PRESSURE INCREASES ON NICARAGUA TO RESOLVE IMF

UNCLAS SECTION 01 OF 03 MANAGUA 001604

SIPDIS

SENSITIVE

DEPARTMENT FOR WHA/CEN
DEPARTMENT PASS USTR, OPIC AND EX-IM BANK

E.O. 12958: N/A
TAGS: ECON EFIN NU IMF
SUBJECT: PRESSURE INCREASES ON NICARAGUA TO RESOLVE IMF
ISSUE

REF: A. 04 MANAGUA 3562

B. MANAGUA 1011


1. (SBU) SUMMARY. A strong message from European donors has
increased the pressure on the GON to take action to awaken
the "dormant" IMF program or jeopardize losing USD 120
million in aid, including direct budget support. This echoes
similar comments from Carlos Castaneda, IDB Executive
Director for Central America, who on May 23 called for an IMF
agreement to help Nicaragua maintain its macroeconomic
stability. Because the IMF program is on hold, Nicaragua has
lost USD 71 million in planned disbursements from the IDB and
IMF to date. In order for an agreement, that would extend
the current program through 2006 to be presented to the IMF
Board in August, the GON needs to finalize budget reform and
reach consensus with the National Assembly on structural
reform immediately. If the GON fails to submit the program
by the first week in June, the GON will have to start
negotiations over with the IMF in 2006. The GON estimates
that USD 175 million in aid is at risk for 2005. The fiscal
reform package continues to be held hostage to the political
debate between the National Assembly and the Executive. END
SUMMARY.

BACKGROUND: THE IMF PROGRAM
--------------


2. (SBU) At a May 4 International Donors Meeting ("Mesa
Global"),Finance Minister Mario Arana provided background on
the current budget reform impasse for major donors. He
recalled how in December 2004, the National Assembly
increased spending by about 700 million cordobas (about USD
42 million),or 0.8 percent of GDP, above the IMF guidelines
(ref A). The spending gap came from salary increases for
health and education workers, increased transfers to other
branches of government, and increased transfers to
municipalities (estimated at 180 million cordobas). However,
the National Assembly was quickly persuaded that the IMF
would not accept this, and negotiations began on how to cover
the spending gap. In April, the Executive and the National
Assembly reached an agreement on a fiscal package of around
300 million cordobas in new revenues by ending special tax
treatment for banks, introducing taxation on casinos, and
reducing tax exonerations, especially for luxury goods. With
revenue projections restated for another 250 million
cordobas, the gap was almost closed.


3. (SBU) Arana explained that although the tax reforms
passed, the National Assembly added a provision that had not
been discussed or agreed to by the Executive, implementing a
constitutional reform to permit taxation of media inputs and
capping the media's tax exonerations (ref B). When the
Executive reviewed the law they determined that the media
amendment had not been agreed, was controversial and
politically sensitive, and had not been discussed with the
affected sector. The President vetoed this article with the
hopes of opening the way to an alternative tax proposal
acceptable to the media sector - a positive list of
tax-exempt inputs. Arana explained that although initially
both the FSLN and the PLC indicated that they would be open
to a discussion, they backtracked and argued that the
President should first remove his veto before any discussion.
The situation has been at an impasse for over a month.

MACROECONOMIC SITUATION
--------------


4. (SBU) In response to Arana's May 4 presentation on the
political background surrounding the IMF program, Humberto
Arbulu, IMF Resident Representative, provided his perspective
on the situation for the donors. He indicated that Nicaragua
was on track as far as statistical figures based on the
current macroeconomic situation. He added that 2004's
economic growth was stronger than expected, and inflation was
under double digits. On the fiscal side, Nicaragua enjoyed
increases in tax revenue and more social spending. On the
monetary side, there was more reserve growth than expected
last year. In the financial system, there was a decline in
interest rates for loans and deposits. Banks are stronger,
more highly capitalized and more profitable, with better loan
loss reserves and smaller portfolios of non-performing loans.
On the external side, exports recovered strongly and
remittances increased in 2004. Regarding 2005, Arbulu felt
that growth (measured by the IMAE indicator) remained good,
and inflation was slightly below previous year's levels. On
the fiscal side, he said tax revenues were better than
targeted and tax administration showed good results. He felt
that bank consolidation had strengthened the financial
system. Finally, on the external side, exports were growing
at 22 percent annual rate and imports at less than 16 percent
annual rate.


5. (SBU) According to Arbulu, the IMF understands that the
political situation cannot always be molded to fit the
bureaucratic needs of the IMF. He has stressed that the GON
needs to get budget reform finalized and get buy-in from the
National Assembly immediately in the hopes of presenting an
agreement to the IMF Board in August. However, Arbulu stated
that Nicaragua could live without an IMF program because the
macroeconomic indicators are satisfactory. He reiterated
that if nothing happens soon, the GON will miss the
opportunity to extend the current program and will have to
start negotiations over in 2006. On May 23, Arana told the
press that if the log jam could not be resolved within two
weeks, their would be no IMF program. Arbulu, standing by
his side, concurred.

EUROPEAN DONORS SPEAKS OUT FORCEFULLY (FINALLY)
-------------- --


6. (SBU) On May 23, Carlos Castaneda, IDB's Executive
Director for Central America and Belize, who was wrapping up
a four day visit to Managua with the IDB Executive Board of
Directors, encouraged the Executive and the National Assembly
to take action as soon as possible to reach a consensus and
allow the IMF agreement to go forward. In a press interview,
Castaneda added that he saw "good will" on behalf of the
Executive and the National Assembly to resolve the impasse
and maintain Nicaragua's positive macroeconomic performance.
Although he strongly encouraged the approval of the IMF
program to maintain economic and political stability,
Castaneda stated that, with or without an IMF agreement, the
IDB was committed to Nicaragua and planned to invest a
guaranteed USD 160 million in 2005 if the country maintained
a stable macroeconomic situation. He added that only USD 35
million were dependent upon having an IMF agreement in place.
Eduardo Balcarcel, IDB Resident Representative, explained
that IDB loans will fund 30 projects including private sector
credit programs, road and infrastructure projects, hospital
modernization and health care programs, and other social
programs.


7. (SBU) On May 24, Dutch Ambassador Kees P. Rade, speaking
on behalf of the European donor community, stated that the
Europeans were serious this time about suspending part of
their aid to Nicaragua if the GON could not reach an
agreement with the IMF. Rade added that although many people
have felt that the Europeans have failed to live up to
similar threats in the past, this case was different. In a
press interview, Rade explained that the donor community had
frozen budget support and announced a new donor mechanism
which conditions further disbursements on macroeconomic and
political stability, the development of budget mechanisms
that guarantee confidence in the management of donor funds,
and policies that promote economic growth and poverty
reduction. The Dutch have euro 9 million in budget support
on hold for 2005 pending the IMF agreement. Rade added that
the Dutch government wants assurances of how its money is
invested and they use the IMF agreement as a measurement
instrument. Jurg Benz, Central American Representative for
the Swiss Development Agency (COSUDE) and the new European
donor coordinator, made similar comments about the need for
substantive reforms and a framework to ensure fiscal
responsibility in the future or else the budget gap could
grow larger in 2006 and 2007.

COMMENT:


8. (SBU) If the GON wants the IMF Board to review a revised
program at its August meeting, they will need to reach a
political agreement with the National Assembly on the
substantive issues by early June. The deadlock between the
GON and National Assembly continues to impede an agreement on
IMF requirements. The budget reform measures are being held
hostage to the standoff over the media taxation reforms. If
it were not for the politics, the issues would not be that
difficult to solve, but political will is lacking to address
some of the substantive reforms the IMF wants such as the
financial administration law, fiscal responsibility law, and
neutralizing municipal transfers. The FSLN and the PLC
continue to manipulate the negotiations to pressure the
Executive to accept the National Assembly's constitutional
reforms. At this time, the IMF program is not officially
"off track" but "dormant" in the words of Mario Alonso,
Central Bank President. In fact, Alonso commented to CDA on
May 19 that Nicaragua remains in compliance with IMF targets.

9. (SBU) Comment Cont. The public statements from the
European donors about the importance of the IMF agreement and
fiscal responsibility in general are most welcomed and
support the Mission's efforts to promote macroeconomic
stability and government transparency. Although Nicaragua's
current macroeconomic situation is stable, the failure to
reach an IMF agreement would have a negative impact on donor
aid in the short term and a concomitant impact on the
Nicaraguan budget in the long term. On May 25, the National
Assembly approved the General Mediation and Arbitration Law,
which could be a positive indicator. Meanwhile FSLN leader
Daniel Ortega and his proxies have ratcheted up the political
debate. In a May 25 declaration Ortega accused the
international financial institutions (IFIs) of doing little
to solve Nicaragua's social problems over the past 15 years
and said he would not give in to their pressure. He blamed
the IFIs for Nicaragua's energy crisis and said that
structural reforms had actually worsened the economic
situation for thousands of Nicaraguans who were forced to
leave the country in search of jobs in Costa Rica and the
U.S. On May 26, hard-line Sandinista Omar Cabezas, National
Human Rights Prosecutor, also took out a one-page paid
advertisement denouncing CAFTA and the neoliberal economic
policies of the 1990s as violations of human rights. END
COMMENT.

BRENNAN