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Cablegate: Nicaragua: Imf Six Month Review

VZCZCXRO0323
RR RUEHLMC
DE RUEHMU #0373/01 0921617
ZNY CCCCC ZZH
R 011617Z APR 08 ZDK
FM AMEMBASSY MANAGUA
TO RUEHC/SECSTATE WASHDC 2349
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEHCV/AMEMBASSY CARACAS 1248
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHDC
RHEHNSC/NSC WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 03 MANAGUA 000373

SIPDIS

SIPDIS

STATE FOR WHA/CEN, WHA/AND, WHA/EPSC, AND EEB/OMA
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN
3134/ITA/USFCS/OIO/WH/MKESHISHIAN/BARTHUR

E.O. 12958: DECL: 03/31/2018
TAGS: ECON EFIN ENRG EPET EAID PGOV PREL NU
SUBJECT: NICARAGUA: IMF SIX MONTH REVIEW

REF: A. 07 MANAGUA 2524
B. 07 MANAGUA 1771
C. 07 MANAGUA 2373
D. 07 MANAGUA 2185

Classified By: DCM Richard M. Sanders for reasons 1.4 b & d.

1. (C) Summary: On March 7 a visiting IMF review team stated
that Nicaragua had performed satisfactorily during the first
six months of its Poverty Reduction and Growth Facility
(PRGF). Nicaragua met most quantitative and structural
targets. General IMF recommendations emphasized improving
the investment climate and Nicaraguan competitiveness and
increasing capital and anti-poverty expenditures. The IMF
team remains concerned about Nicaragua's rising inflation and
the lack of transparency surrounding assistance from
Venezuela. Both of these issues were on the agenda for the
week of follow-up meeting scheduled for March 25. While on
the surface things are progressing well in the IMF-GON
relationship, tensions remain regarding the government's
commitment to the PRGF. End Summary.

Overview on PRGF Performance and Next Steps
-------------------------------------------

2. (SBU) At the end of its two week mission (February
25-March 7) the IMF review team, under the direction of new
team leader Luis Cubeddu, stated that Nicaragua had performed
satisfactorily during the first six months of its PRGF,
noting considerable progress on the implementation of the
overall economic program. Reserves, fiscal expenditures, and
the budget deficit fell within reasonable margins. However,
Nicaragua did not meet its targets for real GDP growth,
inflation, and the minimum for social spending (Ref B). The
IMF team stated that the 2008 National Budget is consistent
with the parameters of the program. Nicaragua met all of the
structural targets, with the exception of the electricity
theft law, which was only passed in general terms in the
National Assembly during the visit.

3. (SBU) 2007 targets and results and 2008 revised targets
are as follows:

2007 Target (Ref B) Result
--------------------------------------------- -----------
Real GDP growth rate 4.2% 3.8%
Inflation 7.5% 16.8%
Deficit (as % of GDP) 1.0% 1.0%
Increase in Reserves (USD) 60 million 160 million
GDP (USD) 5 billion 5.7 billion

2008 Target (Ref B) Revised Target
--------------------------------------------- -------------
Real GDP growth rate 4.5% 4.0%
Inflation 7.0% 10.0%
Deficit (as % of GDP) 1.8% 1.8%
Increase in Reserves (USD) 70 million 70 million
GDP (USD) 6.4 billion

4. (SBU) IMF recommendations emphasized improving the
investment climate and Nicaraguan competitiveness, increasing
capital and anti-poverty expenditures, and hiring a
consultant to create a national development plan. Nicaragua
has requested an overall revision of program parameters given
that the IMF calculated the original PRGF with oil at USD 76
per barrel. The IMF, World Bank (WB), and Inter-American
Development Bank (IDB) will continue to work together to help
the GON improve financial/fiscal transparency. Pending
issues, to have been discussed in Washington meetings the
week of March 25, include an anti-inflation program, salary
policy, and the renegotiation of local bank bonds (CENIs).
The IMF ResRep told us the IMF plans to propose tax reform be
part of the next review in six months.

5. (U) The IMF Board will vote on the semi-annual review and
revised PRGF targets at the end of April. Provided the Board
approves the review, the IMF will disburse USD 16 million.
Nicaragua already received one disbursement of USD 18.5
million in 2007, as part of the three-year USD 110 million
program.

A Message to Donors
-------------------

6. (C) The IMF team expressed concern to the Budget Support
Group donors (BSG), who will provide USD 100 million in
direct budget support in 2008, regarding the delay in
disbursement of funds. Most donors planned on third and
fourth quarter disbursements; dependent on the results of
their semi-annual review of the GON's performance. The IMF
team believes that the delayed disbursements limit the GON's
ability to engage in financial planning and effective fiscal
management. According to the IMF, if Venezuela fills the
financing gap, donors will find they have lost influence with
the GON. The IDB and WB offered to look at moving up their
disbursement schedules.

Inflation is the Central Issue
------------------------------

7. (C) The principal item on the agenda is the steep increase
in Nicaragua's inflation; over twice the PRGF target for
2007. The IMF team agrees with GON analysis that the
principal causes were the supply shocks of world oil prices,
high international food commodity prices, and the rise in
domestic food prices due to the Pacific coast floods (Ref A).
However, the IMF calculated that starting in November 2007,
core inflation (excluding food and energy) rose 8%,
indicating that there are demand components to this
inflation. This problem continues as annualized core
inflation in January was 11.6% and rose to 13% in February.
(Note: Post will report more fully on Nicaragua's inflation
septel. End Note.)

8. (C) The IMF strongly recommends the GON immediately
implement an anti-inflation program which combines monetary,
fiscal and salary policies that can reduce inflation back to
the 8-10% range. Key elements will be for the GON to manage
expectations, control demand, and establish a clear salary
policy which limits further increases.

9. (C) The Nicaraguan Central Bank (BCN) promised it would
announce an anti-inflation program as part of an overall
anti-corruption program; however, the IMF is not optimistic
that a program will take place soon. (Note: The BCN did not
clarify how they would relate inflation to anti-corruption.
End note.) In fact, policy decisions in the last 12 months
have been expansionary: a 33% increase in the minimum wage
and a 14% salary increase for government employees in the
2008 budget. Also worrisome is the GON's stated desire to
take full advantage of the PRGF allowance for an increase in
the deficit by 2% of GDP for social spending using Venezuelan
assistance funds.

Venezuela Assistance: What, Where, and How ) For Now
--------------------------------------------- -------

10. (C) One of the largest unknown factors in any discussion
of Nicaragua's economy and its inflation is Venezuelan
assistance. The PRGF assumed that the GON would funnel most
of the funds through the public sector. The IMF's review of
the books of the companies handling the funds, facilitated by
the GON, revealed that the GON is actually processing the
funds through private and quasi-private companies. The IMF
estimates that Venezuelan assistance (in cash and in-kind) in
2007 was USD 202 million or 3.5% of GDP. Of this, the oil
import scheme represented USD 91 million or 1.6% of GDP. The
estimates for 2008 are total assistance of USD 515 million,
or 8% of GDP. Income from the oil import scheme will be USD
279 million, or 4.4% of GDP. From what the IMF was able to
determine, in 2007 the Venezuelan assistance included items
such as subsidized fuel for state owned electricity
generating plants, hurricane relief, subsidies for public
transportation, and grants to the Ministry of Health and the
Army, among others. Use of 2008 funds remains unclear,
however, complicating the IMF's ability to determine whether
the Nicaraguan economy can absorb these funds effectively.
To capture more data about Venezuelan assistance, the IMF
plans to ask for semi-annual reports on donor assistance,
including assistance to the private sector.

11. (C) Most worrisome for IMF ResRep Humberto Arbulu Neira
is that no one in the GON seems to have a clear grasp of the
scope of what Venezuela is doing in Nicaragua. He told the
Ambassador on March 17 that when the IMF team presented its
data to high ranking GON members, the response was "That is
wrong. That is too much." When asked for the GON's
consolidated figures on Venezuelan assistance, no one could
provide them. Arbulu is also puzzled by the complete
disregard on part of the Minister of Finance for the
potential role these financial inflows are having on
Nicaragua's economy and inflation. The Minister told Arbulu,
"It is not my concern. Show me the economic model which
demonstrates that assistance can have inflationary and
distorting effects."

12. (C) During a March 4 conversation with WHA/CEN Director
Feeley, BCN President Antenor Rosales was also unconcerned
about the effects of Venezuelan assistance, as long as it
finances production, particularly agricultural production.
According to Rosales, he has successfully argued to President
Ortega that Venezuelan assistance could not be in the form of
new loans as it would risk the terms of Nicaragua's benefits
under HIPC. He concluded the discussion by admitting that
the issue is "very political;" a tacit acknowledgment that
inflationary effects of Venezuelan assistance may take a back
seat to Ortega-Chavez political goals.

Pending Issue in Energy Sector
------------------------------

13. (SBU) The PRGF laid out two main energy objectives in
2007/2008, passage of an electricity theft law and a
technical audit of electricity distributor Union Fenosa.
Colombian consulting firm ConCol will complete the audit of
Spanish-owned Union Fenosa's infrastructure investments and
technical losses in July. The National Assembly passed the
electricity theft law "in principle" on March 12, after the
IMF tied its passage to further disbursement of funds to the
GON. Starting on March 27, the National Assembly began to
review and approve the bill article by article. The bill has
been controversial because leftist legislators see it as
favoring Union Fenosa at the cost of the consumers. The bill
lays out fines (up to 1,000 times the minimum wage) and jail
time (six months to five years) for electricity theft and
fraud and focuses on consumers of more than 500 KW a month.
Implementing the law will remain a challenge as it depends
upon the publication of Nicaragua's new Penal Code. The
Ortega government has held up formally publishing the new
Penal Code for political reasons, although it claims it is a
lack of money (Ref C).

Domestic Debt Also an Area of Concern
-------------------------------------

14. (C) The IMF team is concerned that Nicaragua's overall
debt profile remains high because of its excessive domestic
debt load. In 2007 Nicaragua's internal debt was USD 1.1
billion, 19.7% of GDP (Ref C). Two-thirds of the domestic
debt is bonds issued to compensate property owners, including
U.S. citizens, who had their property confiscated in the
1980s. Most of the remainder are bank bonds, bonds issued to
refinance the CENIs bonds originally issued to bail out four
collapsing banks between 1999-2001. The bank bonds represent
less than 25% of domestic debt load and servicing in 2007
totaled 0.5% of GDP. Because the bank bonds are politically
unpopular (Ref D), however, they have been the GON's chosen
target for refinancing. The political frenzy surrounding the
bonds has led to the offices of the Attorney General and
Comptroller General (equivalent to the GAO) to join the
Ministry of Finance and BCN in negotiating with the banks
holding the bonds. The IMF team is very concerned that the
banks have not had a choice on the refinancing and has
emphasized to the GON that the final agreement must be
negotiated in a transparent and voluntary fashion. The IMF
is also trying to dissuade the GON from using the money saved
from the refinancing to increase salaries for state
employees; suggesting they be added to reserves instead.

Comment
-------

15. (C) While on the surface things are progressing well in
the IMF-GON relationship, tensions remain regarding the
government's commitment to the PRGF. Many donors, including
the IMF, are concerned that Ortega is only interested in the
PRGF as a tool to keep donors in country. He, and many of
his closest economic advisors, believe that the PRGF
objectives of economic stability are subordinate to political
goals. As long as the PRGF serves the GON's political
objectives, the GON will take the actions required to abide
by the terms of the agreement. If it becomes politically
necessary, however, the GON will quickly drop the program.
TRIVELLI

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