
regime and is no longer subject to the FATF’s monitoring process
under the International Cooperation Review Group. Nevertheless,
efforts should continue to ensure the effective implementation of
the AML/CFT regime particularly with regard to preventive measures.
Nicaragua is scheduled to undergo in 2017 a full assessment, under
the revised FATF standards that emphasize implementation and
effectiveness. The assessment should be finalized before the end of
the year and the authorities are encouraged to implement its
recommendations.
C. Improving External Resilience and Competitiveness
12. Vigilance of external shocks is warranted.
The crawling peg exchange regime has been effective in anchoring
inflation expectations. However, the peg will likely exacerbate the
negative impact of an external shock on output, competitiveness and
exports. There is, therefore, a tradeoff between the price
stability anchor provided by the peg and the cost of limited
adjustment policy tools. Better understanding and continuous
monitoring of the spillover effects of a persistently strong
dollar, higher interest rates and other U.S. policy changes would
help the authorities in making the appropriate policy choice.
13. Improvements in competitiveness would reduce vulnerabilities to
external shocks
. Supply side reform policies should focus on strengthening medium
and long-term competitiveness. Efforts should be made to diversify
products and markets and reduce external dependence. Although
Nicaraguan wages remain the most competitive in Central America,
other aspects of competitiveness are lagging. Improving
infrastructure, investing in human capital, and addressing labor
skills bottlenecks would facilitate structural transformation and
enhance potential growth.
D. Other Issues
14. Significant progress has been made in strengthening
macroeconomic statistics, but shortcomings remain
. The mission welcomes the progress made in
implementing IMF recommendations on data compilation, particularly
in the external sector and base statistics.
Addressing remaining shortcomings in national accounts, fiscal,
debt, and external sector statistics—particularly data on
FDI—entails continued building on the Fund’s technical assistance
to improve the timeliness, quality, and consistency of statistics.
Regulations to enforce data collection and facilitate exchange of
information across units and institutions should be implemented and
procedures need to be established to monitor data quality.
Table 1: Nicaragua: Selected Social and Economic Indicators, 2012 - 17
