Nicaragua: Selected Issues
Author: International Monetary Fund
Publication Date:
05 Sep 2012
eISBN:
9781475506631
Language:
English
Keywords:
ISCR; CR; tariff; minimum wage; trading partner; current account norm; Nicaragua's dependence; perceived public sector corruption; competitiveness indicator; Current account deficits; Current account; Real exchange rates; Exports; International reserves
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The paper is an elaborated report on Nicaragua’s potential economic growth. The challenges and idiosyncratic shocks were immense but the policies of better education, labor contracts, and accomplishments in public investments paved the way for movement of the economy. The external competitiveness and exchange rate assessment also have an important hand. The achievements in the electricity sector and the improvement in reforming the pension system are the prominent aspects. On the whole, the Board considers this growth as a positive trial of development in the global panorama.

Abstract

The paper is an elaborated report on Nicaragua’s potential economic growth. The challenges and idiosyncratic shocks were immense but the policies of better education, labor contracts, and accomplishments in public investments paved the way for movement of the economy. The external competitiveness and exchange rate assessment also have an important hand. The achievements in the electricity sector and the improvement in reforming the pension system are the prominent aspects. On the whole, the Board considers this growth as a positive trial of development in the global panorama.

II. External Competitiveness and Exchange Rate Assessment1

During the last decade, Nicaragua’s external competitiveness has improved steadily, mainly driven by the maquila and manufacturing sectors. Nevertheless, current account deficits continue to be large. Standard models suggest that the real exchange rate is broadly in line with fundamentals, but non-price competitiveness indicators suggest that structural conditions still weigh on Nicaragua’s external competitiveness. As external vulnerabilities persist, higher reserve coverage could provide a buffer against external shocks.

A. Introduction

1. Nicaragua’s external competitiveness has improved steadily since the early 2000s. Exports as a share of trading partners’ non-oil imports have increased sharply, consistent with the observed real depreciation of the Córdoba. While traditional goods (coffee, meat, and other agricultural products) have remained an important part of exports, the maquila and manufacturing sectors have been the sources of export dynamism with a significantly larger presence in the U.S. market. At the same time, foreign direct investment (FDI) has trended up, in particular in the maquila and energy sectors.

uA02fig01

Market share and real effective exchange rate

(Index, 2000 = 100)

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

Sources: Nicaraguan authorities, IMF, and Fund staff calculations.

2. Despite these competitiveness gains, current account deficits continue to be large. Nicaragua has a history of large trade deficits, averaging 26 percent of GDP over the last decade, in part explained by a high dependency on oil imports (on average 14 percent of GDP over the last 5 years). At the same time, Nicaragua has been a large recipient of remittances (around 17 percent of GDP), mainly from the United States and Costa Rica, which mitigates the vulnerabilities coming from the large trade deficits. Still, the country has faced substantial current account deficits, fluctuating between 12 and 24 percent of GDP. These deficits have been financed mainly by official loans and transfers of around 9 percent of GDP and FDI of around 7 percent of GDP. In most years, capital inflows in excess of the current account deficit have allowed for a gradual accumulation in international reserves.

uA02fig02

Current account balance and main components

(in percent of GDP)

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

Sources: Nicaraguan authorities and Fund staff calculations.

3. Since 2007, Nicaragua has benefitted from an oil collaboration scheme with Venezuela. Under this scheme, Caruna, a private credit cooperative, has received long-term concessional financing amounting to one half of the oil bill from Venezuela. These substantive capital flows (around 7 percent of GDP in 2011) have helped to finance large current account deficits and alleviate pressures on international reserves. However, the collaboration scheme is political in nature and could be discontinued at any time. A sudden stop in these sizable flows could be very disruptive for Nicaragua, potentially leading to reserve losses and requiring an accelerated current-account adjustment. There would also be fiscal pressures, as these flows currently finance well-established social programs. Effects on the balance of payments would also depend on the fiscal policy response.

4. Looking forward, the projected increase in alternative energy generation will gradually improve the current account balance, but vulnerabilities will persist for a while. Ongoing and planned investment in non-oil generation of energy is expected to reduce Nicaragua’s dependence on oil imports over the long run. However, staff projects that the current account deficit will remain large in the meantime, representing a non-negligible risk for Nicaragua’s limited international reserve position and its large stock of international liabilities. Given a relatively fixed exchange rate regime (crawling peg) and vulnerabilities to external shocks, the Nicaraguan authorities should aim at increasing the official reserve coverage.

B. Dynamism in the Export Sector

5. Nicaraguan exports are dominated by maquila and manufacturing exports. Total exports as percent of GDP have skyrocketed during the last decade, mainly driven by maquila and manufacturing products (Figure 1). Traditional agricultural products still accounted for close to 20 percent of total exports during the last few years, compared with around 45 percent in the early 1990s.

Figure 1.
Figure 1.

Export Categories and Destination of Exports

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

6. Nicaragua continues to export mainly to North America. The United States is Nicaragua’s main trading partner, accounting for half of the country’s exports, followed by Mexico (Figure 1). In recent years, Venezuela has also become an important destination for Nicaraguan exports, while exports to other Central American countries have been losing importance. Exports of some Nicaraguan neighbors have not performed as well, as suggested by a relative reduction in their presence in the U.S. market.

uA02fig03

U.S. imports: Articles of Apparel and Clothing Accessories as share of total imports from each country

(in percent)

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

Sources: U.S. Department of Commerce, the U.S. International Trade Commission, and Fund staff calculations.

7. Maquila exports have been capturing increasingly larger shares of the U.S. market. Nicaragua was one of only two Central American countries (the other being Costa Rica) to post a continuous increase in its share of U.S. imports, tripling it between 1996 and 2011. For instance, the share in U.S. imports of apparel and clothing accessories (accounting for about two-thirds of Nicaragua’s maquila exports and ¼ of its total exports) quadrupled since 1996, while the share of other Central American countries has remained unchanged or even declined (Figure 2).

Figure 2.
Figure 2.

U.S. Imports from Central America

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

C. Price Competitiveness: Real Exchange Rate

8. The currencies of Nicaragua’s main competitors appreciated in real effective terms vis-à-vis the Córdoba. In the past four years, El Salvador (a fully dollarized economy) posted a less marked appreciation and depreciation cycle than Nicaragua and ended up at slightly better level of competitiveness (Figure 3). In contrast, by March 2012, the currencies of Honduras and Guatemala were, respectively, 17 and 8 percent above the Nicaraguan Córdoba in real effective terms.

Figure 3.
Figure 3.

Nominal and Real Effective Exchange Rate

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

9. The macroeconomic-balance (MB) approach suggests that Nicaragua’s current account deficit is only slightly larger than implied by economic fundamentals. The MB approach evaluates Nicaragua’s current account after correcting for any temporary factor or shock relative to an estimated current account norm. The calculation of such norm is based on panel estimates from Vitek (2012), explicitly taking into account the role of large remittances in Nicaragua. Assuming that only exchange rate changes can deliver a substantial current account adjustment, a depreciation of around 3 percent would be needed to close the gap between the underlying current account and the norm.2

10. The external sustainability approach (ES) also suggests that Nicaragua’s real exchange rate is broadly in line with fundamentals. The ES calculates the current account balance that is needed to stabilize the net foreign assets (NFA) position. To maintain its current international debtor position at 144 percent of GDP,3 Nicaragua could sustain a current account deficit of 8 percent of GDP, suggesting a small overvaluation of around 5 percent.4 However, the current large international debtor position entails substantial risks, in particular considering that Nicaragua has already benefited from the HIPC/MDRI initiatives and obtained debt relief. Hence, to reduce the NFA position, an even smaller current account deficit seems advisable. The text figure illustrates the path for the International Investment Position that is consistent with staff’s baseline current account projections.

uA02fig04

International Investment position

(in percent of GDP)

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

Sources: Lane and Milesi-Ferretti, Nicaraguan authorities, and Fund staff calculations.

11. Simple exchange rate models suggest that the real exchange rate is either at equilibrium or undervalued. Nicaragua is a price taker in world markets and hence its terms of trade are exogenously determined. A simple equilibrium real exchange rate model suggests that Nicaragua’s real exchange rate is around its equilibrium value (Figure 4). However, accounting for the fact that the real exchange rate tends to appreciate as a country develops and productivity increases (Balassa-Samuelson effect), Nicaragua’s exchange rate seems relatively undervalued (Figure 4).

Figure 4.
Figure 4.

Real Exchange Rate

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

12. These standard methods send mixed signals about Nicaragua’s real exchange rate, but short to medium-term approaches suggest that the Córdoba is broadly in line with fundamentals. A development focused, cross-country analysis accounting for the Balassa-Samuelson effect suggests significant real exchange rate undervaluation in Nicaragua. However, the MB and the ES approaches suggest that the underlying current account is only somewhat larger than the norms and that some depreciation might be needed to close the gap.

Table 1.

Estimates of overvaluation of the Cordoba

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D. Non-Price Competitiveness: Structural Impediments

13. Structural conditions still weigh on Nicaragua’s external competitiveness. Looking at business regulations and their enforcement, the World Bank’s Doing Business Indicators rank Nicaragua at the bottom half of all countries assessed, even though the country’s relative position has improved compared to last year (Table 2). Nicaragua ranks somewhat worse than some of its regional peers, in particular due to low relative rankings on “getting electricity” and “registering property”, well-known structural problems of the Nicaraguan economy (see SIP, chapter 3, and the staff report). However, two of its main trade competitors, Honduras and El Salvador, also rank relatively poorly in general.

Table 2.

Doing Business Indicators (2012, rank out of 183 countries)

article image
Source: World Bank (2012).

14. Perceived corruption can also be holding back Nicaragua’s ability to compete in international markets. The Corruption Perceptions Index from Transparency International ranks Nicaragua’s perceived public sector corruption, as assessed in opinion surveys and by experts, at the bottom third among the 183 countries covered (Table 3). Moreover, it has deteriorated slightly during the past few years. Nicaragua’s score is worse than the median of its regional neighbors, but is comparable to two of its main trading competitors, Honduras and Guatemala.

Table 3.

Corruption Perceptions Index (Rank and Score)

(Score ranges from 0 = highest perception to 10 = lowest perception)

article image
Source: Transparency International (2011).

15. Security and the cost of crime is a concern for businesses in Central America, although Nicaragua scores relatively well in this regard. The Executive Opinion Survey carried out by the World Economic Forum, ranks the business cost of crime and violence in Nicaragua at the bottom third of the countries assessed. However, Nicaragua scores significantly better than all other countries in the region (Table 4).

Table 4.

Business costs of crime and violence

(2011-12, rank out of 142 countries, values from 1=high cost to 7=no cost)

article image
Source: World Economic Forum, The Global Competitiveness Report 2011-12.Notes: Weighted average for 2010-11.

“To what extent does the incidence of crime and violence impose costs on businesses in your country?” [1 = to a great extent; 7 = not at all]

16. Nicaragua’s global competitiveness is low but it is improving. The World Economic Forum’s Global Competitiveness Index, based on a comprehensive assessment of countries’ competitiveness, ranks Nicaragua at the bottom third of 142 countries (Table 5). Nicaragua is also ranked lower than any of its regional peers. On the positive side, this survey identifies Nicaragua as having a comparative advantage in a number of goods and labor market efficiency indicators.5

Table 5.

Global Competitiveness Index

article image
Source: World Economic Forum (2011).

E. Adequacy of International Reserves

17. Nicaragua’s reserve coverage is above standard rules-of-thumb. Countries hold international reserves to self-insure against external shocks. In this regard, standard rules-of-thumb assess international reserve levels as appropriate if, for example, import and broad money coverage is above 3 months and 5-20 percent, respectively. In 2011, Nicaragua’s gross official reserves reached US$ 1,892 million, bringing reserve coverage to 4 months of prospective imports (excluding maquila) and about 120 percent of M2 (Figure 5).

Figure 5.
Figure 5.

International Reserve Coverage

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

18. The costs and benefits of holding international reserves need to be balanced. IMF staff has developed a new methodology to assess reserve adequacy in low-income countries (Dabla-Norris, Kim, and Shirono, 2011) that explicitly looks at the costs of holding international reserves (in terms of foregone alternative investment opportunities) compared to their benefits (in terms of crisis prevention and mitigation). This new methodology is used to assess the adequacy of Nicaragua’s reserves. The key shock variables (external demand, terms of trade, FDI as a ratio to GDP and aid flows as a ratio to GDP) are set equal to the bottom tenth percentile of their realizations in Nicaragua over the last five years, and the fundamentals (fiscal balances and CPIA6) to their 2008-10 average.

article image

19. Nicaragua’s reserve coverage could be increased. The analysis suggests that the optimal level of reserves for Nicaragua varies between 3 and 6 months of imports, depending on the unit cost of holding reserves, compared with 4 months of coverage in 2011. Given a relatively fixed exchange rate regime, Nicaragua needs a higher level of reserves as insurance against external shocks than it would need with a flexible exchange rate, as the exchange rate cannot be used as adjustment mechanism.

uA02fig05

Optimal Level of Reserves

(in months of imports)

Citation: IMF Staff Country Reports 2012, 257; 10.5089/9781475506631.002.A002

References

  • Dabla-Norris, Era, Jun Il Kim, and Kazuko Shirono, 2011, “Optimal Precautionary Reserves for Low-Income Countries: A Cost-Benefit Analysis”, IMF Working Paper 11/249 (Washington D.C.: International Monetary Fund).

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  • Lane, Philip R. and Gian Maria Milesi-Ferretti, 2007, “The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970–2004”, Journal of International Economics 73 (2), pp. 223–250.

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    • Export Citation

  • Lee, Jaewoo, Gian Maria Milesi-Ferretti, Jonathan Ostry, Alessandro Prati, and Luca Antonio Ricci, 2008, “Exchange Rate Assessments: CGER Methodologies”, IMF Occasional Paper No. 261 (Washington D.C.: International Monetary Fund).

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    • Export Citation

  • Tokarick, Stephen, 2010, “A Method for Calculating Export Supply and Import Demand Elasticities”, IMF Working Paper 10/180 (Washington D.C.: International Monetary Fund).

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  • Vitek, Francis, 2012, “Exchange Rate Assessment Tools for Advanced, Emerging, and Developing Countries”, mimeo.

1

Prepared by Julia Bersch.

2

This estimate uses the Nicaragua-specific export and import elasticities calculated by Tokarick (2010) of 1.11 and -1.33, respectively. The standard CGER elasticities (Lee and others, 2008) of export and import volumes of -0.71 and 0.92, respectively, yield a higher overvaluation.

3

We use the International Investment Position in an updated and extended version of the Lane and Milesi-Ferretti (2007) dataset instead of Net Foreign Assets because the NFA position substantially underestimates external debt by excluding private external debt.

4

See footnote 2.

5

Nicaragua ranks in the top third in the goods market efficiency indicators “Number of procedures to start a business”, “Trade tariffs, % duty”, “Imports as percentage of GDP” and in the labor market efficiency indicators “Hiring and firing practices” and “Redundancy costs, weeks of salary”. Also, the 2011 government budget balance (as percent of GDP) indicator ranked Nicaragua 22nd of 142 countries.

6

The World Bank’s Country Policy and Institutional Assessment (CPIA) measures the extent to which a country’s policy and institutional framework supports sustainable growth and poverty reduction, and, consequently, the effective use of development assistance.

Same Series

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Cover IMF Staff Country Reports
Nicaragua: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2012: Issue 257
Publisher:
International Monetary Fund
ISBN:
9781475506631
ISSN:
1934-7685
Pages:
56
DOI:
https://doi.org/10.5089/9781475506631.002

Market share and real effective exchange rate

(Index, 2000 = 100)

Current account balance and main components

(in percent of GDP)

Export Categories and Destination of Exports

U.S. imports: Articles of Apparel and Clothing Accessories as share of total imports from each country

(in percent)

U.S. Imports from Central America

Nominal and Real Effective Exchange Rate

International Investment position

(in percent of GDP)

Real Exchange Rate

International Reserve Coverage

Optimal Level of Reserves

(in months of imports)