Public Information Notice No. 10/83

Public Information Notice: IMF Executive Board Concludes 2010 Article IV Consultation with Nicaragua

July 14, 2010

On July 9, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the 2010 Article IV consultation with Nicaragua.¹

Background

Nicaragua was negatively affected by the global crisis, but there are signs that an incipient recovery is underway. After years of solid economic growth, averaging close to 4 percent per year during 2004–08, real GDP fell by 1.5 percent in 2009, led by sharp declines in private consumption and investment. Annual inflation dropped below one percent in 2009, reflecting lower commodity prices and weaker domestic demand. Despite the large external shock, domestic and external stability have been maintained, and the economy is projected to grow by about 2 percent in 2010, in line with a gradual improvement in the global outlook.

The authorities’ economic policies have sought to balance the objectives of supporting demand in the near term while maintaining domestic and external stability to foster sustained growth in the medium term. While policies in 2009 were geared to cushion the impact of the global downturn on activity and the poor, emphasis must now shift towards ensuring the medium-term sustainability of public finances.

The fiscal deficit is projected to decline to 3.3 percent for 2010 (3.9 percent in 2009), underpinned by an austere budget, tax measures yielding 0.7 percent of GDP, and an increase in the pension contribution rate. However, spending pressures are proving difficult to contain. Going forward, these pressures would need to be resisted and offsetting measures may be required to ensure that the medium-term sustainability of public finances is secured.

Monetary policy has been geared at protecting international reserves in the context of the crawling peg regime. The coverage of gross international reserves has continued to improve, reaching US$1.6 billion by end-2009, the equivalent of over 5 months of imports. Legislation has been submitted to the Assembly aimed at strengthening the central bank’s autonomy and accountability, as well as improving its monetary operations toolkit.

The financial system remains generally stable. Liquidity buffers stand at record levels and banks remain well capitalized. Bank deposits continue to grow and total credit seems to have stabilized, after falling in 2009. The authorities have stepped up on-site supervision and strengthened regulations to increase provisioning on restructured and postponed loans. Regulations have been issued to strengthen transparency of the credit card sector, and ensure the orderly implementation of a law mandating the restructuring of microfinance loans.

Progress has been mixed on the structural front. In the energy sector, electricity tariffs were adjusted in May 2010, for the first time in 6 months, and legislation has been submitted to the Assembly to expand the net of consumers subject to the anti-theft law. Further efforts are required to advance presentation of a comprehensive plan to put the finances of the pension system on more solid footing; in addition, it remains necessary to assess tax exemptions with the view of rationalizing their use.

Executive Board Assessment

Executive Directors noted that Nicaragua’s policy response, which balanced supporting demand in the near term and safeguarding macroeconomic stability, helped the economy weather the global crisis. With an incipient recovery currently underway, Directors noted that policies now need to shift toward consolidating public finances while continuing to protect the poor.

Directors welcomed the authorities’ commitment to reduce the fiscal deficit in 2010, including through the approval of a revenue-enhancing tax reform. However, they raised concerns about slippages on public sector wages and encouraged the authorities to adopt compensatory measures to keep spending at prudent levels, while avoiding off-budget operations. Directors stressed the importance of safeguarding infrastructure and social spending while containing the growth in current spending.

Directors noted that placing public debt on a firmly declining path would require broadening the tax base and reducing budget rigidities and the imbalances of the pension system. They encouraged the authorities to initiate a public consultation process to discuss options to place the pension system on a sound financial footing. Securing debt-relief from non-Paris club creditors also remains a priority.

Directors supported the authorities’ prudent management of monetary policy and efforts to increase international reserve coverage. They emphasized the need to improve the Central Bank's monetary operations toolkit and welcomed the authorities' intention to strengthen the accountability and independence of the Central Bank by modifying its charter.

Directors welcomed efforts to safeguard the stability of the banking system in the wake of the global crisis. They stressed the need to remain vigilant to a further deterioration in loan quality and welcomed the recent adoption of stricter provisioning rules to protect capital buffers. Directors noted the importance of implementing the Financial Sector Assessment Program (FSAP) Update recommendations while resisting initiatives that could undermine creditor rights. They encouraged the authorities to adopt a legal framework that would strengthen the regulation of the microfinance sector.

Reforms in the energy sector are necessary to improve Nicaragua’s competitiveness. Directors welcomed efforts to reduce losses in distribution and encouraged the authorities to establish transparent criteria for adjusting tariffs. Directors noted that a predictable and sound regulatory framework was essential to secure private investment in renewable generation and limit quasi-fiscal risks.

Directors underscored the need to improve the effectiveness of public spending to reduce poverty and boost growth over the medium term. Efforts should continue in strengthening procurement and audit procedures as well as the transparency and accountability of official assistance.

Directors noted that strengthening governance and the business climate are essential to strengthen growth and improve living standards, including by leveraging gains from recent trade agreements and regional integration efforts.

It is expected that the next Article IV consultation with Nicaragua will be held in accordance with the Executive Board decision on the consultation cycle for members with Fund arrangements.