Statement by Carlos Perez-Verdia, Executive Director for Nicaragua and Johny Gramajo-Marroquin, Senior Advisor to the Executive Director

Economic performance in Nicaragua has been better than envisaged; nonetheless, vulnerabilities remain and will be compounded by electoral uncertainties. The decision to use part of the strong revenue performance to lower the fiscal deficit is appropriate. Exchange-rate and monetary policy remain broadly adequate. Fiscal adjustment should set the stage for a strong program of fiscal consolidation following the elections. Continued vigilance in the financial sector will be critical. Improvement in reporting and monitoring of foreign aid flows and transparency is necessary.


Economic performance in Nicaragua has been better than envisaged; nonetheless, vulnerabilities remain and will be compounded by electoral uncertainties. The decision to use part of the strong revenue performance to lower the fiscal deficit is appropriate. Exchange-rate and monetary policy remain broadly adequate. Fiscal adjustment should set the stage for a strong program of fiscal consolidation following the elections. Continued vigilance in the financial sector will be critical. Improvement in reporting and monitoring of foreign aid flows and transparency is necessary.

We thank the staff for a concise and well-written report. On their behalf, we would like to express their appreciation to management and staff for the willingness to maintain a close engagement with the country.

In general terms, the Nicaraguan Authorities agree with staff’s appraisal and recommendations. Nevertheless, they would like to convey that they do not share staffs opinion regarding the country’s current political framework. In spite of the aforementioned and as a signal of their commitment to maintain transparency–in line with the Fund’s policy on this matter–our Nicaraguan authorities consent to the publication of the staff report.

Performance under the ECF arrangement has been satisfactory, reflecting the Government of Nicaragua’s commitment to the ECF-supported program, based on the conviction that it will help underpin macroeconomic stability and effectively support their social and infrastructure policies. All quantitative performance criteria through end-June were met with margins, except the ceiling on non-concessional external debt, which, for strictly technical reasons, was not observed. The authorities have moved forward regarding the implementation of the supplementary agenda, reaching important steps, particularly those related to reforms in the electricity sector, a new Central Bank Charter, the approval of a new procurement law in line with international practices, and steps taken to strengthen fiscal consolidation in 2010 and 2011. Based on the aforementioned, we request the completion of the fourth and fifth reviews, the waiver of nonobservance of performance criterion as well as a one-year extension of the ECF arrangement, the corresponding rephasing of the remaining access, and the approval of the SDR12.8 million disbursement.

Taking into account the international environment characterized by persistent uncertainties, our authorities believe that the extension of the ECF arrangement will play a crucial role in effectively supporting the authorities’ prudent macroeconomic management, which will help maintain confidence and anchor expectations during the next year, while allowing for further implementation of the reform agenda.

Recent Developments and outlook for 2010-11

During 2009-10, implementation of sound macroeconomic policies has been targeted at maintaining macroeconomic stability and helping mitigate the effects of the crisis. In the recovery phase, that commitment to ensuring macroeconomic stability is still strong and important steps geared toward fiscal consolidation in the remainder of 2010 and during 2011, while safeguarding social and investment expenditure, have already been taken.

The Nicaraguan economy has been recovering at a good pace with broad-based growth of 5.9 percent (y/y) during the first semester of 2010. Currently, growth of at least 3 percent is expected for the whole year (1.75 - 2.0 percent envisaged in the program); similar growth is expected for 2011. On the demand side, although investment is rising at a slower pace than consumption, there are signs of further recovery.

After recording a historically low level of 0.9 percent in 2009, inflation is projected to reach around 7 percent in 2010, reflecting the higher economic activity and the rise in prices of oil and other relevant commodities. A slight decline is expected for 2011, between 6-7 percent.

The current account deficit is expected to increase in line with higher economic activity to around 16 percent of GDP for 2010-11. The deficit will be financed by FDI and official foreign aid, allowing international reserves coverage to remain stable.

Fiscal Policy

The Government has implemented a prudent fiscal policy during 2010 which will continue in 2011. In that context, the National Assembly approved a supplement to the 2010 budget which is consistent with a reduction in the fiscal deficit (after grants) of around 0.9 percent of GDP with respect to the program. This result stems from larger-than-programmed tax revenues, reflecting stronger economic activity and the effects of the fiscal reform of 2009.

There is agreement between the authorities and the staff that Social Security Institute (INSS) finances must be strengthened. In that sense, we would like to underscore that the Government of Nicaragua has already taken specific measures aimed at preserving fiscal sustainability, even when they involved significant political costs, including the approval of an increase of 1 percentage point in the rate of contribution to the social security system, implemented as of January 2010. In addition, the authorities have agreed to include a quantitative performance criterion on the INSS’ overall balance for December 2010. Furthermore, INSS–in consultation with an inter-institutional commission–prepared a report that sets out a range of options for improving the system’s financial position while gradually correcting its actuarial deficit, which was published for general circulation last October.

The authorities will continue to assess their options for further streamlining exemptions and exonerations, and for establishing transfer pricing regulations. In addition, they will seek to ensure that minimum wage increases are maintained in line with inflation and economic growth.

Against this background, the overall deficit for the consolidated fiscal sector for 2010 will not exceed 2.3 percent of GDP (3.1 percent in 2009). As part of the measures aimed at preserving fiscal sustainability, it is worth mentioning that for 2011 the authorities have submitted to the National Assembly a budget for the central government consistent with a deficit of 1.5 percent of GDP, which includes 0.7 percent of GDP expenditure necessary to conduct the 2011 presidential elections. Our authorities would like to stress that, considering the election cost, the 2.2 percent of GDP deficit programmed for the consolidated public sector in 2011 is a strong signal of fiscal consolidation.

Nicaragua will also continue its best efforts to secure the debt relief required from Non-Paris Club bilateral creditors. However, in spite of the important progress made so far, approximately US$1.1 billion in debt relief have yet to be secured from this group of creditors. Full creditor participation is crucial to ensure successful implementation of the HIPC initiative in Nicaragua and external debt sustainability over the long term.

Monetary and Financial Policy

Monetary policy will be aimed at ensuring adequate international reserve coverage and maintaining orderly liquidity conditions in the financial system. Although the monetary program envisages a decrease in adjusted net international reserves of around US$40 million both in 2010 and 2011, it is worth mentioning that stocks of reserves by end 2010 are estimated to reach levels well above the original targets. Such consolidation in gross reserves levels is consistent with maintaining ratios of monetary base coverage above two times, contributing to safeguard confidence on the current exchange rate arrangement. After two years of net issuance of central bank papers, aimed at managing the excess of financial system’s liquidity, the monetary authority is programming to start reducing its debt with a view to strengthen its financial position and satisfy market demand for liquidity in line with economic activity recovery. In terms of foreign exchange policy, the central bank will maintain the rate of crawl of the exchange rate of 5 percent per year.

The financial system has weathered the crisis relatively well; although nonperforming loans have increased and bank profitability has fallen, liquidity and solvency ratios have remained at adequate levels. The monetary and financial authorities will adopt further measures to safeguard the soundness of the financial system, including onsite supervision and keeping loan-loss provisioning at adequate levels.

The Nicaraguan authorities would like to emphasize that policy response to strengthen the financial safety net in the early stage of the international financial crisis proved to be effective to strengthen confidence on the financial system and the exchange regime. In that sense, the contingent credit line with the Central American Bank of Economic Integration was renewed by the Central Bank of Nicaragua in August 2010.

Supplementary Agenda

Our authorities are convinced that the supplementary agenda is well focused and critical to underpin medium-term macroeconomic stability and foster their poverty reduction strategy.

Regarding the electricity sector, further improvements in its finances and services have been accomplished, while boosting electricity generation. In order to reduce distribution losses, in July 2010 the National Assembly approved a reform of the legal framework widening the range of residential customers liable to fines for irregularities in the use and payment of electricity, and ensuring that the distribution company makes necessary investments to restrain technical losses and improve the quality of service. The increase in electricity prices of around 7 percent in May 2010, corrected the discrepancies with generation costs.

Regarding external aid, as part of the effort to strengthen the monitoring and transparency in the use of foreign aid, the Fifth Report on Cooperation, incorporating information up to end-June 2010, was recently published, and the Sixth Report (incorporating data for end-2010) will include detailed information on the subject. In addition, the Government will ensure that the use of foreign aid generates no fiscal contingencies.

On the fiscal side, with financial and technical assistance from the World Bank and the IDB, authorities are taking concrete actions with the aim of improving expenditure procedures and promoting efficiency and transparency. At the same time, efforts are under way to reinforce tax and customs administration with a view to strengthen oversight processes and the mechanisms for controlling payment of refunds, and to improve management of the large taxpayers unit.

Regarding the financial sector, the National Assembly approved in July 2010 a new Central Bank Charter which consolidates institutional strength, improves the instruments for monetary policy, and ensures greater accountability. Drawing on the central bank’s strategic planning and latest FSAP discussions, the monetary authority is currently working on revamping its monetary instruments with a view to continue supporting the crawling peg regime but also to manage liquidity in a more efficient way and to promote money market development. Short term FSAP recommendations regarding Safety Nets, Crisis Management and Banking Resolution as well as Money and Debt Markets, and Liquidity Management have already been addressed.

The government remains committed to promote the sound development of microcredit and, more broadly, the payment culture. In that sense, with the aim of enhancing supervision, transparency and efficiency of the microfinance sector, by end-November 2010 the authorities will seek approval of a law to regulate and manage the sector, in particular the regulatory framework applicable to unsupervised microfinance intermediaries. Alongside, enhanced efforts will be made to monitor the activities of financial cooperatives by strengthening the supervisory agency.

Finally, our authorities want to underscore their continued commitment to the objectives and policies established in the ECF arrangement as they are convinced that it will effectively support their economic and social policies. Going forward, authorities anticipate the Executive Board’s approval of the extension of the ECF and will continue to consult with Fund staff on all matters relating to policies under the program.

Nicaragua: Fourth and Fifth Review Under the Three-Year Arrangement Under the Extended Credit Facility, Requests for Extension of the Arrangement, Rephasing of Access, and Waiver of Nonobservance of Performance of Criterion, and Financing Assurances Review-Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Nicaragua
Author: International Monetary Fund