On behalf of the Government of Nicaragua we would like to thank staff and management for their policy advice and for their disposition for a continuous open dialogue. We would also like to thank Executive Directors for their support to the country, especially with the recent approval of the Multilateral Debt Relief Initiative. The authorities of Nicaragua are committed to continue using freed up resources from debt relief to fight poverty and help achieving the MDGs.
Our Nicaraguan authorities have shown a strong commitment and ownership of their economic program, which has been supported by a PRGF arrangement. In late 2004, in the framework of positive macroeconomic results and over performance of quantitative targets, the program went off-track, with the approval of the 2005 budget that increased the deficit in relation with the executive’s proposal. At the same time, the approval of constitutional reforms without domestic consensus resulted in a tense political environment that affected the structural reform agenda. During the first half of the year the government moved quickly to protect the core elements of the program, identifying tax measures and implementing a more strict control of expenditures. The fiscal targets went back on track and technical discussions on structural reforms advanced despite the difficult political environment.
With the main objective of protecting macroeconomic stability, a wide political consensus was achieved in the last months of 2005, which postponed approved constitutional reforms until after the next presidential elections. With this new accord, the National Dialogue was an effective scenario to agree on key policies, including ten prior actions to bring the PRGF back on track. Taking into consideration the political scenario of the 2006 electoral year, there was a front loading of economic and structural measures, which included the approval on the 2006 budget, strengthening of financial laws, the approval of a financial administration law, increases in electricity tariffs and reforms in the area of decentralization.
Despite uncertainties related to the political environment and the negative impact of the oil shock, the macroeconomic framework for 2005 was positive. High oil prices not only had a direct impact on inflation and on the current account, but also resulted in pressures for subsidies in the transport and electricity sectors, as well as greater demands for public wage increases. Nevertheless, the inflation rate was maintained in a single digit (9.6 percent y/y at end 2005), the monthly indicator of economic activity for October shows a 4.9 percent growth rate, in line with the projected GDP growth of 4 percent, and employment has been growing. At the same time, export growth and the increase in remittances helped reduce the impact of the oil bill on the current account, and the disbursement of external resources and reduction of debt service made it possible to accumulate international reserves.
Based on a satisfactory macroeconomic performance and the compliance of prior actions Nicaraguan authorities request the completion of the seventh, eight and ninth reviews under the PRGF and waivers for the nonobservance of two performance criteria. The first one for a small breach on the target for the overall balance after grants of the central government at end 2004, and the second one on the structural PC of submitting to the National Assembly a fiscal responsibility law. They also request an extension of the arrangement to December 2006 to continue supporting sound macroeconomic policies, especially during this electoral year.
The fiscal strategy for 2005 and for the 2006 budget has included the strengthening of revenues and prioritization and improvement on control over expenditures. This, coupled with debt service relief, has permitted an increase in poverty reducing expenditures.
Revenues have been growing at a strong rate reflecting tax measures, growth in economic activity and administrative efforts. Tax reforms during this administration have resulted in an improvement on the composition of the tax structure, increasing revenues from income taxes. To further strengthen tax collection and as part of the structural agenda, a Tax Code was approved in 2005. The authorities are aware that the tax code contains weaknesses and have already initiated technical discussions with the National Assembly to achieve the consensus to make reforms. A PC on these reforms has been established for March 2006.
In terms of expenditures, two major policy issues refer to decentralization and the wage bill. As part of the prior actions to complete this review, the 2006 budget approved maintains the transfer to municipalities to 6 percent of revenues and includes a devolution of expenditures equal to half of the transfer. The transfer law was amended to delay the increase in transfers in the medium term, and a presidential decree was passed to curtail central government spending in areas that should be the responsibility of municipalities. In order to further improve the decentralization framework, an agreement was reached with political parties to reform the municipal transfer and municipality law. A structural benchmark regarding these reforms has been established in the program.
In relation to wage policy, the authorities are aware of the possible risks associated with rapid wage increases and have agreed to monitor the wage bill as a PC on the program. Despite the legal restrictions and limitations regarding wage policy, the authorities have taken corrective measures to limit the growth of the wage bill, including eliminating vacancies and lowering wage payments to consultants. However, it is important to mention that wage increases have been in line with civil service reform and have been targeted to priority sectors such as health and education.
Quasifiscal losses related to the electricity sector have also been addressed. Adjustment of electricity tariffs to eliminate the fiscal impact of losses of the power sector started in July, accumulating a 20 percent adjustment through January 2006, while maintaining targeted subsidies to low usage consumers. In September an Energy Stability Law (ESL) was approved allowing for high frequency adjustments. A PC to monitor further price adjustments is being introduced, and a PC has been established to strengthen the ESL to eliminate potential distortions to the sector.
In order to strengthen the fiscal framework, a Financial Administration Law was approved in 2005 and the development of a road map for the approval of a fiscal responsibility law was established as a PC. The road map will address important vulnerabilities such as the earmarking of spending, to be considered by the next administration. Additionally, reforms to the pension system were postponed, and the preparation of strategy for implementation of a new reform has been established as a PC.
Monetary and financial policy
The monetary program for 2005 was based on an effective coordination with fiscal policy, that supported the strengthening of international reserves and the continuation of the policy of domestic debt reduction. During the first half of the year, after over performing in 2004, there was a moderate loss of international reserves, as a result of delays in disbursement of external resources and lower open market operations related to uncertainties of the political environment. Nevertheless, during the last months of 2005 monetary policy was tightened, which coupled with a strong demand for monetary base, a stronger fiscal position than expected, and external disbursement, resulted in the accumulation of reserves above the annual target.
The authorities believe that their prudent monetary policy has been consistent with the objective of supporting the exchange rate system, which has served appropriately as the main instrument to anchor inflation expectations. At the same time, monetary policy has reduced the central bank’s financial vulnerability by reducing the stock and financial cost of domestic debt. For the medium term, the authorities are aware of the convenience of continuing to reassess the exchange rate system, taking also into consideration relevant conditions such as development of domestic capital market and sound fiscal policies among others. For 2006, the monetary program will maintain the 5 percent crawling peg of the exchange rate and will aim at further strengthening central bank reserve position, especially during the first semester.
Substantial progress has been made in strengthening the legal financial framework, in line with FSAP recommendations. In 2005, reforms were made to the banking law, the law of superintendency of banks and the deposit insurance fund. The government plans to develop a road map to further improve the financial sector framework.
Debt sustainability has been at the core of this government’s economic policy. Debt strategy has included many fronts, the most important being the access to international initiatives such as the HIPC initiative and more recently the MDRI. Other important policies have included the strengthening of the debt framework through the implementation of the debt law, the improvement of the debt monitoring system and the renegotiation of domestic debt. These measures, coupled with fiscal consolidation have resulted in a positive impact on long term sustainability, however, more still needs to be done.
Important steps have been taken regarding debt reduction. Thanks to the HIPC initiative, Nicaragua has successfully completed negotiations with all its Paris Club creditors, basically all its multilateral creditors, and nine non-Paris club creditors, covering together 61 percent of expected HIPC debt relief. It is important to mention that in all its negotiations with external creditors Nicaragua has adhered to the principles of comparable treatment and equitable burden sharing.
The authorities are committed to continue implementing sound macroeconomic policies, focusing on fiscal adjustment and a responsible debt policy. The government is committed with the rest of the international community to advance towards debt sustainability and liberate resources to help achieve the MDGs.
As part of the poverty reduction strategy, a second generation PRSP-II has been revised and improved, and is now incorporated in the 2005-2009 National Development Plan. The strategy focuses in four key areas: (i) economic growth for poverty reduction (ii) human capital development and social protection, (iii) productive and social public infrastructure and (iv) governance and state reforms.
The authorities believe that a comprehensive national plan is being presented. Private sector led growth is being fostered with an improved investment climate based on macroeconomic stability, improvement in public infrastructure and initiatives such as HIPC, MDRI and CAFTA-DR. Public spending is being rationalized, supported by efforts to achieve a multiyear budgeting process, and prioritization of poverty reducing expenditures, including the tracking of HIPC debt relief through the Supplementary Social Fund. International cooperation is being harmonized, the Joint Financial Agreement for General Budget Support signed on May 2005 is another proof of the international community’s support and confidence on the transparency and ownership of the government’s economic program, and in 2006 the first investments of the US funded Millennium Challenge Account are expected to take place.
The Nicaraguan government believes that the completion of the pending reviews of the PRGF as well as the extension of the program will serve as basis for the continuation of sound macroeconomic policies during the last year of this administration and during this year’s electoral period, and will provide an appropriate framework for Nicaragua’s long term objective of growth and poverty reduction. In line with the government’s transparency policy the authorities intent to publish the related documents of this review.