NICARAGUA AND THE IMF HAVE A PRGF AGREEMENT

C O N F I D E N T I A L SECTION 01 OF 04 MANAGUA 001771

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: 07/21/2017
TAGS: ECON EFIN ENRG EPET PGOV PREL NU
SUBJECT: NICARAGUA AND THE IMF HAVE A PRGF AGREEMENT

REF: A. MANAGUA 1672


B. MANAGUA 1180

C. MANAGUA 639

D. MANAGUA 640

Classified By: Ambassador Paul Trivelli, for reasons 1.4 b&d.


1. (C) Summary: The IMF and GON have almost completed a
three-year Poverty Reduction Growth Facility (PRGF)
agreement. After finalization of some budgetary numbers, the
PRGF will go before the IMF Board in October. Characterizing
the agreement as "plain vanilla," IMF ResRep Humberto Arbulu
Neira stated it has no special or unusual components. The
fiscal targets all follow the patterns established by the
last PRGF (concluded December 2006.) The main structural
issues include energy, capital spending controls, tax
administration, pensions, and decentralization. The major
hurdle throughout the negotiation, accounting for Venezuelan
assistance and debt, may have become a non-issue when the
ALBA oil deal was revised as a simple commercial credit
program. Given the lack of any other coherent economic
program from the Sandinistas, donors considered the agreement
essential for releasing more funds to Nicaragua. Whether
this program is completed will depend on the GON economic
team's ability to balance the PRGF terms with Ortega's
rhetoric of "battling global capitalism, led by the Yankee
imperialists." End Summary.

The Agreement
--------------


2. (SBU) On July 9, after two weeks of intensive
negotiations, the IMF and GON had almost completed a
three-year Poverty Reduction Growth Facility (PRGF)
agreement. A short meeting in DC the week of July 23 will
finalize budgetary numbers and the PRGF will go before the
IMF Board in October. Characterizing the agreement as "plain
vanilla," IMF ResRep Humberto Arbulu Neira stated it has no
special or unusual components. The PRGF contains specific
targets for 2007 and projected targets for 2008 and 2009.
Actual targets will be negotiated at the beginning of each
year. The IMF will review Nicaraguan progress every six
months. Stemming from this agreement, Nicaragua will receive
between USD 80-90 million in disbursements over three years
(an equivalent of 45% of Nicaragua's quota in the IMF.)

The Macroeconomic Indicators
--------------


3. (SBU) The major macroeconomic targets include:

2007 2008 2009
-- Real GDP Growth 4.2% 4.5% 5%
-- Inflation 7.5% 7% 7%
-- Deficit (as % of GDP) 1% 1.8% 1%
-- Increase in reserves (USD) 60M 70M 80M
-- Exchange rate (crawling peg) 5% 5% 5%
(Note: Nicaraguan GDP for 2007 will be about USD 5 billion.
End note.)


4. (C) Arbulu believes the targets for GDP growth and
inflation for 2007 will not be met. He feels the 4.2% growth
rate is optimistic given the flat growth rate of 3% measured
by the Major Economic Activity Index (IMAE),the slow GON
capital spending, and the continuing lack of an economic plan
by the Sandinista government. Since the June accumulated
annual inflation was 6% due to high oil prices, inflation for
2007 will be closer to 9%. Arbulu believes the deficit
target will be easily reached, given that tax revenues are
already higher than budgeted. Contrary to local press
reports, IMF-GON differences over net international reserves
were easily resolved, according to Arbulu. The IMF convinced
the GON to tie reserves to imports and not the M2 monetary
base. (Note: Nicaragua has already met its 2007 reserve
target. End note.) Both sides agreed that, even with the
increases, reserve rates are not high enough to support
Nicaragua abandoning its crawling peg exchange rate for a
free float.


5. (SBU) Differing from past years, the IMF required the GON
to include the full costs and funding sources for its poverty
reduction programs. Given President Ortega's habit of
announcing large-scale social programs with no clear source
of financing, the IMF felt it was prudent to commit the GON
to clear numbers for its eight major poverty reduction
programs (all based on Millennium Development Goals- MDG).
Usually, financing sources for such programs are the purview
of the government, not the IMF.

Social Indicators
--------------


6. (SBU) The GON will include social indicators in its
Memorandum of Intent. Originally, the GON's wanted these
indicators to replace the PRGF's macroeconomic indicators as
targets. According to Central Bank (BCN) General Manager
Jose de Jesus Rojas, the GON will publish yearly
results/advances for their chosen targets. Matching MDG
goals, the major indicators will be:

2007 2008 2009
-- Primary education reg. 85.1% 87.6% 90.1%
-- Illiteracy rate 18.5% 14% 10%
-- Maternal mortality 96 94 90
(Per 100,000 live births)
-- Access to potable water 65% 70% 78%
(% of total population)

The Structural Agenda
--------------


7. (SBU) The main structural issues in the PRGF include
energy, capital spending control, tax administration,
pensions, and decentralization. None of the structural
targets from the previous PRGF were carried over (pension
reform, energy regulation reform, etc.) The primary focus of
the energy target will be the high loss level in the system
(almost 30%),caused principally by theft. Commitments
include a law penalizing electricity theft and fraud, an
audit of the electrical system to determine sources of
technical losses, and a plan to increase coverage in poor and
rural areas, thereby reducing theft and improving service.
(Note: This program is modeled on a successful Colombian
program and will receive IDB technical assistance. End note.)
As part of these commitments, the GON will revisit the
current 100% subsidy for users of less than 150KW per month
(about 60% of users.) The GON also agreed to publish the
formula for calculating the automatic tariff increases, and
will announce the scheduled increases throughout this year,
increasing transparency in the system. (Note: The National
Assembly has frozen electricity tariffs for one year. The
GON has committed to raising tariffs to the scheduled level
when the freeze ends in the summer of 2008. End note)


8. (C) The IMF was particularly concerned over the low levels
of capital spending by the Sandinista government and
dedicated a significant portion of the last round of
negotiations to the issue, according to BCN GM Rojas. The
GON requested that the PRGF allow them to take advantage of
the increased inflows of concessional rate funds for
infrastructure projects in energy and water. The PRGF
objective is to increase capital expenditures from 5.1% of
GDP to 7.4% (from USD 225 million to 370 million). The PRGF
allows the GON to create a state-owned development bank
(Banco de Fomento) which could become involved in some of
these capital projects. Both Rojas and Arbulu expressed
concern about the GON's ability to meet these markers and the
economy's capacity to absorb these funds. They also believe
that the increased spending may not result in quality
projects. Complicating the issue, according to Arbulu,
Nicaraguan capital accounts are heavy on salaries as a result
of a transfer from the current account to meet the last
PRGF's savings target. The IMF has promised technical
assistance to help the GON figure out how to reverse this
action.


9. (SBU) The PRGF, endorsing current improvements in tax
policy and administration, focuses on improving the
accounting and budgeting process for state revenues. For the
last three years, as a result of technical assistance
programs such as U.S. Treasury's OTA program, the General
Office of Taxes (DGI) has collected 0.5% of GDP more than
allotted in the budget (in 2007 it will be 0.6% - USD 30
million.) The PRGF requires the GON prioritize projects so
additional funding will be assigned according to state needs.
Clear guidelines for programming and spending are a key
component of this section of the PRGF.


10. (SBU) Decentralization will be on the back burner until
2009 as the GON refused to contemplate changes to the system
until after the November 2008 municipal elections.
Currently, the municipalities receive 6% of the budget
(increasing 1% a year for the next four years). In exchange
the municipalities are expected to administer local schools,
water, health, and social security services. So far, the
municipalities receive the money but have not taken on the
additional responsibilities, claiming they need new
infrastructure to do so. As a result the central government
provides these social services from its own budget and the
mayors do not have to account for how they spend their 6%.
The PRGF contemplates a 2008 law mandating the municipalities
take on the social services in exchange for their 6%. In
2007 and 2008, the GON must cut spending in other parts of
the budget to offset the mandated 1% increase to
municipalities.


11. (SBU) Due to the large divergence between IMF and GON
estimates on the viability of Nicaragua's pension system
(INSS),both sides agreed to step back from pension reform at
this time. Instead the PRGF calls for a new actuarial
analysis of INSS, so that future discussions center on the
same numbers. The PRGF also requires a phase out of a law,
currently on legislative hold, which increases INSS benefits.
These additional benefits, both sides agreed, would bankrupt
INSS in five years.

Where is the Venezuelan Assistance?
--------------


12. (C) The major hurdle throughout the negotiation has been
accounting for Venezuelan assistance. The IMF was
particularly concerned with the potential revenues and debt
accumulated through the Bolivarian Alternative for the
Americas (ALBA) oil deal (reftels). Ortega has been
consistence in his calls to keep the assistance off-budget
and out of the public spending accounting system. (Note: In
response to GON statements during the negotiations that MCC
assistance is off-budget, the IMF responded that they would
be pleased to have the Venezuelan assistance contain all of
the transparency and public spending reporting requirements
contained in the MCC-GON agreement. End note.)


13. (C) According to Arbulu, even though the PRGF now
requires three operational and financial reports a year from
Petronic, the oil debt with Venezuela may become a non-issue
as the deal has been completely revamped, again. (Note: This
would be the fourth iteration of the deal since the original
signing on January 11. End note.) The GON told the IMF that
the deal had been converted to a straight commercial credit
program, with no long-term debt accrual. According to
Arbulu, Venezuela will sell petroleum products (not crude) to
Nicaragua (through state oil company Petronic) at market
rates, and provide a 90-day market credit. These new terms
are to be singed during the upcoming ALBA meeting in Cuba.
The IMF is requiring a finalized agreement before the PRGF
can go to the IMF Board.


14. (C) The GON also informed the IMF that during the Havana
meeting they will sign the charter creating the ALBA Fund
Bank, which will finance projects in all its member
countries. Details on the Bank, how it will be funded (from
some of the money from the oil payments?) and how this money
will be distributed to the different ALBA countries, are not
clear at this time. According to Arbulu, the GON confirmed
that funds from the ALBA Bank will follow all of the standard
transparency regulations and any loans will be approved by
the National Assembly, per Nicaraguan budgetary
administration laws. The amount of funds involved, and the
ability of the Nicaraguan economy to absorb then, is an issue
the IMF will continue to explore as the PRGF progresses.
Currently, the PRGF allows for Venezuelan assistance amounts
equivalent to around 2% of GDP (about USD 100 million) to be
used for infrastructure projects. (Note: Some sources
indicate that this may actually be an allowance for the
deficit to go up to 2% of GDP in order to finance the
Nicaraguan portion of the new Venezuelan refinery. End note.)


15. (C) BCN President and lead GON negotiator Antenor Rosales
has evaded press questions on accounting for Venezuelan
assistance by saying that the issue was clarified in past
negotiation sessions; adding that "the IMF did not succeed in
getting Petronic to be part of the National Budget." He has
not publicly revealed the changes in the terms of the oil
deal, claiming instead that the assistance is a non-issue
because existing laws provide for transparency on the funds.


Comment
--------------


16. (C) While it is true that this is a bare-bones PRGF, it
provides much needed assurances for macroeconomic stability.
Given the lack of any other coherent economic program from
the Sandinistas, donors have long considered the agreement
essential for providing the assurances necessary to release
additional funds to Nicaragua. This release of funds is
important for the GON economic team, according to Arbulu,
because they have realized that Venezuela is not the cash cow
Chavez had painted it to be. Whether this program is
completed will depend on the GON economic team's ability to
balance the PRGF terms with Ortega's rhetoric of "battling
global capitalism, led by the Yankee imperialists." End
Comment.
TRIVELLI