Nicaragua
Poverty Reduction Strategy Paper Second Progress Report

The government of Nicaragua has worked toward adopting the necessary economic measures to put the country’s economy on the course of fiscal sustainability and those that guarantee transparent and austere management, not affecting the most vulnerable population. The government has managed to protect social spending, providing resources for strategic sectors, improving performance indicators for health and education, and implementing reforms that will have a greater impact on these sectors. It is expected that the tendency for social spending will be maintained in the coming years.

Abstract

The government of Nicaragua has worked toward adopting the necessary economic measures to put the country’s economy on the course of fiscal sustainability and those that guarantee transparent and austere management, not affecting the most vulnerable population. The government has managed to protect social spending, providing resources for strategic sectors, improving performance indicators for health and education, and implementing reforms that will have a greater impact on these sectors. It is expected that the tendency for social spending will be maintained in the coming years.

I. Introduction

1. After two years (August 2001 – August 2003) of having gotten the Strengthened Growth and Poverty Reduction Strategy (SGPRS) underway, the Government of Nicaragua is now presenting the second progress report to its citizens and the international community providing information about the progress made, the setbacks and difficulties encountered over this short period. This report, besides fulfilling the agreements made with international organizations, offers an excellent opportunity for the governmental entities, civil society, and the donors themselves to provide new recommendations based on what has transpired in order to improve the content of the SGPRS. Along this line, it should be remembered that the strategy paper was not to be considered a static document, but rather it was meant to be improved along the way of its implementation.

2. Since the development of the SGPRS, it was recognized that some fundamental principles had only been stated, hastily developed or weakly formulated given the lack of adequate analytical instruments, the novelty of the subject matter or the over-optimism permeating its elaboration. The frailty of the Strategy facing world events and internal political situations was also recognized. It was necessary to make various revisions to the medium-term macroeconomic scenario on which the SGPRS is based and there were several advances made on positions with the International Monetary Fund (IMF) without being able to reach a formal agreement for the Poverty Reduction Growth Facility (PRGF) in 2001. In the end, the goals of the SGPRS were established with the best criteria available at the time under the prevailing economic prospects and in the frame of an interim program agreed on with the IMF.

3. During its two years of implementation, the SGPRS has not had a climate that is propitious for its development. It came to life under a political environment of elections that slowed down the expectations of the private sector and the donor community. There was also the need to take severe fiscal measures in order to cope with the effects of the financial crisis. In addition, the international setting continued to be highly adverse; the fight against corruption generated political costs that affected the implementation of the government program; and the economic growth was less than expected.

4. Social reform proceeded slowly because of the sector’s difficult situation, which imposed its pace for action in the Government’s struggle to respond to the most felt needs with a limited budget, also because the accelerated population growth in some regions of the country and the low level of dynamism of the private sector in generating employment in relation to the growth of the economically active population. The budget currently given to health and education is the lowest in the Central American region 1, and this limits the coverage of services in these sectors. In the long term, the low level of investment for increasing the country’s health centers capacity and for building more schools could have an influence on attaining the objectives of the SGPRS.

5. On the other hand, cutting extreme poverty by half by 2015 requires having the economy grow faster than the population, and an increased capacity of the Government to provide health and education services at a rate higher than the present one. It is important to compensate for the cumulative shortfall in these sectors with regards to coverage and have the economy generate sustainable employment over this period.

6. This situation becomes particularly relevant when analyzing the evolution of the economy over the last few years. In 2002, economic growth was barely 1.0 percent over the previous year, showing an average annual deceleration of 2.6 percent since 1999. It is estimated that the Gross Domestic Product (GDP) for 2003 may grow by 2.3 percent, in which case per capita income would fall for the third consecutive year, which in turn will further distance the fulfillment of the poverty reduction goals. It is necessary to have greater GDP growth in the future, above 5.0 percent, in order to reach the millennium development goals in 2015, or more time at a lower growth will be needed.

7. The above is due in part to structural factors related to property rights, the judiciary system and the technological gap. In addition, the international setting has not improved for agricultural producers, the private sector is cautious in the presence of political issues, and foreign investment arrives at a slow pace. On the other hand, in 2002 the Government had to maintain a restrictive public spending program, because of the internal debt, the economic slowdown effect on fiscal revenues and the need to increase savings.

8. Nevertheless, due to the efforts that the Government made to control the fiscal deficit and on taking some measures of a structural nature, the first PRGF agreement was reached in December 2002 with the IMF and the World Bank (WB) that guaranteed external resources to support government policies, and included the interim debt relief from HIPC for poverty reduction programs. In 2003, the Government continued to further the adjustment, introducing the Law for Fiscal Equity and regulating spending performance quarterly, which improved the primary savings rate. It was also possible to renegotiate a portion of the internal debt associated with bankruptcies of banks, and given the improvement of some performance indicators for the economy, the IMF agreed in its third quarter review of the PRGF to make the public investment program for 2003 and 2004 more flexible, which is consistent with the initiatives aimed at stimulating economic growth.

9. The Government has worked towards adopting the necessary economic measures to put the country’s economy on the course of fiscal sustainability and those that guarantee transparent and austere management, not affecting the most vulnerable population. In the second year of implementing the SGPRS, the Government has managed to protect social spending, providing resources for strategic sectors, improving performance indicators for health and education, and implementing reforms that will have a greater impact on these sectors. It is expected that the tendency for social spending will be maintained in the coming years.

10. It should be mentioned that the international community has supported the Government in this effort by: supporting the fight against corruption undertaken from the onset through programs that strengthen institutionality and the control and supervision of public affairs; granting interim foreign debt relief that has served to protect spending on the priority social programs of the SGPRS; condoning the debt that was impossible to pay in previous years, thereby putting the country into a better balance of payments position; providing technical assistance and, signing new cooperation agreements for budgetary support and financing of public investment.

11. Through these efforts, during the second year of execution of the SGPRS, social indicators showed a general improvement (including those related to the well-being of health and education workers). Modest salary increases, increases in the supply of medicines and medical inputs, greater coverage of drinking water, drainage, and sewage, and more poverty-related capital spending are some indications of good performance in this area.

12. Nonetheless, the historical shortfalls in these sectors, the growth of the population, and the decline in economic activity combined with the effect of the public debt have made these efforts insufficient. To reach the targets committed to in the SGPRS, it is necessary to have more efficient public spending, tax evasion reduction, production stimulation, and institutional reforms. Likewise, there must be greater budgetary allocations for the social sectors, compatible with the savings to assure sustainability.

13. The second report on the SGPRS benefited from the first program for economic growth and poverty reduction agreed on with the IMF for the October 2002 – September 2005 period, signed in December 2002. It also includes the results from the fourth quarter review of the PRGF carried out by the IMF mission of November 2003. Help from other reports related to poverty spending and the economic situation, such as the annual report on social and economic policy for 2002 prepared by the Coordination and Strategy Secretariat of the Presidency (SECEP) and the annual BCN report for 2002, were influential in reinforcing the content of this report. Likewise, the information for drafting the National Budget for 2003 and 2004 was important for reporting on the availability of resources channeled towards the SGPRS.

14. The guidelines for a production strategy and for new ideas to strengthen social policy that were formulated in 2002 and 2003 have served to evaluate the conceptual framework for the SGPRS. The Government began a consultation process to prepare the National Development Plan (NDP), the results of which were presented to the international community at the Consultative Group meeting in October of this year. This strategic plan is consistent with the PRGF and strengthens the poverty reduction strategy (PRSP) agreed on with the international community. It will include a more integral vision between economic growth and poverty reduction, putting forward a production strategy based on the development of clusters and incorporating new mechanisms for allocating resources, combining the poverty map with the map of economic and productive potentials, among others.

15. This second report differs from the first, that besides evaluating the progress of the goals, programs, projects, and intermediate indicators under the different pillars on which the SGPRS rests, it also analyzes the conceptual framework, the assumptions, and macroeconomic projections estimated three years ago. With all this, it has been possible to identify the critical areas in which the initial proposals of the SGPRS must be strengthened based on the strategic guidelines of the NDP.

II. Executive Summary

16. The evaluation of the second year of implementation of the SGPRS shows major progress in the execution of strategic policies, programs, and projects that are aimed at achieving the goals set for 2005 and paving the way for achieving the major strategy objectives: poverty reduction and economic growth in the medium and long term. It also indicates the shortfalls of some policies and performance indicators in the economy and in the social sector, having to cope with adverse settings in several fronts.

17. The Government has channeled all possible efforts in order to fulfill what is set down in the SGPRS, and it is also seeking to strengthen it with new proposals in the areas of production, public investment, and fiscal and monetary stability. Despite the Government moving ahead with a severe adjustment program in 2002 and 2003 to achieve fiscal sustainability, the major gain was to protect social spending channeled to the public sector in order to improve the welfare of the most vulnerable population. Poverty spending in real terms showed an increasing tendency during the 2001-2003 periods.

18. This allowed for increasing the net rate of primary schooling from 81.1 to 84.7 percent from 2001 to 2002, based partly on the construction and rehabilitation of classrooms, adding 815 in 2002. As of June 2003, the Government has been building classrooms at a similar rate, adding 380 more. There has also been an increase in preschool enrollment by 7.0 and 3.0 percent for 2002 and 2003, respectively.

19. In the health sector, the Government was able to overcome the medicinal shortage crisis in the country’s healthcare centers, channeling US$13.0 million in 2002 and an additional US$13.0 million as of September 2003, surpassing the 2002 expenditure. This helped reduce the maternal mortality rate from 114 to 100 per 100,000 live births between 2001 and 2002, a 12.2 percent improvement. The mortality rate for children under 5 also improved, dropping from 50 to 40 per thousand live births, a 20.0 percent improvement during 2002. The infant mortality rate improved from 40 to 31 per thousand live births, a 22.5 percent improvement during 2002. Access to reproductive healthcare services also improved, going from 24.5 to 24.7 percent over the 2001-2002 periods.

20. This is consistent with the tendency of decreasing poverty in Nicaragua. According to the 1993 Living Standard Measurement Survey (LSMS), 50.3 percent of the population was poor, 76.1 percent in the rural zones. In 1998, the level of poverty fell to 47.9 percent overall and 68.5 percent in rural areas. In 2001, these figures dropped further to 45.8 percent and 67.8 percent, respectively. The Government can speed up this process through more economic growth, an objective emphasized in the proposed NDP presented in September 2003.

21. The 2002-2003 period was one of great challenges in the economic field. The goals put forward from the start to reduce the fiscal deficit, increase public sector savings, and overcome the crisis of international reserves in 2001, were achieved. This helped in reaching the agreement with the IMF, signing a PRGF in December 2002. This program includes gains obtained in matters of fiscal and monetary discipline and established a medium term path for the economy that allowed the entry of external resources (including HIPC relief) to finance the SGPRS, mainly its public investment program.

22. In the context of the previous actions and its implementation for the first four quarters (October 2002 – September 2003), the Government was able to reduce the Non-Financial Public Sector (NFPS) deficit before donations from 12.5 percent of GDP in 2001 to 8.6 percent in 2002. The goal for 2003 is a deficit of 6.7 percent. The Government will also manage to improve its savings position this year, going from a negative 2.0 percent of GDP in 2001 to 1.9 in 2003. This allowed for an increase in international reserves in 2002 of US$48.5 million, after the US$171.0 million loss of 2001. The monetary and fiscal discipline continued strongly in 2003, and by September the international reserves increased by US$36.0 million. Not withstanding this, due to the internal debt, in the end, they will slightly increase by US$5.8 million by the end of the year.

23. One achievement in matters of economic policy during the 2002-2003 period was the approval of tax reforms (Law for Broadening the Tax Base and Law for Fiscal Equity) that the Government put before the National Assembly (NA). The implementation of these laws has not only allowed for an increase in revenues, it has also reduced exonerations, exemptions, and special treatments in the application of taxes, thereby achieving greater equity among taxpayers and greater orientation towards the objective of stimulating exportable production.

24. The approval of other laws by the NA, like the ones for health, the regime of communal property of the indigenous peoples, municipal solvency, the Social Housing Fund (FOSOVI), forestry development, fisheries, the penal procedural code, and municipal transfers will help the Government implement its medium- and long-term strategic program and will lead to greater ownership of its objectives of poverty reduction and economic growth rate.

25. The renegotiation of the internal debt, due to 2000-2001 bankruptcies, carried out by the Government with its main banking creditors has also been important accomplishment in 2003. The first negotiation included debts expiring in 2004 and allowed for deferring US$250 million in payments for 10 years at a lower interest – 6 percentage points lower –. This initiative has allowed for the interest rate reduction of BCN titles and an attenuating effect on market rates. This will allow private banks to better manage their liquidity and diversify their investment portfolio. Also this will facilitate making the public investment program more flexible and the 2004 investment program will be broadened and facilitate meeting the goals set in the PRGF.

26. The Government has also placed emphasis in the transparency of the public administration and its open and decisive fight against corruption, commitments with the Nicaraguan population and the international community. State institutions have adopted measures for administering resources with increased transparency and accountability. Among other actions, the Government has gone further with investigations into acts of corruption; it has created an Anti-Corruption Fund with support from the international community; it has implemented the single account system for the Government; it has started the work of the Office for Transparency and Public Ethics (OEP); and implemented the program for efficiency and transparency in State contracts and procurements.

27. As has been recognized since the outset, these efforts have been supported by the international community in various ways and it is expected that they will continue not only in the framework of the strategy for poverty reduction and economic growth, but also in strengthening democracy in our country. A lot of support has been received since 1990, but the route towards the objectives posed is too long. The Government is grateful to the international community for the support they have provided to the people of Nicaragua in the battle against poverty.

28. Lastly, the Government acknowledges that despite the progress made, there is still a long way to go. Yet despite the economy facing an adverse juncture, the Government is optimistic and it has managed to overcome the difficulties in a responsible manner, taking the necessary measures to steer the economy along a course of fiscal sustainability and greater economic growth. Expectations around the proposed NDP pose a panorama of greater gains in the future, but it will be necessary to carry out the pending reforms, maintain fiscal discipline, and keep the support of civil society and the international community.

III. Macroeconomic Framework and Poverty Reduction Strategy

29. Already in the first progress report, the adverse structural profile of the economy was mentioned, as was the international setting, mainly in regards to the prices for coffee and petroleum, the difficulties in the financial system coming out of 2001, and consequent economic slowdown. This situation was not foreseen in the SGPRS, except for the effect on economic growth of the deterioration of the trade balance that led to setting a more modest path for growth of GDP.

30. The prolongation of these effects beyond what was foreseen forced the strengthening of macroeconomic policy and structural reforms to realign the economy and strengthen poverty reduction. As part of this process, a new adjustment program implemented in 2002 conducted to a PRGF agreement, facilitating international financing. At the same time strategic elements were developed to enhance the SGPRS by formulating a NDP.

A. International setting

31. It is important to begin with a brief description of the adverse international setting. First, the world’s economies were affected after the events of September 11, 2001 and the consequences of the war with Iraq. The most developed economies had a downturn in economic growth, to an average annual rate of 2.3 percent with respect to the expectations put forward by the IMF 2 in 2000. The expansion of world trade was not at the 7.0 percent average annual rate expected, but was only 2.4 percent during the 2001-2003 period. According to the most recent estimates, the average annual growth for the strongest economies in the world may be around 3.0 percent for the 2004-2007 period, 4.4 percent less than initially expected. 3

32. Second, the deterioration of prices for non-manufactured products and the increase in petroleum prices had negative effects on a number of the less developed economies. Coffee prices fell sharply in 2002. In real terms, coffee prices dropped to a third of their level in 1960. The drop was mainly due to a major increase in supply, but also because of weak demand, which had been stagnant for the last 12 years, according to the United States Department of Agriculture (USDA). The price for petroleum rose slightly in 2002 and is expected to continue increasing in 2003 because of the military actions in Iraq and the squeeze on supply resulting from restrictions by the Organization of Petroleum Exporting Countries (OPEC).

33. This situation led to a worsening of the trade relations of developing countries of -3.1 in 2001, after having had a 6.3 percent recovery in 2000. From 2002 to 2003, there was a slight recovery, but it is estimated that as of 2004, the trade relations of these countries will face a new decline. In this context, the countries that are net exporters of raw materials were affected by this behavior with their exports increasing by only half what was expected (on average, 8.6 percent).

34. It should be mentioned that, according to the IMF, the effect on inflation because of the worldwide economic downturn and the price movements previously noted, will manifest itself differently in the two groups of countries analyzed. In the developed economies, inflation will increase at an average annual rate of 2.0 percent from 2003 to 2007, close to what was projected. In the less developed economies, it is expected that the inflation rate will be 4.6 percent, 20 percent more than the initial inflationary expectations.

35. Of relevant importance in the world economy was the marked deterioration of shareholding financial markets, accompanied by the depreciation of the dollar. Latin American markets were not only affected by the poor performance of their economies that resulted in a per capita GDP reduction of -2.0 percent and macroeconomic deterioration, but also by the weakening of the currencies, the rise in price in debt markets, and the reduction of external savings, which forced the economies to procure more domestic savings.

B. The route to an agreement with the IMF and the World Bank

36. 2002 was a year of great challenges for the Government that took office on January 10 of same year. To begin with, it had to take measures to overcome the effects of the economic debacle of the previous years, and it also had to provide attention to the most felt needs of the population in coping with a generalized short supply of basic inputs in the health sector and a shortage of resources in all State institutions. Likewise, it had to build up a track record and implement tough measures to control public spending and promote savings; and to deal with corruption frontally and decisively.

37. The Government took all the necessary measures in the political, economic, and social fields to meet these challenges. Unfortunately, it faced an adverse international setting, a moderate flow of external resources, and expected to have a slight economic growth in 2002; it was believed that the external conditions for 2003 would present a better outlook. Likewise, the fight against corruption affected the approval of laws important to the performance of the SGPRS, as did the maturity of the internal debt and the losses of international reserves in 2001, which restricted public spending.

38. In December 2002, Nicaragua reached the first agreement PRGF with the IMF and the WB. This was possible after taking monetary and fiscal measures to align public finances, which in 2001 had shown the most disproportionate fiscal deficit in Latin America. This agreement determines the macroeconomic framework, policy measures, and structural reforms for the next three years. The Government is committed to this, which constitutes the cornerstone for its economic and social strategy in the medium and long term.

39. To reach this agreement, it was necessary to reduce the NFPS deficit almost 4.0 GPD 4 points in 2002. Public spending had to be reduced by more than US$120 million 5 and it was also necessary to make a tax reform in order to increase revenues by 1.0 percent of GDP. 6 In this context, spending on public investment had to be reduced by more than 20.0 percent in the 2002 versus what it was in 2001, with the subsequent effects on GDP growth rate.

40. The structural agenda incorporated into the agreement included 7: (a) presenting a tax reform to the NA that would generate additional revenues equivalent to 1.0 percent of GDP (previous series) with an annual base; (b) approving a set of prudential norms that would limit the risk stemming from the diminishing gap between assets and liabilities and assuring better supervision of financial entities; (c) implementing a plan by the BCN to liquidate the remaining assets of the liquidation boards; (d) approving the 2004 National Budget consistent with the fiscal deficit goals of the agreed-on macroeconomic framework; (e) liquidating the remaining State shares in the Nicaraguan Telecommunication Firm (ENITEL); and, (f) preparing a proposal for judicial reform and beginning the consultation process.

41. This agreement allowed the flow of external resources needed mainly to support public policies and to finance the public investment program, free up interim foreign debt relief, and lead Nicaragua to the HIPC completion point. This is one of the basic objectives of the PRGF agreement. Four years ago (September 1999), Nicaragua was declared eligible to receive assistance under this initiative and it reached the decision point in December 2000. The Government has slated reaching the completion point in December 2003. After reaching the HIPC completion point, Nicaragua’s stock of foreign debt would be reduced to half its GDP and its debt service would be reduced to a third of what it currently pays.

42. The results of the fourth quarterly review (to September 2003) of the PRGF, during the last IMF mission in November 2003 confirmed the Government’s seriousness to its commitments with the international community in fulfilling the economic goals set, the performance indicators, and the measures and reforms agreed on in the framework of its poverty reduction strategy. This means that the Government has maintained its fiscal discipline for 24 straight months, 12 of which were before concretizing the PRGF.

43. The BCN international reserves to September 2003 have increased by US$36.0 million, and it is expected that by year end there will be a slight increase of US$5.8 million.

44. The majority of the necessary steps to reach the HIPC’s completion point (programmed for December 2003) have been achieved, as is shown in the following table.

Table 1.

Measures to Reach HIPC Completion Point

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45. The Civil Service Law has been approved in a general sense in the NA and its particularities are being discussed. With regards to the pension system reform, the Government is currently formulating a working plan to implement the new system. ENITEL privatization process is underway and is expected to conclude shortly. Regarding the National Electricity Utility (ENEL), the Government concluded that privatization is not recommended at this point in time and is formulating a global energy sector strategy to improve its efficiency.

C. Performance of the economy 2002-2003

Economic growth and inflation

46. The expectations for economic growth posed in the SGPRS for 2002 were not met, and those for 2003 will be less than expected, according to the third quarter results. The immediate effects of this behavior is a reduction in per capita income, which had a cumulative fall of 4.1 percent over the 2001–2003 period, contrary to the expected increase of 3.4 percent as put forward in the SGPRS; Government revenues were reduced and compensated in part by the tax reforms; and export levels were stagnant contributing to the trade gap by having a faster increase in imports (Graph 1 and 2).

Graph 1
Graph 1

Nicaragua: Real GDP Growth

Citation: IMF Staff Country Reports 2004, 013; 10.5089/9781451829167.002.A001

Graph 2
Graph 2

Nicaragua: Real Per Capita GDP Growth

Citation: IMF Staff Country Reports 2004, 013; 10.5089/9781451829167.002.A001

47. The economy has been decelerating at an annual average rate of 2.0 percent for the 2000-2002 period. This indicates that GDP rose over that period at an average annual rate of 2.7 percent, lower than the estimated growth in the SGPRS of 3.7 percent. This means it will be necessary to grow at a rate of over 5.0 percent in the coming years in order to meet the millennium development goals, or more years will be needed at a slower pace. Given that increased per capita income is directly related to poverty reduction, the public investment program (PIP) is being designed to stimulate private investment, emphasizing high-impact social and economic projects.

48. In 2002, GDP grew 1.0 percent with respect to the previous year, the lowest rate since 1994 when the country began the first cycle of economic growth after 10 years of continual decline. According to what was set down in the SGPRS, the estimated growth rate for that year was 3.7 percent and 4.5 percent for 2003. 8 However, despite a greater demand for consumption and an increase in public investment, GDP in 2003 will only grow by 2.3 percent because of the drop in foreign investment and a lack of dynamism in exports.

49. The decline in agriculture, affected by the drop in coffee prices and other major products of the sector, less dynamism in manufacturing and the fishery sector, the restriction of public spending in terms of the investment program, and the effects on the bank credit caused by the financial crisis are the most important elements determining this behavior.

50. The value added for agriculture in 2002 dropped 5.1 percent in relation to 2001. This behavior was a result of the 24.5 percent decline in export production related to the situation with world prices. Coffee fell by 29.1 percent which is important since it represented 26.0 percent of the real gross value of agricultural production. This tendency will continue on a lesser scale in 2003, with the agricultural GDP dropping by around 1.0 percent. In 2003, the livestock and fishery sectors will grow by 4.2 percent and 5.7 percent respectively, compensating for this, making the primary sector as a whole grow by 1.7 percent over the previous year.

51. It is important to note that agriculture has slowed down at an average annual rate of 6.0 percent since 2000. Except for basic grains and tobacco, this situation is generalized for all agro-export products, showing an agricultural economy more for domestic consumption than for export. The Government has promoted the production of basic grains through the “pound-for-pound” program, increasing production by more than 10.0 percent in 2002, partially compensating for the decline in export production. In 2003, this program is continuing with good success and it is expected that basic grains will again compensate for the poor performance of export products.

52. In the particular case of Nicaragua, the declining trend in the terms of trade not only has severely affected the economy, but has also caused social problems in areas where the population depends on growing coffee. Over the last few years, these peasants have seen their real disposable income decline. The depression in the prices for the main export products has caused a situation of insolvency for producers with the banking system, negatively impacting the credit policy for troubled agricultural products.

53. Both the general worsening of the terms of trade and of the price of coffee in particular have been prolonged and consistent since 1998, as can be seen in Graphs 3 and 4. This has caused great losses to the economy, not only because export income has fallen, but because the country’s petroleum invoices on the international market have increased considerably. The combined effect 9 of this trend in prices has resulted in income losses of around US$1,000 million over the 2000-2003 period, which has not allowed for capitalizing the agricultural sector, and has made the adjustment program more severe.

Graph 3
Graph 3

Nicaragua: Index of Trade Terms 1999-2003

Citation: IMF Staff Country Reports 2004, 013; 10.5089/9781451829167.002.A001

Graph 4
Graph 4

Nicaragua: Evolution of Coffee Prices 1998-2003

Citation: IMF Staff Country Reports 2004, 013; 10.5089/9781451829167.002.A001

54. On the side of aggregate demand, economic growth has been sustained more by consumption and private investment than on public spending and exports. In 2002, private consumption increased by 4.1 percent in real terms and investment rose 6.3 percent in relation to the previous year. Nevertheless, given the major adjustment in public spending that year, public consumption and public investment dropped by 13.0 and 16.4 percent, respectively. There was a decline in exports of 3.3 percent, making aggregate demand as a whole grow by only 0.5 percent with respect to 2001. 10 For 2003, it is estimated that the demand growth rate will be below 1.0 percent, with the aggravating factor that this increase would be sustained by public investment (9.3 percent), compensating for the projected drop in private investment (8.9 percent).

55. Aside from the worsening trade relation, there are other factors limiting economic growth. Insecurity around property rights continues to be a determinant factor in private sector investment decisions. Unfortunately, the scope of the problem calls for many resources to solve it and a propitious political atmosphere that has yet to be achieved. The infrastructure in roadways, communications, ports, and airports is not competitive at the Central American level, raising the country’s transaction costs. The absence of a medium- and long-term savings and loans market decreases the possibilities for private investment. Likewise, the low technological level of many of the country’s productive activities restricts access to international markets.

56. Contrary to what was expected, for a number of reasons, the privatization of public services has led to a persistent increase in rates, affecting the transaction in the different markets. Likewise, in spite of the macroeconomic policy being directed at maintaining price stability as a necessary condition for stimulating economic growth, it is obvious that this has not been enough. Structural problems still persist in the public sector, the financial system, and the economy, and combined with the investors’ risk perception making interest rates in Nicaragua remain at uncompetitive levels, limiting access to credit for production and private investment.

57. It is important to note that the macroeconomic framework has allowed a major flow of external resources, which has facilitated monetary stability and controlling inflation. In 2002, the average annual inflation rate was 3.75 percent, the lowest rate in 10 years. This is associated with better conditions for supply and less demand pressure caused by less liquidity and the economic slowdown. In 2003, the effect of increased fuel prices, the impact of the tax reform, and the increased demand pressure will force inflation to be higher than the previous year. In any case, it is expected that the inflation rate will not surpass 6.0 percent in 2003.

Monetary and credit policy

58. Because of the 2001 financial crisis, the instruments for monetary policy were used to avoid the contagious effect of the broken banks on the rest of the financial system, guaranteeing public savings and maintaining exchange rate stability. However, as of 2002, the policy for open market operations was oriented at reducing the internal debt of the BCN, in this way propitiating a drop in interest rates for its titles/securities and in the financial system. The credit policy reversed its expansive policy, the legal reserves were adjusted, and the BCN began a process to liquidate assets taken over during the bankruptcies. All this is congruent with the adjustment program that would align public spending at sustainable levels.

59. In 2002, the agreed monetary program as a prior action for reaching the PRGF resulted in an increase of net (adjusted) international reserves of US$61.7 million. This was due to the inflow of US$51.0 million in external resources in December 2002, after the IMF Board of Directors approved the PRGF, to an increased level of governmental deposits, and higher legal reserves of the private banks into the BCN. As of September 2003, fiscal and monetary discipline continued as established in the program, major progress in negotiating the internal debt of the BCN was made, and the rest of the government institutions’ deposits were transferred to the BCN, increasing the net international reserves to September 2003 by US$36.0 million.

60. In terms of flows in 2002, the BCN managed to reduce the internal debt by placing US$33.0 million in titles/securities, combined with the payment of interest and maintenance of value, meant an injection of US$112.0 million into the financial system. In 2003, this debt will be reduced by US$70.0 million, which could mean an injection of US$175.0 million if the financial cost is added.

61. The debt renegotiation operations undertaken by the BCN with the private banks will improve the outlook for 2004. In July 2003, the first operation with a major bank creditor was concretized. Under this agreement, the interest and amortizations to mature for the Negotiable Investment Certificates (CENI) acquired by this bank were renegotiated to a 10 year term at a rate of 8.4 percent. This operation means that the BCN will defer payments of US$250.0 million by 2004. improving its reserves position and increasing flexibility in the fiscal program favoring production and social programs. The BCN continues to make arrangements to renegotiate all the internal debt with the rest of the creditor banks.

62. A number of positive effects have come out of the actions noted above. On the one hand, interest rates showed a declining trend because of the increased monetary supply produced by the reduction of the internal debt and legal reserves caused by the fiscal discipline shown in 2002-2003 and by the lowered interest rates negotiated for CENI During the March 2001 to September 2003 monitoring period, the average savings rate (three-month deposits) dropped by 5.3 percentage points and the average short term lending rate fell by 3.6 percentage points (Graphic 5).

Graph 5
Graph 5

Nicaragua: Interest Rates

Citation: IMF Staff Country Reports 2004, 013; 10.5089/9781451829167.002.A001

63. On the other hand, the BCN’s credit policy 11 towards the Government changed over the 2002-2003 period, after being exaggeratedly expansive in 2001. That year, the BCN granted US$202.6 million credit to the Central Government. In 2002, the Government transferred US$98.2 million in resources to the BCN, increasing to US$115.4 million in 2003 and US$141.6 million in 2004, regardless of the renegotiation of the internal debt.

64. Likewise, banking credit policy had some major changes in favor of production. Greater accumulated liquidity in the banks provided the opportunity for expanding the system’s credit portfolio. While in 2001, the system’s balances for productive credit 12 fell by 43.5 percent with respect to the previous year, increased by 14.3 percent in 2002 and about 20.0 percent as of September 2003. An important change in the composition of the credit is the 22.0 percent increase for the agricultural sector, after a 61.2 percent drop in 2001. This tendency was also felt in credit for livestock, commerce, and industry.

65. In 2003, the Government took another step towards sustainability by renegotiating a portion of the bilateral public foreign debt. As part of the Agreed Minutes with the Paris Club (December 2002), the BCN renegotiated US$575.6 million in foreign debt (till July 2003) with countries like Russia (US$258.9 million), Germany, (US$156.9 million), Spain (US$85.9 million), and France (US$40.2 million), with the recent addition of Italy in the end of October 2003. This renegotiation partially eased the international reserve pressures and alleviates fiscal policy, providing the Government with resources for production and for its poverty reduction strategy.

66. It is important to note that the change in monetary, credit, and fiscal policy as of 2002 is part of the program for realigning the medium- and long-term macroeconomic framework favoring economic growth. Along this line, the Government is evaluating its exchange rate policy, creating conditions for having a more flexible regime. This will not be possible as long as medium- and long-term fiscal sustainability is not achieved and the gaps in the balance of payments are not closed.

Fiscal performance

67. The policies in matters of revenues and public spending during the 2002-2003 period had the fundamental objective of leading the country towards the path of fiscal sustainability, which would allow for maintaining stability and creating conditions for economic growth. The expansion of public spending in 2001, the bankruptcies of banks, and the financial difficulties in most public institutions resulted in tacit abandonment of the interim program agreed on with the IMF. The Government had to act responsibly through tough fiscal measures, austerity, and transparency in public affairs. It drafted bills for tax reforms and for the expenditure budget before the NA to achieve fiscal equilibrium, and this performance facilitated the PRGF in December 2002.

68. More than seeking a balance between revenues and expenditures, fiscal policy served as a support for the BCN’s international reserves recovery and payment on the internal debt service, without abandoning the objectives of the poverty reduction strategy. The appropriate management of the public expenditure was a determinant to achieve this objective, even though the decreased public investment further affected an already poor economic performance. However, in the absence of other economic policy instruments 13, the fiscal policy and the support from the international community were strategic for the first two years of the current Government.

69. The indicators for fiscal performance agreed on with the IMF in 2002 were met, as were the goals agreed on to September 2003. Nevertheless, the weight of the internal debt and the economic slowdown are factors of concern since the National Budget lacks room for social programs. Both the international community and the private sector have been cautious and this has limited possibilities for the Government’s program.

70. In light of these limitations, the Government was able to reduce the combined public sector 14 deficit (before donations) from 13.8 percent of GDP 15 in 2001 to 10.6 percent in 2002 as was agreed with IMF. It should be noted that the quasi-fiscal losses of the monetary authority increased to 1.7 percent of GDP, deficit which partially has been compensated with the saving of the NFPS. To do this, it was decided to reduce public spending by 3.3 GDP points, equivalent to US$127.8 million and increase revenues by 0.6 of a point, or US$30 million. Savings went from -3.2 to -2.5 percent of GDP over the same period. (Table 2, Annex Table 1).

Table 2.

Nicaragua: Fiscal Indicators

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IV PRG Preview.

In accordance to the new national account system of BCN.

b/g: before grantsSource: MHCP, BCN.

71. In 2003, the Government continued with its fiscal discipline and the indicators by September indicated that the combined public sector deficit will drop by 8.4 percent of GDP, according to the tendency considered in the program. Over the two years, the reduction of the overall deficit before donations will add up to an equivalent of 5.4 GDP points (US$207.2 million). Primary savings reversed its tendency by doubling during 2001-2003, going from 3.0 percent in 2001 to 6.6 percent in 2003 (Graph 6).

Graph 6
Graph 6

Nicaragua: Overall Deficit NFPS

Citation: IMF Staff Country Reports 2004, 013; 10.5089/9781451829167.002.A001

72. It is important to note that the net performance of the fiscal reforms has been less than expected given the problems of implementing some lines of reformed taxes and the effect of the economic slowdown. However, Central Government revenue increased by 2.3 GDP points since 2001, of which 1.5 points resulted from the 2003 reform.

73. The NFPS deficit before grants decreased from 12.5 to 8.6 percent of GDP for the period 2001–2003. Along this line, total spending decreased by 3.5 GDP points for the same period. It should be recalled that the greatest adjustment was in public investment, reducing it by 2.0 GDP points, or US$70.6 million, more than 60.0 percent of the total NFPS spending adjustment of US$110.0 million.

74. The rigidity of current expenditures shown in the weight of the salary mass, interest payments, and the legal transfers to universities, the judiciary, and the municipalities, as well as the demands from other State branches were the main reasons for having the adjustment fall on capital spending in 2002. However, current spending in 2003, as part of fiscal discipline and debt renegotiation, will slightly decrease in spite of the salary increases considered in the budget.

75. In terms of financing, the Government not only had results of its own efforts but also from the support of the international community, which channeled resources equivalent to 9.2 percent of GDP in 2002 and 10.2 percent in 2003, including interim relief from the HIPC initiative. Net internal financing had a total turnaround by contracting by -1.0 percent of GDP in 2002, while a greater contraction of -4.7 percent of GDP is expected for 2003. This was because of the transfers that the Government has made to the BCN to cover for payment of the internal debt. These transfers are estimated at 3.1 percent of GDP for 2003 (Table 3).

Table 3.

Nicaragua: Financing Sources of NFPS Deficit

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IV PRGF review.

In accordance to the new national account system of BCN.

Source: MHCP, BCN.

76. The delay in reaching an agreement with the IMF did not allow for the timely entry of external resources in 2002. That year, the Government did not receive any liquid resources until December when the PRGF was approved. This trend was reversed in 2003 when the country received US$41.0 million in liquid resources and US$92.5 million for projects, 8.0 percent more than scheduled.

77. A major source of financing was the HIPC relief. In 2002, the Government freed up resources under this concept of approximately US$70.8 million (1.8 percent of GDP) and in 2003, it will free up US$100.9 million (2.5 percent of GDP), (Annex Table 2). It should be mentioned that many donors have substituted donations with HIPC relief. In 2000, donations represented about 4.5 percent of GDP; currently, they represent 2.6 percent. This mainly affects the principle of the additionality of HIPC relief within overall poverty spending, which is analyzed further.

78. The containment of public spending and the reverse of the downward trend of fiscal revenues are an achievement, and more important is the fact that it could protect social spending for its poverty reduction strategy (see section on poverty spending). The downside of this behavior is the slowdown in the execution of major infrastructure projects and the allocation of additional resources to service the internal debt.

D. Fiscal reform: tax, budgetary, and administrative

79. The measures for revenues that Government took during 2002-2003 are structural and administrative measures that not only seek increasing revenues, but also mending the tax structure aimed in part at eliminating distortions. It has been estimated that the reforms of 2002 and 2003, the fiscal loss because of the burden of exonerations, exemptions, and special fiscal GDP (in reference to the new GDP base); that is, about US$235.0 million 16, which reflected a treatments applied to taxes on consumption and imports amounted to more than 6.3 percent of GDP (in reference to the new GDP base); that is, about revenues collection efficiency of 54.0 percent in 1999.

80. Besides this inefficiency, the tax system rested on a very narrow base, not only because of the high levels of exonerations, but also because it applied to few goods, which made it highly discretional and complex to manage. Therefore, it was necessary to carry out structural and administrative reforms in the system in order to help with revenue collection but also to promote economic growth and strengthen the poverty reduction strategy.

81. This frame of reference helped the Government to introduce draft bills for budgetary and tax reforms before the NA and to apply administrative measures to increase revenue raising efficiency. The essential objectives were directed at: (a) seeking medium-term fiscal sustainability; (b) implementing a more efficient spending policy with greater impact on social programs and economic growth; (c) increasing consistency among the budget, the international reserve targets, and the exchange rate stability; and, (d) making the tax system less discretional and more equitable.

82. The Law for Broadening the Tax Base approved in 2002 introduced the following measures: (a) the Value Added Tax (IGV or sales tax) was increased from 6.0 to 10.0 percent in 2002 and from 10.0 to 15.0 percent in 2003 for international air transport services and the sales mechanism for zero rate invoices was derogated; (b) the base for applying the Specific Consumption Tax (IEC) for carbonated beverages was changed, applying the tax to the retailer price rather than the producer/wholesaler price and eliminating the duty reduction schedule taking effect in 2003; (c) Income Tax was applied to interest on savings and term deposits for commercial entities in the financial system, to lottery prizes, and the retention of income tax for professional services was increased from 5.0 to 10.0 percent; and, (d) all benefits for exemptions and exonerations for imports were removed, except for those granted by the Constitution.

83. The Law for Fiscal Equity approved by the NA in 2003 continued furthering the principle of fiscal equity and broadening of the tax base. The main tax reforms included: (a) a minimum income tax payment of 1.0 percent over total gross assets, excluding firms with less than US$150,000 in assets; (b) a levy on financial income of 10.0 percent over interest earned on personal savings accounts and term deposits of more than US$5,000; (c) derogation of exonerations, exemptions, and special treatments applied to the Value Added Tax (VAT), the Selective Consumption Tax (ISC), and the Import Tariff Rights (DAI), except for those established by the Constitution, international treaties, and exports; and, (d) a 25.0 percent tax return on fuels for firms under the Temporary Admission Law, against proper presentation of Bill Lading.

84. Achieved results under these reforms in terms of revenue collection have been important in reducing the fiscal deficit and leading the economy along a path of sustainability. In annual terms, the two reforms could add an estimated C$2,074.7 million (US$142.7 million), or 3.5 percent of GDP (Table 4). This marginal increase in tax revenues collection has been estimated under an economic slowdown scenario, which would indicate that the yield from broadening the tax base and from administrative measures could partially compensate for the decrease in fiscal revenue collection.

Table 4.

Nicaragua: Tax Reform and Measures 2002 – 2003

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Law of Broadening the Tax Base 2002 (Law No. 439), Law of Fiscal Equity 2003 (Law No. 453).

Source: MHCP. BCN.

85. As noted in the preceding table, the greatest effect of the lax reforms has been on imports, income, and consumption, which is consistent with the recommendations made in the analysis by the IMF. On an annual basis, the reform of these three taxes would generate 79.6 percent of the estimated revenues collection during the two years. Likewise, the measures taken to improve tax administration would mean 10.8 percent of the total estimated revenues collected.

E. Evolution of poverty spending

86. In 2002 and 2003, poverty spending has been the Government’s priority in its budgetary policy; despite the severe adjustments to which total spending has been subjected to reduce the fiscal deficit to sustainable levels. The main characteristic of poverty spending in the second year of implementation of the SGPRS has been increased capital spending and the priority given to health, education, housing, and drinking water.

87. The poverty reduction spending efforts were maintained under a context of lower economic growth rates than those estimated in the SGPRS, high fiscal cost resulting from the banking crisis, and the adverse international setting, which resulted in the worsening of the terms of trade.

88. The effects on the slowdown of economic activity have been more serious and prolonged than expected, which had a direct impact on the levels of fiscal revenues and public spending. Accordingly, in December 2002, under the PRGF agreement, the medium-term policies were determined in line with the new macroeconomic frame, ensuring that the fiscal program reduces the public sector deficit and guarantees an increase in poverty reduction spending. New levels for poverty spending were set from 10.0 percent of GDP in 2002 to 11.0 percent in 2003, and 11.4 percent in 2004.

Government policy

89. Government poverty spending policy was directed to shield poverty spending from additional reduction resulting from budgetary constraints and to increase efficiency and impact. As a result, while NFPS spending had a declining profile, poverty spending actually increased. Under this circumstance the adjustment fell mainly on non-poverty spending such as infrastructure, particularly the rehabilitation and construction of highways, airports, and ports, as well as on other governmental branches and sectors.

90. Protecting poverty spending, particularly in the social sector (health, education, water supply, and sanitation) has allowed for coping with the difficult problem of a shortage of medical materials and supplies, and this has helped with a recovery of the supply of basic services, avoiding a further worsening of social indicators.

91. Regarding operational efficiency, the Government is taking steps to evaluate the impact of the existing programs and to adequately define a hierarchy of priorities. Through the Solidarity program, dispersed resources from a number of social protection and rural development programs will be concentrated to coordinate actions, have a more appropriate selection of beneficiaries, and improve the impact.

Execution (2002-2003)

Spending dimensions and tendencies

92. The most relevant trends in public spending are the ascending profile of poverty spending in real terms, as well as the structural change caused by increased capital spending; the greater share of poverty spending with respect to the Government’s total primary spending; the concentration on poverty spending on investment in human capital; and the proliferation of micro projects, their high degree of territorial dispersion, and their high level of dependency on external resources.

93. In terms of budget, total poverty spending with respect to total spending by the Central Government has gone from 40.7 percent in 2001 to 56.8 percent in 2003. The share of external resources in poverty spending rose from 40.4 to 45.8 percent of total spending over the same period. An average of 54.5 percent of total poverty spending goes to human capital and 25.2 percent is for economic growth (the most important pillars of the SGPRS) during that period.

94. It is important to clarify that although the reference for poverty spending consigned in the SGPRS is only Central Government spending in the National Budget, This report adds consolidated information from the NFPS in order to know the dimensions of total poverty spending. Likewise, the poverty spending reflected in this report for 2001 and 2002 does not include the extraordinary poverty spending caused by the emergency situation left by hurricane Mitch. To attain a sustainable tendency for poverty spending, it was necessary to apply this methodology.

95. In this context, total poverty spending by the NFPS in 2002 amounted to USS401.2 million, equivalent to 10.0 percent of GDP, an increase of 0.9 percent of GDP over 2001. Spending 11.0 percent (US$450 million), an increase of 1.0 percent of GDP, is projected for 2003 as a result of a greater increase in capital spending than originally programmed and agreed on with the IMF (Table 5, Annex Table 3 and 4).

Table 5.

Nicaragua: Poverty-reducing Spending 1/

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Period 2001-2002 corresponds to the Poverty Spending adjustment, which exclude additional spending caused by Hurricane Mitch and Special Programs and Support for Health, Education and Housing, by 2.3 and 0.2 percentage of GDP, respectively.

Preliminary.

IV PRGF review.

Source: SECEP, MHCP, BCN.

96. The structure of NFPS poverty spending between current and capital expenditures has been maintained over the last three years. In 2002, current spending was US$194.2 million (4.9 percent of GDP), representing 49.0 percent of the total. For 2003, the estimated amount is US$196.5 million, 4.8 percent of GDP and 44.0 percent of total poverty spending. Capital spending was US$206.9 million (5.2 percent of GDP), of which almost 90.0 percent corresponded to the Central Government. An estimated investment of US$253.5 million (6.2 percent of GDP) for 2003.

Spending by pillar and crosscutting themes

97. Investment in human capital is critical for increasing productivity, income, and the well-being of the population, and so it has been prioritized in the execution of the SGPRS. In 2002, resources equivalent to 55.9 percent of the total spending for fighting poverty were channeled to this pillar (US$224.1 million, 15.4 percent more than the year before). In 2003, given the need to speed up economic growth and improve attention to the most vulnerable groups, more resources were channeled to those pillars, resulting in a drop in the share of spending on human capital to 53.9 percent; however, in absolute terms, spending will increase to US$242.8 million (Table 6, Annex Table 5). This increase is explained by the program for improving educative quality entering the final phase.

98. Education and health are the priority sectors in this spending. In the former, spending went to expand coverage, particularly that of basic education (primary and preschool) and to improve the pertinence of this subsystem and the efficiency of the regulatory institution. In health, priority was put on the coverage and the quality of services of the primary network by strengthening the Local Integral Healthcare Systems (SILAIS) and the epidemiological control and prevention. In poverty spending in 2002, US$99.9 million (24.9 percent) went to the pillar for broad-based economic growth, US$32.4 million (8.5 percent) went to social protection and governance, and US$43.1 million (10.7 percent) went to the crosscutting themes.

Table 6.

Nicaragua: Poverty Spending by Pillars and Cross-cutting Themes 1/

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2001-2002 exclude spending caused by hurricane Mochand Special Programm and Support for Health, Education and Housing.

Prelimary.

IV PRGF review.

Source: SECEP MHCP.

99. For 2003, it is estimated to increase funds for economic growth by 18.5 percent in relation to total poverty spending for the year before, raising it to US$118.4 million (Annex Table 5). It is also estimated that spending on social protection and governance will reach US$47.2 million. A slight reduction to US$41.8 million is expected for spending on the crosscutting themes.

Current expenditures and capital expenditures

100. Definitions. Annex 6 of the SGPRS contains definitions of the criteria used for estimating spending directly related to poverty reduction. Special emphasis is put on the fact that, as of the publication of this document, no homogeneous method had been established internationally to define what should be included in this category, and for the effects of systematic and consistent follow up of this indicator, the following method was adopted:

101. The capital spending defined in the SGPRS portfolio of programs is linked to the four pillars of the strategy (broad based economic growth and structural reform, investment in human capital, protection of vulnerable groups, and institutional development) and to the three crosscutting themes (environmental vulnerability, social equity, and decentralization).

102. The current spending for the SGPRS refers mainly to the programs related to the MECD – central activities; preschool, primary, special education, and continuing adult education; training of primary teachers; community activities to support nutrition programs; and, community activities for coordinating the development of different educative programs, among others –; MINSA – central activities; level 1 and II healthcare programs; laboratory services; programs for attention to the community, among others –, MAGFOR and the IDR – central activities; sanitary and photo sanitary services, agricultural and forestry services, and INTA technology transfers programs –; MIFAMILIA – central activities, community programs, family support services, special attention programs, social development, and transfers for decentralized activities –; and the Social Safety Net (RPS).

103. It should be clarified that this definition has been observed, but the projects portfolio has been expanded as new programs directly linked to the objectives proposed for each pillar and crosscutting theme of the SGPRS are incorporated, particularly in the area of broad-based economic growth, which was not developed in the original document. Included in poverty spending are programs related to territorial zoning and the titling of properties, support for competitiveness and the development of small and medium firms, as well as those related to environmental vulnerability. This definition will be adjusted during the SGPRS revision.

104. Execution of current spending. Current expenditures on poverty cover the Central Government and refer mainly to salaries for the health and education sectors, but also those expenditures related to programs directed at other social sectors, as noted earlier. In 2002, this spending increased by 10.0 percent over the previous year, going from a GDP share of 4.4 percent (US$177.3 million) in 2001 to 4.9 percent (US$194.2 million) in 2002. For 2003, it is estimated that this spending will be around 4.8 percent of the GDP (US$196.5 million) (Table 6; Annex Table 5).

105. It should be mentioned that in 2002, 85.1 percent of these resources (US$165.2 million) went to the pillar for investment in human capital, particularly the financing of programs to improve quality and extend the coverage of health and education services. For 2003, this percentage rises to 88.0 percent, going to US$172.4 million and reflecting the same priorities.

106. The pillar for economic growth was allocated US$14.3 million (7.4 percent of current expenditures) to cover the cost of running the programs of the MAGFOR, MIFIC, and the IDR, all oriented to strengthening the activities of small and medium urban and rural producers in zones of extreme poverty and promoting export production activities by means of a tax rebate on exports. For 2003, it is estimated that spending will be around 7.0 percent of total poverty spending, equivalent to US$13.0 million.

107. For social protection of the most vulnerable groups (elderly, disabled, children and adolescents in situations of risk), 2.6 percent (US$5.1 million) of the total current spending was used for attending to the functioning of the operative units of those programs in MIFAMILIA. During this period, the pillar for governance got about 1.0 percent (US$1.3 million) for financing activities of the Office of the Human Rights Ombudsman (PDDH) and the National Council for Economic and Social Planning (CONPES). Similar amounts and percentages will be maintained in 2003.

108. For environment and decentralization, there was 4.3 percent (US$8.3 million) of the SGPRS current expenditures. In the case of environment, it went to the current expenditures of the Nicaraguan Institute for Territorial Studies (INETER) and conservation programs for protected areas and for forest and geological resources. Spending on the theme of decentralization basically consisted of transfers to local governments and the Autonomous Governments of the RAAN and the RAAS to help with their operating costs and for the current spending of the Nicaraguan Institute for Municipal Affairs (INIFOM). For 2003, it is projected that current spending will be of US$5.9 million to cover these crosscutting themes.

109. Execution of capital expenditures. NFPS capital spending on poverty in 2002 amounted to US$206.9 million, or 5.2 percent of GDP, an increase of 13.0 percent over 2001. The Central Government invested US$182.5 million (4.6 percent of GDP), 6.5 percent more than the year before. For 2003, the Central Government has scheduled investments of US$227.4 million, a 24.6 percent increase over the previous year (Annex Table 3).

110. In terms of allocation by pillar, the resources went as follows: 41.3 percent (US$85.5 million) for economic growth and social infrastructure; 28.4 percent (US$58.9 million) for investment in human capital; 11.8 percent (US$24.5 million) for social protection programs; 1.6 percent (US$3.3 million) for governance; and, 16.8 percent (US$34.8 million for the crosscutting themes of environment and decentralization (Annex Table 5).

111. Among the economic growth programs, priority was given to programs aimed to improve and extend water and sanitation systems in marginal urban zones and rural areas, executed by ENACAL. Rural development programs were also prioritized, like fostering production of livestock and basic grains, projects for rural road rehabilitation and maintenance, rural electrification, and strengthening and developing agricultural technology. For 2003, capital spending is estimated at US$105.4 million, raising its share of total capital poverty spending to 41.6 percent.

112. Regarding investment in human capital, priority was put on the construction, rehabilitation, and equipping of primary and preschool education centers, as well health centers and the equipping of the hospital network. Resources were assigned to the modernization of the administration systems of the institutions governing health and education. For 2003, there is an increase of 19.4 percent because of entering the final stage of some programs, like APRENDE in education and the Modernization of the Health Sector (PMSS).

113. Priority was given to three programs in social protection: the Social Safety Net (RPS), the Integral Program for School Nutrition (PINE), and the Program for Integral Attention for Children and Adolescents (PAININ). In 2003, this spending will increase by 63.7 percent (US$15.6 million) in order to provide better coverage for these and to start other programs related to social infrastructure executed by FISE and other food assistance programs in extreme poverty zones.

114. In the area of governance, the Government concentrated efforts on developing the Program for Efficiency and Transparency in State Purchases and Contracts and on building the Women’s Penitentiary Center. For 2003, it is estimated that this pillar will represent less than 1.0 percent (US$1.9 million) of capital expenditures.

115. Standing out in the area of environment are the programs for forest conservation and the maintenance of the Mesoamerican Biological Corridor and the Bosawás Reserve, and for decentralization, local development programs, and transfers to municipalities for the development of roadways and municipal infrastructure. For 2003, a similar amount to that of 2002 is budgeted.

F. Financing the SGPRS

116. The main characteristic of financing poverty spending in 2002 was the greater share of internal resources, representing 57.2 percent of total spending, US$229.4 million, or 5.8 percent of GDP. It should be mentioned that of this, US$70.8 million (1.8 percent of the GDP) came from interim HIPC relief. For 2003, more internal resources disbursements are projected, representing 6.0 percent of GDP. This increase is associated with the increased relief and more Treasury resources as counterpart funding for external resources for investment spending.

117. For 2002, it should be made clear that greatest share of internal resources over total poverty spending was due more to a reduction in non-poverty spending than to a real increase in Treasury resources. The Treasury resources (US$158.6 million) were slightly above the levels of the previous year, but in 2003, they were reduced by 9.7 percent. This situation is framed in the constraints that the Government applied to total spending to have more public sector savings as part of the fiscal discipline imposed in its adjustment program (Table 7).

Table 7.

Nicaragua: Financing Sources of Poverty Spending

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IVPRGF review.

Source: SECEP.

118. External resources increased by 17.7 percent in 2002 over the previous year, going from US$146.0 million to US$171.8 million. Based on execution during the first half of 2003, it is estimated that there will be an increase of 19.8 percent over 2002, reaching a level of US$205.9 million. This trend reflects the government policy of restricting those public investment projects financed with Treasury resources and prioritizing those that have assured external financing with a minimum national counterpart. This is in line with the macroeconomic objectives established in the program agreed on with the IMF (Table 7).

119. During the 2001-2003 period, prevailing among the sources of external financing were loans with 51.0 percent of the total. The rest was made up by donations. Most of the loans came from multilateral sources, led by the IDB and the WB with 86.5 percent of total disbursements. Donations from Japan, Germany, the European Union, and the World Food Program (WFP) represented 62.5 percent of total donations during that period.

G. HIPC relief: allocation and tracking mechanism

120. Methodology for calculation. Given that the maturing of the contractual service for all the public foreign debt is more than the country’s payment capacity, Nicaragua has to prioritize its payments to multilateral bodies and member-countries of the Paris Club in order to remain with the IMF program. The non-prioritized service has been reflected in the balance of payments as extraordinary financing due to accumulation of delays. The debt pardon by creditors on which debt service was being paid can easily become relief for poverty spending since the budgeted resource are allocated, except for debt pardoned by those countries outside the payment scheme.

121. The Government of Nicaragua agreed with the IMF and WB on a methodology for calculating the cash relief (relief for poverty spending) that would go to poverty spending. For the country’s “effectively paid service,” the average service paid with its own resources during the 1992-1998 period, was used. The average amount turned out to be US$216.6 million. In this way, the HIPC relief is the difference of the service after a hypothetical operation of total debt stock in terms of Cologne (90.0 percent reduction) and the service for the same stock operation but in terms of Naples (67.0 percent). The completion point for these calculations was assumed to be December 2003.

122. It was also agreed that if in a given year, the amount of cash relief was less than the amount of interim relief; the latter would be taken as cash relief. This is only valid for the interim period. For the distribution of cash relief among creditors, it was agreed that first the relief for the multilaterals would be exhausted and any balance that was lacking to complete the total amount would be assigned as part of the bilateral relief for the Paris Club. It is assumed that all foreign debt service relief that was not paid before is considered as relief for balance of payments purposes.

123. For the interim HIPC debt relief period, this methodology has served its purpose since it was established for Nicaragua in 2001 and will end by 2003, once the completion point is reached in December, as programmed. As explained before, the objective was to calculate a debt relief that would provide resources to finance SGPRS social programs. The capacity to carry out this budgetary action was associated to the historic payment capacity of the country in previous years.

124. After reaching the completion point and an expected sustainable economic growth rate, the payment capacity will improve and the Government will find itself in a better financial position to increase poverty spending, in accordance with the HIPC initiative spirit. The methodology currently used to calculate HIPC debt relief allocated to poverty is static and does not foresee the above situation.

125. In conjunction with the WB, such methodology is being revised to adjust it to the new mentioned situation, so that the estimate of these resources will be dynamic in accordance with the evolution of the economy. This methodology and its corresponding estimates will be included in the completion point document for its application starting in 2005, given the fact that the 2004 HIPC relief has been already incorporated into the national budget proposal to be approved by the NA shortly.

126. Amounts of relief. Starting in 2001, Nicaragua began to receive interim foreign debt relief at an annual average of US$78.3 million, after complying with the requirements for reaching the decision point of the HIPC initiative. After that year, the amounts of relief have increased to the extent that more countries join this initiative at the same time as more interim relief is received from the multilateral bodies. From 2001 to 2003, the HIPC relief going to poverty spending amounted to US$235.0 million. This relative increase was 56.3 percent, by going from 1.6 to 2.5 percent of GDP during the 2001-2003 period. It is expected to reach the equivalent of 2.9 percent of GDP by 2004.

127. Table 8 shows the total amount of interim HIPC relief for the 2001-2004 period. An average of 82.9 percent of this relief comes from the multilaterals, with the IDB having 40.2 percent of the total and the CABEI having 30.0 percent. The increase in HIPC relief amounts has made their share of total poverty spending go from 17.5 percent in 2001 to 22.4 percent in 2003.

Table 8.

Nicaragua: HIPC Debt Relief 2001-2004

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Average service 1992-1998 paid with domestic resources.

Difference between service after a stock operation in Napoles’s Terms (hypothetic) and service after implementation die culmination point in December 2003.

Calculated from the biggest amount that came out as a result of substracting the service effectively paid during 1992-1998 and service to be paid after HIPC relief: or else the total HIPC relief coming from creditors.

Source: SECEP, BCN.

128. Allocation of the relief. The allocation of these resources has been according to the social priorities defined in the SGPRS. The application of the HIPC relief for the 2002-2005 period is taken up in this document in general terms, emphasizing that this would be used to finance ten second-generation programs, each of them with a given percentage of the total relief, that have been developed based on the experience with donors. Most of these programs are based on demand and all have rigorous systems for follow up and evaluation. It is also assured that the programs to be financed, including those that may be incorporated in the future, have to be directly related to poverty reduction.

129. On average, 84 percent of these resources during the 2001-2003 period have been allocated to have greater coverage of basic social services. As can be seen in Table 9, 55.0 percent of the relief has been allocated to education, 20.0 percent to health, and around 9.0 percent to water, sanitation, housing, and municipal infrastructure. Seven percent was allocated for protection of vulnerable groups.

Table 9.

Nicaragua: HIPC Relief Allocation

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Source: SECEP. MHCP.

130. Part of the relief was allocated to FISE to finance social infrastructure in areas of extreme poverty and to the local development program for the Atlantic Coast to strengthen their regional and local governments, to increase their capacity to identify and formulate projects, land use zoning, and natural resource administration.

131. The implementation of the SGPRS, as estimated in the document, is costly. Part of the HIPC relief funds goes to developing and applying systems for follow up and evaluation, fostering greater rural participation in programs, and strengthening the capacities of the National Public Investment System (SNIP). Lastly, coherent with the first pillar of economic growth, funds were applied for different programs to support production and upgrade agricultural technology.

132. The principle of additionality of the HIPC relief. The foreign debt relief, granted to countries selected for this initiative, shall be invested in strategies for poverty reduction was the condition established in Cologne, Germany in 1999. This was the condition set to increase flexibility in the initial classification parameters and the basic principles for accessing this relief. It was also established that the relief should reflect additional spending for the efforts that the countries were making to fight poverty with their own resources. HIPC relief should not substitute for internal resources that were used for those purposes before.

133. It is necessary to have the following in order to comply with the above principle: (a) the HIPC relief would mean real available resources for poverty spending and not merely an accounting transaction; (b) the rest of the funding sources for poverty spending would remain constant or increase; (c) the additionality of poverty spending because of increased HIPC relief would not counter macroeconomic stability; (d) there would be no substitution effect by donors of HIPC relief for donations granted earlier; and (e) the projected economic growth would be achieved.

134. Nicaragua has been working on the conditions to comply with the principle of additionality of the HIPC relief by increasing the poverty spending in a continuous way for the 2001–2003 period, and by allocating Treasury resources in the 2004 budget similar to those in the previous year (Table 10). It is important to note that external aid declined in real terms after the Mitch bubble effect, which coincided with less liquid donations once the 2001 interim HIPC debt relief started, a decrease in the economic growth rate and 2002 public spending reduction to reduce the fiscal deficit and increase savings.

135. Nevertheless, the tendency in sustainable poverty spending (without the Mitch effect) has been upwards during the 2001-2003 period, due in part to the increase debt service relief. This shows that the Government has put priority on poverty spending over non-poverty spending. Table 10 shows that spending not related to the SGPRS dropped with respect to 2000, the year of reference before the interim relief was allocated.

Table 10.

Nicaragua: NFPS Resources and HIPC Relief Additionality

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b/d: before grants.

Includes Annual 2004 National Budget Project.

Includes Interests.

Includes disbursement, grants, HIPC relief, arrears reduction, and foreign amortization payments.

Source: MHCP, BCN, SECEP.

136. In this report, the importance of a sustainable fiscal policy has been emphasized as well as the present need to manage public expenditure with higher efficiency and greater impact. At this stage, the Government finds itself in a better fiscal and budgetary situation to be eligible for debt relief.

137. The realignment of the financial sources of public spending was important for achieving a better macroeconomic performance and increasing public spending. This resulted in an increased use of external resources since the internal resources substituted for poverty spending were assigned for an improved macroeconomic balance. As can be seen in the same table, while the HIPC resources increased during the 2001-2003 period by US$235 million, total internal resources for poverty spending fell by US$196.0 million, substituted in part by an increase in non-HIPC external resources of US$125.9 million. This shift of resources allowed for an increase in poverty spending of US$164.9 million during the period in question and for a reduction of the NFPS deficit of US$107.6 million.

138. This substitutive tendency of the HIPC resources will be overcome through an improved budgetary position in the next year. In the project for the 2004 annual budget, the Government hopes to maintain the same internal resources that were expected in 2003 that is US$144.4 million. This means that in 2004, aside for increasing HIPC resources by US$24.6 million, poverty spending will increase by US$38.2 million. Internal resources remain constant and there will be an increase in non-HIPC external resources of US$12.5 million complying with the additionality principle, increasing total poverty spending to 11.4 percent of GDP.

139. The unsustainability of the fiscal deficit and its consequences on inflation levels particularly affects the most vulnerable population. When in the end the corrective measures are adopted, the cost of adjustment also affects the poorest, an effect that the Government can successfully sort out by maintaining a rising profile of poverty spending. Along this line, the Government considers that in this initial stage, having destined part of the HIPC relief to improve the macroeconomic balance was a correct choice. Through the temporary nature of this measure, the Government, in coordination with the IMF and the WB, has been able to increase public investment spending flexibility in 2003 and 2004.

H. Economic growth and poverty reduction

140. With a less optimistic profile for economic growth than was set down in the SGPRS, in the first progress report the question was if the growth expected in the following years would be enough lo reach the millennium development goals in terms of reducing extreme poverty by half. To assess the impact of a lower economic growth, data from the 2001 LSMS and the method of Ravaillon M. and Datt G. 1991 were used, using the POVCALC program developed by the WB.

141. The results presented in Table 11 show three illustrative scenarios. In preparing them, the same income distribution shown in 2001 is maintained, varying the per capita GDP growth rates by half a percentage point. This exercise shows that as the per capita GDP increases, the proportion of the population in extreme poverty decreases and that the elasticity of the proportion of extreme poor with respect to changes in per capita income is 2.1 percent.

Table 11.

Nicaragua: Per Capita Growth and Poverty Reduction

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Source: SECEP, based on the 2001 LSMS

142. After the low growth rates of 2002 and 2003, it shows that only in scenario 3 (the most optimistic) would the proportion of the population in extreme poverty not increase up to 2005 with respect to base year 2001. In scenarios 1 and 2, there are moderate increases in the proportion of extreme poor. The real result will depend on the success of other components of the SGPRS designed to ensure that the poor benefit more from future economic expansion.

I. Prospects 2003-2008

143. The prospects for the coming years have been reviewed in light of the evolution of the economy to September 2003, a review of the prospects for the world economy, the fourth review in November of the program agreed on with the IMF, the policies and programs of the Government that are reflected in the NDP, and 2004 budget guidelines.

Table 12.

Nicaragua: Basic Economic Indicators

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Excludes interests.

Deficit of the NFPS before grants, less interests.

1997-1998 average.

Includes quasi-fiscal losses of the BCN.

Gross international receives in months of imports of goods and services.

Calculated using IMF methodology.

Calculated using BCN National Accounts methodology, which includes the savings for earned contractual interest.

Source: BCN, MHCP, SECEP.