Nicaragua: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
13 Dec 2002
eISBN:
9781451829181
Language:
English
Keywords:
ISCR; CR; debt; VAT; Nicaragua; GDP; Public Sector debt sustainability framework; debt problem; debt stock; public sector debt; creating capital inflows; Debt service; Deflation; exports of g
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This Selected Issues paper and Statistical Appendix examines factors that have determined long-term growth in Nicaragua. Stylized facts suggest that government policies have had a decisive influence on growth. In particular, productivity and capital accumulation suffered during periods of excessive deficit spending and inadequate enforcement of private property rights. A sectoral analysis of growth reveals that liberalization and deregulation in the 1990s led to deep structural changes in the economy. The paper also describes the main characteristics of Nicaragua’s tax system, identifying key weaknesses and their economic costs.

Abstract

This Selected Issues paper and Statistical Appendix examines factors that have determined long-term growth in Nicaragua. Stylized facts suggest that government policies have had a decisive influence on growth. In particular, productivity and capital accumulation suffered during periods of excessive deficit spending and inadequate enforcement of private property rights. A sectoral analysis of growth reveals that liberalization and deregulation in the 1990s led to deep structural changes in the economy. The paper also describes the main characteristics of Nicaragua’s tax system, identifying key weaknesses and their economic costs.

III. Debt Sustainability7

A. Introduction

Nicaragua’s public sector debt represents a major source of vulnerability. A key objective of the authorities’ economic program is to reach medium-term fiscal and external sustainability by addressing the underlying macroeconomic and structural weaknesses that gave rise to the debt problem. In addition, implementation of the enhanced HIPC initiative will reduce substantially the size and cost of the debt. Even so, medium-term debt management will remain a challenge, requiring pursuit of prudent fiscal policies and strictly limiting new nonconcessional borrowing. While the baseline medium-term outlook is favorable, sensitivity tests indicate that the debt reduction could be considerably slower under a number of alternative scenarios (including terms of trade, exchange rate, and fiscal shocks).

28. This chapter analyzes the size and dynamics of Nicaragua’s public debt and presents a number of stress tests to illustrate the effect of alternative assumptions on the debt dynamics. Although external debt has traditionally been at the center of attention, the large size, short maturity and high cost of domestic debt are also a major source of vulnerability. While at end-2001 the face value of Nicaragua’s external debt (250 percent of GDP) was four-times the size of the domestic debt (60 percent of GDP), in net-present value terms and after expected debt relief under the enhanced HIPC Initiative, the external debt by end-2003 should be down to about 63 percent of GDP, only slightly higher than domestic debt (56 percent of GDP - Table 1). In terms of debt service, the domestic debt is already much more onerous than external debt (Table 2).

Table 1.

Nicaragua: Public Sector Debt

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Sources: Central Bank of Nicaragua, Ministry of Finance; and Fund staff estimates.

External debt in nominal terms.

External debt in NPV terms. Preliminary projections based on revised aggregate data, not strictly comparable to decision point projections.

External debt stock presented after debt relief, assuming a Cologne flow rescheduling after approval of a new PRGF arrangement, and a stock operation at end-2003.

Table 2.

Nicaragua: Public Sector Debt Service (Cash basis) 1/

(In millions of US dollars)

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Sources: Central Bank of Nicaragua; Ministry of Finance; and Fund staff estimates.

External debt service presented after debt relief The high amount of interest on domestic debt interest in 2004 reflects, zero-coupon-type bonds includes coupon-type bonds falling due in that year.

B. Size and Origins of the Public Sector Debt

External debt

29. Most of Nicaragua’s external debt is owed to official creditors, with multilaterals representing 37 percent of the total, other official bilateral creditors 35 percent, and Paris Club creditors about 23 percent (Figure 1). Nicaragua was declared eligible for debt reduction under the enhanced HIPC Initiative in December 2000 (EBS/00/259). The reduction was designed to cut the debt by 72.2 percent in net present value terms (after full application of traditional debt relief mechanisms), in order to bring the ratio of external debt to exports down to 150 percent. Assuming that the HIPC completion point is reached by about end-2003, Nicaragua’s external debt is expected to be cut by about two-thirds in net-present value terms, to US$1.7 billion, with external debt service reduced to below US$100 million in 2004 (8 percent of exports, or 13 percent of central government revenue).8

Figure 1.
Figure 1.

Nicaragua: Stock of External Debt, End-December 2001

National value of Debt: US$ 6.4 billion

Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A003

30. Nicaragua’s external debt problem arose as borrowing grew much faster than repayment capacity, due to unsustainably high government spending in the late 1970s and the 1980s. By 1990, the debt stock amounted to US$10.7 billion, 40 percent of which was in arrears. Thereafter, Nicaragua benefited from three Paris Club reschedulings (1991, 1995 and 1998), reached a number of bilateral rescheduling agreements with non-Paris Club creditors, and implemented a commercial debt buy-back operation, at a 92 percent discount, for US$1.1 billion in debt (around 83 percent of the total commercial debt offered). These operations reduced Nicaragua’s debt burden from six-times GDP at the end of 1993, to less than three-times GDP at the end of 1999 (face value).

Domestic debt

31. Most of the domestic debt (US$½ billion) is indexed to the U.S. dollar. There are two types of domestic paper: about half of them are so-called “property indemnization bonds (Bonos de Indemnizacion de la Propiedad-BPIs), issued by the ministry of finance, with the other half represented by “negotiable investment certificates” (Certificados Negociables de Inversion - CENIs) issued by the central bank. CENIS have maturities of up to three years and carry market interest rates (currently about 14-15 percent), while BPIs are long-term instruments (15 years, with a ten-year grace period) with interest rates of 3-5 percent.

32. The domestic debt problem arose mainly as a result of institutional weaknesses and governance issues. In the case of BPIs, they started being issued in the early 1990s to compensate previous owners of properties confiscated during the Sandinista regime, as ill-defined land rights and vested interests prevented alternative solutions. Out of a total of US$817 million of BPIs that have been approved for issuance by the ministry of finance, so far US$637 million have been issued. While these debts start maturing in 2004, maturities become significant after 2007. CENIs bancarios were issued by the central bank (i) to mop up the liquidity created in supporting public sector banks in financial difficulties; and (ii) to cover the difference between performing assets and liabilities of insolvent private banks that were intervened and absorbed by other private banks in 2000-01. These new placements amounted to about 20 percent of GDP.

33. The domestic debt is a major source of vulnerability. Given its high level, short-term maturity, and indexation to the U.S. dollar, it is subject to major exchange rate, interest rate and rollover risk.

C. Medium-Term Outlook and Sensitivity Analysis

Baseline

34. The baseline medium-term outlook is favorable, assuming implementation of prudent macroeconomic policies and of structural reforms (Table 3). In particular:

  • Real GDP is expected to increase gradually to 5 ½ percent by 2007, based on a recovery of international commodity prices, higher foreign direct and private investment (reflecting improvements in the business environment and financial sector reform, and the targeted fiscal adjustment). Inflation would remain low, based on prudent fiscal and monetary policies.

  • The external current account deficit would improve gradually from 38 percent of GDP in 2002 to 17 percent in 2007, based on continued growth in nontraditional exports as well as a recovery in international commodity prices and lower oil prices (in line with WEO assumptions). The services balance would benefit from higher tourism and free-trade zone revenues, while private remittances would remain significant.

  • Medium-term fiscal consolidation efforts center on tax reform, expenditure restraint and public sector restructuring. The combined public sector deficit after grants is targeted to decline from 9.2 percent of GDP in 2002 to about 3 V½ percent of GDP by 2007.

  • Thanks to the fiscal adjustment and exceptional resources from balance of payment support, asset recovery and privatization proceeds, the central bank reserve position is expected to improve significantly by 2007, to US$230 million (three months of imports), and the domestic debt is to decline by about US$195 million.

  • As noted, Nicaragua’s participation in the enhanced HIPC Initiative will substantially reduce the external debt.

Table 3.

Nicaragua: Medium-Term Economic Indicators

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Sources: Central Bank of Nicaragua; Ministry of Finance, and Fund staff estimates.

Includes debt denominated in and indexed to the U.S. dollar.

35. On this basis, the stock of total debt would decline from 230 percent of GDP in 2001 to 95 percent in 2007. Debt service would peak at 26 percent of GDP in 2004 and fall to 11 percent of GDP by 2007. Although the debt service burden projected for the next few years is still high, the prospect of continuous reduction in the stock and implementation of prudent fiscal policy, with a return to primary surpluses by 2005, should help build private sector confidence and facilitate rollovers at longer maturities and more favorable interest rates. Progressively lower public sector debt service over the medium-term will allow the government to expand poverty-reducing expenditures, and the repayment of debt to domestic banks will increase the amount of credit available for domestic investment.

Sensitivity analysis

36. The sensitivity of the projected path of public debt to a number of shocks has been tested, using a methodology in line with the analytical framework developed in a recent Board paper on assessing sustainability (SM/02/166). For total (domesticplus external) public debt, the projections have been tested for their sensitivity to three types of shocks (Figure 2 and Table 4).

  • A 30-percent sustained real depreciation of the exchange rate in 2003;

  • A delay in implementation of the HIPC initiative, and/or another large issue of domestic debt in response to banking sector problems, resulting in a 30-percent higher stock of debt at end-2003; and

  • A higher combined public sector deficit in 2003 and 2004 (by two standard deviations of the past five-year average, or 6.5 percent of GDP) and lower proceeds from asset recoveries, privatization, and balance of payments support (by about 10 percent of GDP).

Figure 2.
Figure 2.

Sensitivity Tests of Public Debt Dynamics

Citation: IMF Staff Country Reports 2002, 269; 10.5089/9781451829181.002.A003

Table 4.

Nicaragua: Public Sector Debt Sustainability Framework, 1997-2007

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Sources: Central Bank of Nicaragua; Ministry of Finance, and staff projections.

Combined public sector.

Defined as: r = interest rate; π = GDP deflator, growth rate: g = real GDP growth rate.

Real appreciation is approximated by nominal appreciation against U.S. dollar plus increase in domestic GDP deflator.

37. These shocks would result in a stock of debt roughly 25-30 percent higher by 2007. Other scenarios examined include a higher fiscal deficit but with “exceptional” proceeds as programmed, which would lead to a debt-to-GDP ratio of about 110 percent by 2007 (compared with about 95 percent of GDP in the baseline); and lower GDP growth in 2003-04 (1.7 percent) resulting in a moderately higher debt ratio (100 percent).

38. The dynamics of external debt under various sensitivity tests are shown in Table 5. In the baseline scenario, mainly because of the impact of the enhanced HIPC initiative, the ratio of external debt to exports falls from over 300 percent in 2002 to about 140 percent in 2007, and the debt-to-GDP ratio also falls steadily from 111 percent to 63 percent over the same period. Sensitivity analysis shows that if key variables were at their average level of the past 5 years, the ratio of external debt to GDP would be much higher in 2007 than in 2002 (by 80 percentage points) reflecting the unsustainable path of those variables between 1997 and 2001. The simulations also show that the projection is most sensitive to a large, sustained depreciation. In case of a 30 percent real depreciation in 2003, the external debt by 2007 would be about 30 percent of GDP higher than in the baseline. In case of a deterioration in the external environment (higher oil prices as well as lower commodity prices and private remittances)9, the debt to GDP ratio would be about 10 percentage points higher at the end of the projection period than in the baseline scenario. However, as mentioned earlier, in all scenarios the impact of HIPC clearly dominates and would still lead to a steadily declining external debt to GDP ratio.

Table 5.

Nicaragua: External Sustainability Framework, 1997-2007

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

External debt in NPV terms.

D. Conclusion

39. This chapter illustrates the importance of looking at total public sector debt when assessing medium-term fiscal sustainability, and shows that looking at external debt in isolation of domestic debt can be misleading. This is particularly true in Nicaragua, where domestic debt is large, costly, and mostly indexed to, or denominated in, foreign currency. The baseline outlook is for the ratio of total public debt to GDP to decline toward sustainable levels, mainly as a result of the HIPC initiative, fiscal adjustment, and exceptional proceeds from privatization, asset recoveries, and balance of payments support. However, the high level of domestic debt and its sensitivity to shocks remains a vulnerability. In particular, a large exchange rate depreciation would worsen the debt dynamics, and large domestic maturities in the next few years are subject to roll-over risk.

References

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  • Beaugrand, Philippe, Loko, Boileau, and Mlachila, Montfort, 2002, “The Choice Between External and Domestic Debt in Financing Budget Deficits: The Case of Central and West African Countries,” IMF Working Paper 02/79 (Washington: International Monetary Fund-available on the IMF website at http://www.imf.org).

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STATISTICAL APPENDIX

Table 1.

Nicaragua: Gross Domestic Product by Expenditure

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Source: Table 19.

General government current expenditure minus interest payments, pensions and indemnizations, current transfers, and “other” current expenditure.

Table 2.

Nicaragua: Resource Balance and Financing of Investment

(In percent of GDP at current prices)

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Source: Table 19.

General government current expenditure minus interest payments, pensions and indemnizations, current transfers, and “other” current expenditure.

Includes quasi-fiscal losses of the Central Bank of Nicaragua.

Table 3.

Nicaragua: Gross Domestic Product

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Source: Table 18.
Table 4.

Nicaragua: Value Added in Agriculture

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Source: Table 20.
Table 5.

Nicaragua: Value Added in Manufacturing

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Source: Table 23.
Table 6.

Nicaragua: Consumer Price Index

(Index: 1994=100)

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Source: National Institute of Census and Statistics (INEC).
Table 7.

Nicaragua: Operations of the Combined Public Sector

(In percent of GDP)

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Source: Table 33.

Includes the general government (central government, the social security institute, and the municipality of Managua); and the public utility enterprises.

Includes other current revenue of public utility enterprises.

Table 8.

Nicaragua: Central Government Operations

(In percent of GDP)

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Source: Table 27.