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 -------------- -------------- ¶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 -------------- -------------- ¶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 -------------- ¶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 -------------- ¶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 -------------- ¶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