NICARAGUA: 2007 INFLATION RATE MAY REACH 16.5%

UNCLAS SECTION 01 OF 02 MANAGUA 002524 SIPDIS SENSITIVE SIPDIS STATE FOR WHA/CEN, WHA/EPSC, AND EEB/IFD TREASURY FOR SARA GRAY USDA/FAS FOR BRIAN GRUNENFELDER, ONA; YVETTE WEDDERBURN, OCRA USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN 3134/ITA/USFCS/OIO/WH/MKESHISHIAN/BARTHUR E.O. 12958: N/A TAGS: ECON EFIN ETRD EAGR PGOV NU SUBJECT: NICARAGUA: 2007 INFLATION RATE MAY REACH 16.5% REF: A. MANAGUA 2368 REF: B. MANAGUA 2516 ¶1. (U) Summary: In the last four months, the GON has thrice revised its 2007 inflation estimate from the 7% target established in the recently approved Poverty Reduction and Growth Facility (PRGF) with the International Monetary Fund. The Nicaraguan Central Bank's (BCN) latest estimate is 16.5%, higher than the 13.5% predicted by most private economists. The increase in prices of basic commodities has had the greatest impact on poor and working class Nicaraguans. One significant factor contributing to inflation has been the continuing rise in the international price of crude oil, but the government believes that the most important factor has been the weather. Its solution, therefore, is to supplement the local supply of basic foodstuffs by opening the economy to cheaper imports of beans, wheat flour, oats, barley, noodles, pastas, and foods with a soybean base. End Summary. Inflation Surges -------------- ¶2. (SBU) In the last four months, the GON has thrice revised its 2007 inflation estimate from the 7% target established in the recently approved Poverty Reduction and Growth Facility (PRGF) with the International Monetary Fund. The first revision was in August, when the BCN announced that the rise in world oil prices would drive inflation to 9.5%; the second, on November 23, when the BCN announced a rate of 14.5%. On November 28, only five days later, the BCN released an inflation estimate of 16.5%. If this figure proves true, 2007 would have the second highest annual inflation rate since 1998, when oil prices were low but shortages caused by Hurricane Mitch produced 18.5% inflation. ¶3. (SBU) BCN's latest inflation estimate is higher than the 13.5% predicted by most private economists. According to Mario Arana, former BCN president and CEO of local economic think tank FUNIDES, BCN president Antenor Rosales announced a higher rate to "control expectations and cap the upward trend." Arana feels that this strategy is ill-advised because producers and suppliers are likely to raise prices on the expectation that inflation will be higher. ¶4. (U) The increase in prices of basic commodities has had the greatest impact on poor and working class Nicaraguans. According to the Ministry of Labor, the last two months have shown a marked reduction in purchasing power. The price of the market basket of 53 basic consumer products, tracked by the BCN to measure consumer inflation, currently exceeds the monthly minimum wage. The costs of transportation, communications, housing, education, food, and beverages have most contributed to price increases. Internal and External Factors -------------- ¶5. (U) Both internal and external factors are responsible for the inflation spike. One significant external factor has been the continuing rise in the international price of crude oil, now more than $90 a barrel. More expensive oil not only affects the cost of shipping and transportation, but also the cost of power because Nicaragua generates 80% of its electricity by burning imported fuel oil and diesel. This dependency means that the negative consequences of rising oil prices flow quickly and directly to all segments of the Nicaraguan economy. ¶6. (U) The most important external factor has been the weather. On September 4, Category 5 Hurricane Felix slammed into the north-east coast of Nicaragua, killing more than 130 persons and destroying 440,000 hectares of tropical forest. Felix was followed by low pressure weather systems hovering over the country for the next two months, producing sustained rainfall that flooded farmlands and destroyed homes, roads, and crops, including staples such as rice, beans, and corn. Shortages of these basic grains have led to higher prices for bread, tortillas, and processed foods, as well as animal feed, thus increasing the cost of beef and poultry. ¶7. (U) A significant internal factor contributing to inflation has been persistent and growing electricity shortages caused by rising demand, lack of investment in power generation, poor regulation, and periodic breakdowns of aging power plants. Interruptions to the supply of power raise the cost of business throughout the country and reassign value chain incentives. In particular, sales of refrigerated products have plummeted, as retail stores close out inventories of chilled and frozen products to avoid losses caused by daily power outages. Many manufacturers are forced to run diesel or gasoline powered generators to avoid shutdowns and meet their production targets. ¶8. (U) Another contributing internal factor has been BCN's decision in October to reduce the reserve requirement from 19.25% to 16.25%, injecting liquidity into the market. BCN made the move because the growth in lending capacity and deposits had returned, signaling a recovery in borrower confidence to pre-2006 election levels (Ref A). The increased liquidity, however, coming at a time of rising oil prices and commodity shortages, may have had the unintended consequence of contributing to inflation. GON Response -------------- ¶9. (U) The GON views the crisis as primarily weather related and thus temporary. Its solution has been to supplement the local supply of basic foodstuffs by opening the economy to cheaper imports. In the past two months, the Ministry of Trade and Industry (MIFIC) has eliminated tariffs for three months on beans and for six months on wheat flour, oats, barley, noodles, pastas, and foods with a soybean base. Based on consultations with local producers, MIFIC is also considering temporarily removing tariffs on other products, such as rice and chicken, and extending the window on zero tariffs. The idea is that lower priced imports will keep local food prices down and discourage hoarding and speculation. ¶10. (SBU) To date, very small amounts of food commodities have been imported under the zero tariff import scheme - only 245 metric tons (MT) of beans, 78 MT of which are from the U.S. A MIFIC source relates that the GON has purchased beans from a local FSLN cooperative - the third local bean harvest having commenced - with the objective of selling them at below-market prices through the Citizen Power Councils (CPC),established by President Ortega to carry out his social and political agenda (Ref B). A Taiwanese rice donation has reportedly also been sold through the CPCs. ¶11. (U) The disconnect between rising inflation and the lack of adjustment to the cordoba's crawling peg is worth noting. While inflation estimates have risen from 7 to 16.5 percentage points, the rate of depreciation of the Nicaraguan Cordoba against the U.S. dollar (set at a 5.5% annual rate) has not changed. The increasing spread between Nicaraguan and U.S. inflation (16.5% vs. 3.3%) suggests that the cordoba may now be overvalued, making Nicaragua a more expensive place to do business. TRIVELLI