UPDATE ON NICARAGUA'S DOMESTIC DEBT

UNCLAS SECTION 01 OF 02 MANAGUA 001719

SIPDIS

SIPDIS
SENSITIVE

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

E.O. 12958: N/A
TAGS: EFIN ECON PGOV PREL NU
SUBJECT: UPDATE ON NICARAGUA'S DOMESTIC DEBT

REF: MANAGUA 371


1. (SBU) Summary: Working with the U.S. Department of Treasury's
Office of Technical Assistance (OTA),Nicaragua is taking the first
steps in addressing its excessive domestic debt burden. The OTA
designed National Debt Management Strategy aims to develop an
internal market for government debt to serve as a strong financing
alternative for the GON once HIPC/IDA-only concessional terms are
phased out. The 2007 auction schedule calls for USD 40 million in
one- and three-year instruments and USD 40 - 60 million a year for
the next three years. The issuances will have staggered maturity
dates, hopefully creating a domestic yield curve and promoting a
domestic secondary bond market. While at this point, bond-based
government debt is more expensive than the concessional loans
currently available, establishing a regular market for these
domestic instruments will provide Nicaragua with a cheaper financing
alternative in the future. End Summary.


2. (U) Nicaragua is taking the first steps in addressing its
excessive domestic debt burden. In 2006, Nicaragua's internal debt
reached USD 1.2 billion (equivalent to 23% of GDP). Despite
President Ortega's rhetoric regarding "foreign and domestic
oligarchic creditors," the GON has kept its domestic debt repayment
schedule. In February, it paid USD 124.3 million in Property
Indemnification Bonds (BPI - bonds issued as compensation for lands
seized in the 1980s). In May, it paid USD 21.7 million in bank
bonds (CENIs - used to cover costs of four bank failures in 2001-2).



3. (SBU) Since 2002 the U.S. Department of Treasury's Office of
Technical Assistance (OTA) has been working with the Central Bank
(BCN) and the Ministry of Finance (MHCP) to create a National Debt
Management Strategy (DMS) to develop a more sustainable program for
domestic public debt and to address the problem of ballooning debt
payments in 2008 and 2009. (Note: Nicaragua's debt service will
increase to USD 187.2 million in 2008 and USD 175 million in 2009
due primarily to the maturation of BPIs. End note.) In 2004-5, in
an attempt to develop a local market for government debt
instruments, MHCP issued USD 16 million in short-term bills
("letras") but detected a lack of demand for medium-term bonds.
This lack of demand in the medium-term instruments was most likely
due to the controversy surrounding the CENIs and the lack of
consistency and transparency in the 2004-5 issuances.

A New Debt Management Strategy
--------------


4. (SBU) In 2007 the GON prioritized the OTA-designed DMS, whose
primary objective is the development of an internal market for
government debt to serve as a strong financing alternative for the
GON once HIPC/IDA-only concessional terms are phased out for
Nicaragua. In May the Economic Cabinet approved the MHCP domestic
debt auction calendar for 2007, allowing MHCP to raise USD 40
million this year. (Note: These include both competitive and
non-competitive auctions. End note.)


5. (SBU) An essential part of the DMS will be a regular dialog
between MHCP and investors in order to improve demand and liquidity
for government bonds, increase transparency in the process, and
promote the development of an active secondary market. Five basic
components of the DMS are:

-- MHCP will only issue standardized bonds.

-- Issues will be concentrated in fewer series in order to increase
their liquidity.

-- Time periods for the bonds will be extended gradually. (i.e. in
2007, MHCP will only issue one and three-year bonds.)

-- MHCP will issue a quarterly report on the auction plan and
calendar.

-- Communication with investors will be improved by creating a
government-investors consultation mechanism; they will meet
regularly with the principal market players.


6. (SBU) The auction schedule for 2007 includes USD 10 million in
Treasury Bills and USD 30 million in Republic of Nicaragua Bonds.
The Bills will be in denominations of USD 10,000 and mature in one
year with payment in cordobas at the prevailing official exchange
rate. The Republic of Nicaragua Bonds will be in denominations of
USD 10,000 and will mature in three years. Payment will be in
cordobas with interest paid out every six months.


Bond Issuances in 2007
--------------


7. (SBU) The Central Bank will continue to issue its own paper, all
with maturities of less than one year (one, three, and six months.)
As of May 23, BCN had placed short-term bills valued at USD 80.6
million for 2007. The growing demand for BCN paper has allowed it
to start lowering the rates it accepts for its bonds (i.e. cutoff
rates.) (Note: The DMS calls for a gradual phase-out of BCN issued
paper and increased use of MHCP's bonds to support monetary policy.
End note.)


8. (SBU) MHCP has already begun implementing the DMS. In May it
issued USD 10 million in one-year bills. All but 800,000 were
placed. (Note: The final bonds were sold in June. End note.) 65%
was placed in a non-competitive auction and 35% through a
competitive process. In both auctions the rates came in at under
10%, lower than expected. MHCP will auction USD 30 million in
three-year Republic of Nicaragua Bonds in the fall, with private
banks among their target audience. The current plan is to issue USD
40 - 60 million a year for the next three years, with staggered
maturity dates, to create a domestic yield curve and promote a
domestic secondary bond market. (Note: Nicaragua has a securities
exchange where bonds are traded, and the National Assembly passed a
Capital Markets Law in 2006, both of which will facilitate this
process and eventually lead to a commercial debt market. End Note.)



9. (SBU) To address the upcoming balloon payments, MHCP plans an
additional auction to raise the funds to buy back BPIs with 10-15
year maturities, which currently trade at about 40 cents on the
dollar. BPIs currently represent over 80% of the domestic
government debt and the buy-back would represent a huge savings for
the GON. OTA is focusing MHCP on issuing only standard paper for
all of the GON's financial needs and avoid past habits of special
types of bonds for different situations (i.e. BPIs, CENIS).


10. (U) OTA and MHC believe that this additional auction to cover
the BPIs should be successful as private banks currently have excess
liquidity due to high deposits, but lower demand for credit.


11. (U) Information on BCN and MHCP bonds can be found at:
http://www.bcn.gob.ni/titulos_valores/

Conclusion
--------------


12. (SBU) While at this point, bond-based government debt is more
expensive than the concessional loans currently available under
HIPC/IDA terms, establishing a regular market for these domestic
instruments is essential for the time when Nicaragua no longer
qualifies for concessional loans. An established bond market will
provide the GON with a much cheaper alternative to raising needed
funds than the regular loan market. Success of this plan will
depend on presenting a coherent economic plan and keeping stable
macroeconomic policies in place.

TRIVELLI