NICARAGUAN IMF PROGRAM ON THE ROPES

C O N F I D E N T I A L SECTION 01 OF 04 MANAGUA 001867

SIPDIS

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

E.O. 12958: DECL: 06/20/2015
TAGS: ECON EFIN NU IMF
SUBJECT: NICARAGUAN IMF PROGRAM ON THE ROPES

REF: A. MANAGUA 1604

B. MANAGUA 1770

Classified By: CDA Peter M. Brennan. Reasons 1.4 (b and d)


1. (C) SUMMARY. On May 31, President Bolanos broke the
two-month standoff over fiscal reform legislation intended to
close the spending gap created by the National Assembly's
2005 budget. He yielded to the Assembly's refusal to accept
or override his partial veto and sent the measure for
publication with a controversial media taxation provision
included. However, this step is not sufficient to revive
Nicaragua's dormant IMF program. Pressure from the
international donor community over the past month has failed
to force the Executive and the National Assembly to overcome
their political differences and reach an agreement on the
pending package of structural reforms (ref A). Assessing the
current situation, the IMF Resrep stated that, even though
the political actors all agree on the structural reform
agenda, it is almost impossible to revive the program due to
politically motivated procrastination. He added, the program
will be left to die of natural causes. GON officials plan to
travel to Washington the week of June 20 to meet with the IMF
and request an extension or a new framework for negotiations.
At the technical level, it seems unlikely that the IMF will
be lenient with Nicaragua. Even if an eleventh hour
agreement were to be reached, recent legislative actions
regarding social security and pension reform and pending
subsidies for transportation and electricity have further
complicated the budget situation and raised IMF concerns
about spending and deficits. As reported in ref B, the
macroeconomic situation is generally stable despite the
uncertainty regarding the IMF and general political
instability; however, the prospects for continued medium-term
economic growth without an IMF program are uncertain.
Unfortunately, the IMF program has become yet another hostage
in the battle between the PLC-FSLN forces in the National
Assembly and the Executive. END SUMMARY.

IMF RESREP: TOO LATE FOR NICARAGUA TO SALVAGE A PROGRAM
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2. (C) On June 10, econoffs met with Humberto Arbulu
(protect),IMF Resrep, to discuss the prospects of reaching
an agreement at the upcoming IMF Board meeting in August.
Arbulu responded that, at this late date, it would be
"impossible" for Nicaragua to be considered at the meeting.
When questioned about the delays in reaching a consensus on
the IMF package of budget and structural reforms, he replied
that Pacto politics, not consensus on technical issues, was
responsible for program delays. Arbulu added that in his
experience he had never been in a country where all the
political actors generally agreed on the IMF structural
reforms. He added that even the Sandinista economic team
understood the importance of the IMF, but they misunderstood
the Fund's limited flexibility. He asked, "why not go
forward if everyone agrees." Arbulu pointed out that
Nicaragua has caused considerable debate within the IMF due
to a history of program procrastination and that the IMF was
frustrated with the idiosyncrasies of Nicaraguan politics.


3. (C) Arbulu informed econoffs that Finance Minister Mario
Arana and Central Bank President Mario Alonso planned to
travel to Washington the week of June 20 to meet with the IMF
staff and request an extension. He acknowledged that the IMF
rarely speaks in blunt terms and that the consultations with
the IMF provide the GON some political cover; however, he
said the IMF understanding was clear - you either have a
program or you do not. Arbulu said that Arana will attempt
to persuade the IMF by citing short term positive indicators.
First, the GON will argue that the current macroeconomic
situation is generally acceptable, with the exception of
inflation, which Arbulu projected will reach 9.1 percent.
According to Alonso, Nicaragua is not "off-track" on its
indicators and even Arbulu agreed that "notionally" Nicaragua
is on track. However, Arbulu discounted the impact of this
argument because the Nicaraguan first quarter is usually good
due to low levels of public spending. He acknowledged growth
in the construction sector, increases in agricultural
exports, and improved tax revenue collection as positive
indicators, but he said the economy would deviate excessively
from the IMF indicators over time.


4. (C) Arbulu believes that Arana's second card will be
approval of the budget reform and progress on the new tax
code. He said the reaction in Washington will be pressure to
schedule an Article IV consultation in order to gauge the
state of the economy and provide a projection for the next
two years. He added that the IMF is pushing to schedule the
consultation for this fall to present to the Board in
mid-December, along with the seventh, eighth and ninth
program reviews, which have been pending since June of last
year. Arana may also cite the political-constitutional
battle between the Executive and the National Assembly, which
has impeded movement on the approval of structural reforms.
Arbulu felt that the GON would be criticized for not going
forward with the reform package almost three months ago after
an agreement with the IMF had been reached. Special
Assistant to Finance Minister Luis Alejandro Matus told
Econoff on June 20, that the Minister had attempted to use
the preceding three months, since negotiating a reform
package with the IMF, to push for consensus with the National
Assembly. Matus concluded that the Deputies had no interest
in consensus with the Executive branch, but was unclear as to
why the consensus option was ever considered realistic. He
added that other issues, including the violent transportation
protests and the energy crisis, had intervened and deflected
attention away from the IMF program.


5. (C) Arbulu was clear that the Executive's basic budget
and structural reform were important building blocks for
keeping the IMF program current; however, reforms pending in
the National Assembly, which threaten spending and deficit
limits, were also of concern to the IMF. He specifically
mentioned the proposed state-sponsored development bank
("Banco de Fomento"),social security and pension reform
measures, and government subsidies for urban transport and
electricity. Finance Ministry cost estimates for the reform
measures, excluding the Banco de Fomento, add an additional
USD 70 million to the budget in 2005. However, it is not
known if the administration's gambit to combine budget
allocations from several existing programs will be sufficient
politically and financially to fund the proposed development
bank. Further, the USD 70 million figure will increase
substantially in the out years for some reform categories.
For example, costs associated with new social security
benefits will increase incrementally over the next five
years, until they almost double from the 2005 estimate of USD
37 million, for a five-year total of USD 277 million.


6. (C) At the conclusion of the meeting, econoffs asked
Arbulu to clarify what was at stake immediately for Nicaragua
if the GON failed to reach an agreement with the IMF. He
said that to date Nicaragua had lost USD 28 million in funds
destined for international reserves from the IMF, and that
other funds for budget support and development were
threatened. He estimated the total package at USD 110
million, including budget support. Based on the IMF's
experience in other Central American countries, Arbulu
guessed that around 50 percent of these funds would be
converted into project lending by European donors and others
if Nicaragua failed to reach an agreement with the IMF.


7. (C) On the subject of donor aid, econoffs and Arbulu
discussed Nicaragua's participation in the Millennium
Challenge Account. Arbulu stated that the MCC accounting
procedures run afoul of the general IMF preference that each
country manage all its donations "on the books." However, he
understood the USG need to manage its bilateral assistance
off-budget and agreed that running the MCC donation through
the budget would reduce the contribution through troublesome
earmarks like the constitutionally mandated and violently
defended 6 percent for universities. (Note: In an
interesting side comment, Arbulu quoted a World Bank study
which found that not one student from the lowest
socioeconomic quartile benefited from the scholarships funded
by the 6 percent earmark for universities. End Note.)

THE EXECUTIVE RESPONDS: LAYS THE BLAME ON PACTO FORCES
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8. (SBU) On June 14, Finance Minister Mario Arana used his
monthly economic update press conference to address the IMF
issue and lay blame for a lack of progress firmly upon the
National Assembly. He said the IMF negotiations had become
another pressure point for the Pacto forces in the National
Assembly to force the Executive to accept the constitutional
reforms. Arana admitted that "it was almost impossible" to
have a program ready to present to the IMF Board meeting in
August. Arana announced that the Executive was sending the
structural reform package laws to the National Assembly for
their approval. He stated clearly that these laws had been
consulted with the IMF as part of the country program
negotiations; however, conversations with the National
Assembly's Economic Commission had broken off over almost
three months ago.


9. (SBU) Arana did not explain why the Executive had not sent
the legislation to the National Assembly sooner and, oddly
enough, this issue was not raised by the press. Arana was
clear that the reform package was the minimum necessary to
move forward with the IMF program. He said other challenges
such as the social security and pension reforms, subsidies
for transportation and electricity, pending debts with
electricity distributor Union Fenosa, and the Development
Bank threatened to take Nicaragua "off-track" and the IMF
would want an explanation of their impact on the budget.
Central Bank President Mario Alonso indicated that Nicaragua
was in compliance with the structural indicators established
by the IMF program. Arana and Alonso announced that they
would travel to Washington the week of June 20 to evaluate a
new strategy with the IMF and discuss the recent G-8 debt
forgiveness announcement. On June 21, Finance Ministry
officials reported to Econoff that Arana and Alonso have
tentative plans to travel to Washington on June 23 and 24.


10. (SBU) After introductory remarks by Arana and Alonso,
President Bolanos joined the press conference and signed the
transmittal letter sending the reform package to the National
Assembly. The pending structural reforms include a tax and
budget reform plan that guarantees a 3.2 percent deficit.
Bolanos recalled that Nicaragua has lost its IMF program on
three previous occasions, after which the economy had
experienced a serious decline in growth. Bolanos stated that
the IMF program provides Nicaragua a strong framework for
future macroeconomic growth and stability, without which, the
economy will experience backsliding. Arana added that the
IMF program was essential for future growth, employment and
development, and that the Bolanos administration wanted to
leave office with an IMF program in place to ensure future
economic stability and leave a positive legacy.

THE NATIONAL ASSEMBLY RESPONDS
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11. (SBU) In a meeting with international donor missions on
June 18, FSLN Deputy Bayardo Arce, President of the National
Assembly's Economic Commission, stated that, although the
National Assembly agrees with the need to approve an IMF
reform package, the legislation sent by the Executive on June
14 lacked sufficient consultation and thus the Committee had
determined that they could not be treated as urgent. (Note:
Under the rules of the National Assembly, an urgent piece of
legislation is sent directly to the Chair for scheduling and
a floor vote without Committee hearings. End Note.) Arce
added that the financial sector reforms did not include
possible comments from the Association of Private Banks,
although he did not mention which areas could be of concern
to the banking industry. Furthermore, Arce stated that
several members of the Economic Committee would travel to
Spain on an exchange program June 19 and would deal with the
issue upon their return. PLC Deputy Wilfredo Navarro, a
member of the Economic Committee, said that the National
Assembly would approve the laws, but they needed to hold
consultations with the affected sectors because the Executive
had failed to do so. Navarro added that neither the PLC nor
the FSLN wanted to inherit a country in institutional
shambles; however, he redefined "consensus" in a novel
fashion, by suggesting that consensus follows the will of the
majority if all parties are not in agreement.

DONOR RESPONSE AND RESPONSIBILITY
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12. (C) Local Budget Support Group Coordinator and Swiss
development official Jurg Benz (protect) confided in econoffs
on June 14 that seven of nine donors that provide the GON
budget support would likely freeze such support if the IMF
program falters. He believed that the British DFID and one
of the Nordic countries are prone to a softer approach. Benz
added that for most of the other donors, budget support money
will not be converted to project support, claiming that a
general climate of scarce development resources fueled a
responsibility among most donors to contribute to the
significant budget needs of other countries rather than
reward bad behavior in Nicaragua by converting budget to
project support. Benz also placed the Central Bank's
macroeconomic analysis in a harsh light by stating that
Nicaragua is doing well relative to its historically poor
performance, but compared to the rest of the region is
remains very weak. Reviewing the recent track record on
budget support, Benz reminded econoffs that only the European
Commission had released budget support in the last year, to
the tune of 30 million Euros. All other multilateral and
bilateral sources remain frozen. Benz admitted that he was
mystified by the Finance Minister's three-month delay on
moving the reform package to the National Assembly, guessing
that perhaps Arana believed that a build-up of international
and domestic political pressure would help the package sail
through the legislature.

COMMENT
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13. (C) The Nicaraguan economy remained somewhat isolated
from the growing political instability throughout 2004 and
recorded moderate economic growth of 5.1 percent. Rising oil
prices had a significant impact on inflation, which jumped
from 6.48 percent in 2003 to 9.26 percent in 2004. While
continued economic growth in the medium-term seems doubtful
without an IMF program, indications are that the political
instability has already had a short-term negative impact on
direct foreign investment in Nicaragua. Even with the
possible loss of direct budget support hanging in the
balance, European donors were unable to influence the
political actors and shape a positive outcome. It seems that
donor threats to pull budget support rang hollow, however
serious they might be. Even the IMF Resrep painted a rosier
picture on the possible conversion from budget to project
support than some donors seem willing to swallow.
Nicaragua's history with the IMF has demonstrated the
benefits of the program to the country's macroeconomic
situation. On three occasions since 1990, Nicaragua has
dropped an IMF program with disastrous consequences for the
economy. The political procrastination over the IMF reform
package demonstrates the extent to which the Executive, the
PLC and the FSLN will push political brinksmanship even with
Nicaragua's economic development on the line. END COMMENT.
BRENNAN