NICARAGUA: INFLATION: A GATHERING STORM

C O N F I D E N T I A L SECTION 01 OF 02 MANAGUA 001381

SIPDIS

STATE FOR WHA/CEN, WHA/EPSC AND EEB
TREASURY FOR SARA SENICH
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN

E.O. 12958: DECL: 11/12/2028
TAGS: ECON EFIN ELAB ETRD NU PGOV PREL
SUBJECT: NICARAGUA: INFLATION: A GATHERING STORM

REF: A. (A) MANAGUA 1213

B. (B) MANAGUA 1157

Classified By: Amb. Robert J. Callahan for Reasons 1.4 b & d.


1. (C) Summary. The rate of inflation in Nicaragua is the
highest in Central America and the second-highest in Latin
America. High petroleum and food prices, and off-budget cash
inflows from Venezuela appear to be the main causes. The
steep rise in food prices disproportionately affects the
poorest in Nicaraguan society. President Daniel Ortega has
raised the minimum wage three times since assuming the
presidency, rendering the country,s apparel sector less
competitive in global markets (Ref A) and likely contributing
to inflationary pressures. One problem from a monetary
policy point of view is that the country,s crawling peg
exchange rate has not kept pace with inflation, resulting in
a stronger cordoba. An abrupt devaluation of the cordoba in
the future would result in higher prices for imports,
especially for food. End Summary.

PRICES CONTINUE TO CLIMB
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2. (C) According to the Central Bank of Nicaragua,
accumulated annual inflation for 2008 is forecast to be 18%.
The rate of inflation in 2007 was 17%, which means that by
the end of this calendar year Nicaraguans will have
experienced an approximately 35% increase in prices over the
last two years. While August registered the lowest monthly
inflation rate in two years as a result of the sudden
worldwide decrease in petroleum prices, other inflationary
pressures persist. Nicaragua,s rate of inflation is
second-highest in Latin America after Venezuela.


3. (U) Prices of items in the basic market basket of goods
have risen by more than 25% so far in 2008. The dramatic
increase in food prices (especially for rice, beans, and
corn) disproportionately affects the poor: 20% of the
country,s poorest households spend as much as 80% of their
income on food, making them vulnerable to high prices for
staples. Transportation prices also have risen as a result
of the international price of petroleum, although there has
been some relief recently. The steep rise in food and
transportation prices motivated President Ortega to increase
minimum wages for laborers in key sectors such as
manufacturing, not coincidentally an important political base
for the Sandinista National Liberation Front (FSLN). Since
taking office in January 2007, Ortega has increased minimum
wages by 60%; the last time was an 18% hike on October 1 (Ref
A). While helping to mitigate the effects of inflation on
the working class, these wage increases may be contributing
to an inflationary spiral.


4. (U) To partially offset internal and external
inflationary pressures, the Central Bank has pursued a strong
cordoba policy, maintaining a controlled 5% per year
devaluation against the dollar through a crawling peg
mechanism--even as the differential between the Nicaraguan
and U.S. inflation rate would support a devaluation more than
twice this rate. The strong cordoba policy has reduced the
cordoba cost of importing beans and rice, as well as fuel.

VENEZUELAN CASH, A HIDDEN INFLATIONARY CATALYST
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5. (C) Substantial Venezuelan assistance, most of which is
off-budget, may be contributing to inflation, but no one
knows how much. In September 2008, the Central Bank of
Nicaragua (BCN) published a report detailing in rudimentary
terms Venezuelan assistance to Nicaragua in 2007 (Ref B).
According to the report, Venezuela provided $185 million in
official assistance to Nicaragua in 2007. In May 2008,
however, President Ortega declared that official Venezuelan
assistance totaled $520 million, nearly three times the 2007
figure stated in the BCN report. Either amount of Venezuelan
cash moving through a small economy such as Nicaragua,s
(2007 GDP $5.7 billion) would likely contribute to inflation.

EXPORTERS AND CURRENCY EXPOSED
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6. (U) One problem, from a monetary policy point of view, is
that the dollar exchange rate for the cordoba has not kept
pace with inflation. Despite an inflation differential with
the United States of around 15% for two years running, the
Central Bank has continued to depreciate the cordoba at an
annual rate of 5%. The cordoba,s relative strength
vis-a-vis the dollar is hurting local businesses which export
to the United States. To counter pressures to devalue
faster, the Central Bank had to increase its reserves, but at
some cost to the economy. While this strategy has allowed
the country to import food and fuel at less expensive prices,
inflationary pressures on the overvalued cordoba are
mounting. Remittances from the United States partially
mitigate this pressure, but are expected to decrease in the
near future as a consequence of the global financial crisis.
As of November 6 the exchange rate was officially 19.70
cordobas per dollar.

COMMENT
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7. (C) The GON cannot afford to ignore the creeping effects
of inflation. The apparel sector (which supports 75,000
jobs) is suffering from the latest round of wage hikes and a
declining U.S. market. For the first time, garment companies
in Nicaragua have started relocating to more competitive
labor markets in East Asia. Moreover, an abrupt adjustment
of the crawling peg exchange rate would result in a sudden
price increase for imported goods such as rice, fuel and
certain foodstuffs that many Nicaraguans rely on to meet
their basic needs. Thus, the FSLN ignores inflation trends
at its own peril.
CALLAHAN