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Nicaragua risk: Macroeconomic risk
(RiskWire Via Thomson Dialog NewsEdge) COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT
RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentC58C56Macroeconomic riskC50C55Note: E=most risky; 100=most risky.SUMMARY
Nicaragua's economy accelerated to more than 5% growth in 2004 when accession to HIPC debt relief boosted consumer and investor confidence. The economy expanded by 4% in 2005 before slowing significantly in 2006. While the implementation of DR-CAFTA in 2006 will have boosted the external sector, uncertainty in the run-up to the presidential elections in November will have affected consumption and investment decisions. Slower US growth in 2007, hesitant domestic demand, and uncertainty over what an Ortega government may bring, will dampen growth prospects in the forecast period. Barring a forced devaluation, inflation will average around 7.5% in 2007-08.
SCENARIOS
A recession in the US hurts Nicaraguan growth prospects (Moderate Risk)
As domestic demand slows owing to uncertainty surrounding the new policies of the Ortega government, the external sector will drive growth helped by DR-CAFTA, which was implemented in 2006. The exports of traditional products and non-traditional manufactures should perform particularly well. However, a recession in the US--Nicaraguas main trading partnerwill damage Nicaragua's export prospects. Companies should take into account the degree of uncertainty regarding the prospects of the US when preparing their business plans.
The Ortega government does not manage to agree a new PRGF with the IMF (High Risk)
The Poverty Reduction and Growth Facility (PRGF) agreement expires in December 2006 after which the incoming Ortega government will have to negotiate a new agreement with the IMF. These talks are likely to be tortuous as the government objects to IMF conditionality including caps on fiscal spending. Mr Ortega is likely to use economic assistance from Venezuela and other countries to enhance his bargaining position and avoid certain IMF strictures. But even with this type of financial assistance, the lack of an IMF agreement will undermine investor and consumer confidence, and donors may withhold aid and grants, affecting growth prospects negatively.
BACKGROUND
(Updated: November 9th, 2005)
Economic Structure
Main economic indicators, 2003Real GDP growth (%)2.3(a)Consumer price inflation (av; %)5.3(b)Current-account balance (US$ m)-803(c)Exchange rate (av; C:US$)15.14(b)Population (m)5.48(c)External debt (year-end; US$ bn)5.8(c)(a )Preliminary Central Bank data. (b) Actual. (c) Economist Intelligence Unit estimate.Sources: Banco Central de Nicaragua, Indicadores Economicos; IMF, International Financial Statistics.Although Nicaragua is an impoverished country still struggling to recover from the political and economic upheaval in 1979-90 that destroyed its infrastructure, reduced productivity and increased poverty levels, it has been recognised that the countrys current GDP of US$2.5bn, and per head income of US$472 per year (with 1980 as a base year), have been severely underestimated, while the level of tax revenue and the debt burden were conversely overstated. In 2003 the Banco Central de Nicaragua (BCN, the Central Bank) published new national accounts with 1994 as a base year, presenting major corrections in these variables.
The new accounts so far provide systematic coverage for 1994-2000, and have radically changed the statistical profile of the Nicaraguan economy. The accounts, which have been in preparation since 1996, not only change the base year from 1980 to 1994, but also incorporate a host of new survey and census information. This process has corrected the gross underestimation that long characterised national GDP measurements. For 2000, the new data raise GDP to US$3.95bn, compared with US$2.44bn under the old accounting system, while GDP per head rises from US$480 to US$780. However, the rate of growth of real GDP has been revised down to an average of 4.4% a year during the administration of the former president, Arnoldo Aleman (1997-2002), instead of the previously calculated average of 4.9%.
The higher GDP level substantially changes statistical ratios. Whereas Nicaraguas national tax coefficient as a percentage of GDP has long been considered the highest in Central America (23.3% under the old system), the corrected figure of 14.5% for 2000 places it squarely in the sub-regional mainstream. At 170% of GDP, Nicaraguas foreign debt burden, although still massive, is less onerous than the 274% calculated using the old methodology. By contrast, gross fixed investment remains relatively constant under both systems, at 26-27% of GDP.
Between 1998 and 2002 the importance of agriculture diminished slightly (from 32.5% to 31.4% of GDP) largely because of problems in farming, in particular in the coffee sector. A drop in fishing in GDP terms also contributed to this development. Industry, however, grew in GDP terms from 20.9% to 21.5%, owing to a sharp expansion in construction activity. Services remained largely stable, at 46.9% of GDP, although the government saw its share of GDP increase over the period.
Cultivation of basic food crops is concentrated in the central and Pacific coast regions, while coffee is grown in the uplands north of Matagalpa. Livestock farming, mainly cattle ranching, is most prevalent in Boaco and Chontales and in the southern provinces near the border with Costa Rica. Commerce and manufacturing, which comprised 23% and 14.4% of GDP respectively in 2002, are concentrated in the capital, Managua, and in the cities of Matagalpa, Chinandega, Leon, Masaya and Esteli. Agriculture remains by far the countrys largest employer, accounting for 42% of all employment in 1998-2002, according to official estimates. Most agricultural jobs are in the informal sector.
Comparative economic indicators, 2003Nicaragua(a)Costa Rica(b)El Salvador(b)Guatemala(b)Honduras(b)GDP (US$ bn)4.117.414.924.76.8GDP per head (US$)4544,1792,2912,002977GDP per head (US$ at PPP)2,4648,4333,5104,8802,578Consumer price inflation (av; %)5.39.4.7(a)2.1(a)5.4(a)7.7(a)Current-account balance (US$ bn)-0.8(b)-1.0-0.7-1.1-0.3% of GDP-18.9(b)-5.5-4.9-4.4-3.8Exports of goods fob (US$ bn)1.06.13.13.01.4Imports of goods fob (US$ bn)-2.0(b)-7.3-5.4-6.2-3.1External debt (US$ bn)6.2(b)5.66.45.45.6Debt-service ratio, paid (%)24.1(b)12.39.39.514.6(a) Actual. (b) Economist Intelligence Unit estimates.Source: Official sources; Economist Intelligence Unit estimates.Economic Policy
Following the hyperinflation and recession of the 1980s, Nicaragua has pursued a policy of stabilisation and structural adjustment in the 1990s. The emphasis of economic policy shifted over the past five years towards the need for debt relief and implementing the necessary preconditions.
In March 1998 the Aleman government signed a second three-year enhanced structural adjustment facility (ESAF) agreementknown as ESAF IIwith the IMF. (The first was signed in April 1994). It provided SDR100.9m (US$138.3m) in IMF assistance over three years and committed the government to pursue further fiscal adjustments and to privatise public utility companies. The public finances improved in 1997-98, although they remained heavily dependent on foreign grants. Fiscal targets were revised after Hurricane Mitch, which created the need for vastly increased public spending on reconstruction. With the agreement of the IMF, public capital spending almost doubled in 1999, to 20.6% of GDP, and the non-financial public-sector (NFPS) deficit (before grants) reached 12% of GDP.
Although market-oriented reforms were successful in jump-starting the economy, by 1998 concern had emerged among donors that renewed economic growth was not benefiting the poor. In October 1999, the ESAF was renamed the poverty reduction and growth facility (PRGF). Meanwhile, the Aleman administration began seeking access to the IMF-World Banks heavily indebted poor countries (HIPC) initiative to gain development funds from foreign debt relief. As a prerequisite, in consultation with civil society, the government began formulating a poverty reduction strategy, which was completed in mid-2001. Interim reductions in foreign debt service under the HIPC programme have been applied to fighting poverty within the strategys guidelines since the beginning of 2002. Nicaragua was set to reach completion point under HIPC in January 2004.
Fiscal reform and privatisation stalled in the latter years of the Aleman administration. After 1999 the budget gap was supposed to decline, but election-year spending in 2000 and 2001 kept the NFPS deficit extremely high, resulting in PRGF fiscal targets being missed by an increasingly wide margin. Progress in privatising public utilities was also inadequate. The social security reform was passed by the National Assembly in March 2000 but was not implemented. In view of these fulfilment shortfalls, the 1998 PRGF was allowed to lapse in mid-2001.
In December 2002 the president, Enrique Bolanos Geyer, signed a new three-year PRGF covering 2002-05. The primary goal of the agreement is fiscal adjustment, through the broadening of the tax base, improvement of collections and the elimination of tax exemptions. The tax reform was approved in April 2003. The PRGF also aims to rebuild reserves after their depletion in 2001 and improve the financial position of the Central Bank through a significant net redemption of internal debt instrumentsa 10% reduction in the internal debt stock of around US$1.5bnreducing future domestic debt servicing.
Major economic policy events
March 1998: A second three-year ESAF is signed.
December 2000: The government pledges financial-system and other reforms to achieve debt forgiveness under the heavily indebted poor countries (HIPC) initiative.
December 2002: The Bolanos government signs a new three-year poverty reduction and growth facility (PRGF) with the IMF.
April 2003: The National Assembly approves a tax reform, the Tax Equity Law, a PRGF condition.
December 2003: The government sells its remaining stake (49%) in Enitel to America Movil of Mexico, meeting another PRGF requirement.
In December 2003 the government sold its remaining 49% stake in the Empresa Nicaraguense de Telecomunicaciones (Enitel) to America Movil of Mexico. The government will introduce private pension funds in 2004. It is also attempting to proceed with the sale of power-generating units. Although the political environment has slowed progress on some of these goals, it is felt that Nicaragua has met all the pre-conditions for HIPC debt relief, which should be granted at the beginning of 2004.
From 1997 monetary policy aimed to combine inflation control with a strengthening of foreign reserves. The 1998 ESAF II agreement established targets for further reserve growth and limitations on domestic NFPS borrowing, and committed the government to redeeming certificados negociables de inversion (Cenis, negotiable investment certificates) to control quasi-fiscal losses of the Central Bank, which were expanding the money supply.
The economys extensive dollarisation, and the effective indexation of most domestic prices to the crawling-peg exchange rate, convinced authorities to adopt the nominal exchange rate as an inflation anchor in 1993. In 1999 the government slowed the crawling-peg devaluation from 12% to 9% annually, and then further, to 6%, in an effort to keep prices to single-digit levels. The policy was successful, as prices rose by a scant 4.8% year on year in 2001 as domestic demand levelled off, reflecting election-year nervousness and a fall in imported oil prices.
Excessive public spending in 2001 forced the BCN to extend large credits to the non-financial public sector, resulting in a fall in net foreign reserves, which closed the year at just US$211m. In 2002-03, Mr Bolanoss first two years in office, fiscal spending was cut ruthlessly, producing a large resource transfer from the government to the Central Bank, helping net reserves rebound.
Openness to trade and foreign investment has been a cornerstone of economic policy since 1990. In May 1997 the Tax Justice Law introduced timetables for reducing all customs tariffs on goods from outside Central America to 10% by mid-2001. In 2000 the government radically simplified foreign investment regulations without adding new enticements. Despite this stance, the government continued to use incentives to try to turn the country into a haven for maquila (in-bond assembly for re-export) operations and tourism. Because Nicaragua remains a low-income country, World Trade Organisation (WTO) rules will allow it to go on offering tax breaks to free-zone companies after 2003, giving the country an advantage as a site for maquila relocation.
The Bolanos government has built on this base, and seeks to attract greater investment from the US through the US-Central American Free-Trade Agreement (CAFTA), which includes Nicaragua, El Salvador, Honduras and Guatemala, and which was finalised in December 2003. The government is also implementing a national competitiveness programme to boost export performance.
Central government finances(C m unless otherwise indicated; Jan-Sep)20022003% changeRevenue6,3307,50118.5Expenditure-9,871 -10,6277.7Balance before grants-3,541 -3,126 11.7Grants received1,768 2,180 23.3Balance incl grants-1,773 -946-46.6Source: Ministerio de Hacienda y Credito Publico, Banco Central de Nicaragua.Economic Performance
In 1997-2001, according to official figures (using 1980 as the base year), annual GDP growth was a healthy 5%. Continued recovery of agricultural output, especially coffee and basic grains, led the advance, while government services continued to be cut back under the ESAF (renamed PRGF in October 1999). Fishing, livestock raising and construction activity also grew faster than overall GDP. Powered by post-hurricane reconstruction, real growth in 1999 reached 7% and the contraction in government services was temporarily reversed. Growth fell back to just 3% in 2001, owing in part to uncertainty about the outcome of the elections. It slowed further in 2002, to just 1%, as a result of weak external demand for agricultural exports and the severe fiscal adjustment the Bolanos government implemented during its first year in office. A recovery became apparent in 2003 when the economy expanded by an estimated 2.3%. This was largely driven by private consumption as investment stalled, because of uncertainty over CAFTA, and because the external sector performed poorly.
Since 1997 an influx of foreign direct investment (FDI)particularly in telecommunications, electricity generation and some maquila operationshas boosted private investment spending. FDI levels, which accounted for nearly half of all private investment in 1998-2000, peaked at US$337m in 1999. A boom of FDI in cellular services helped lift private investment in 2002, to 17.3% of GDP. Overall, however, private investment efforts are still too low to spur future growth, while public capital spending will inevitably decline in the coming years as foreign assistance wanes. Weak national savings and financial intermediation, coupled with lingering property disputes, a corrupt judiciary and periodic political unease, contribute to deterring higher levels of private investment. Other hindrances are the low skills levels of the workforce and the countrys huge debt stock, both external and internal, which crowd out the private sector.
Inflation, which peaked at over 13,000% in 1990, has fallen steadily owing to improved fiscal and monetary discipline. The crawling-peg mechanism further helped reduce inflation, which rose by just 3.9% in 2002. Prices picked up in 2003, to 6.5%, owing to high oil prices and higher food prices.
Although dollarisation is not an official policy goal, dollars are accepted in almost all transactions, and the public prefers to keep more than 70% of its bank deposits in US dollar-denominated accounts. This preference has been augmented by the return of domestic savings from abroad and the removal of controls on foreign-exchange movements.
Real wage levels have increased since 1997 owing to more rapid economic growth, a reduction in inflation, and pay rises for government workers. Partly spurred by hikes in official minimum wage rates, nominal wages increased by 8.2% in 2002; this translated into a 4.3% rise in average real wages.
Inflation and wages(% change, year on year)1998-20022002Consumer price inflation (av)7.83.7Nominal wages14.28.2Real wages4.44.3Sources: Banco Central de Nicaragua, Indicadores Economicos; Economist Intelligence Unit.The combination of a rising economically active population and slower growth has kept unemployment at high levels. Underemployment, reflecting in part the low level of skills, is also a problem. Much new job creation is in the informal sector. According to the Central Bank, the informal sector accounted for 52.5% of all jobs in urban areas in 2002.
Although poverty percentages declined in the Pacific in the 1990s, they increased on the Atlantic Coast. Regional GDP figures are not available, but growth is likely to have been well below the national average as the areas traditional mining and timber industries are in decline, leaving lobster and shrimp fishing as the main growth sector. In-migration has slowly altered the ethnic balance in favour of mestizos (people of mixed Spanish and Amerindian ancestry) from the Pacific, putting pressure on the land base and fomenting tension over land titles and demarcation. Sparsely populated and poorly policed, the Atlantic coast has also become a transshipment route for Colombian drugs moving north, and local drug addiction is a serious problem. The North and South Autonomous Regions are officially self-governing, and 45-member governing councils are chosen every four years. But the 1987 Autonomy Law remains largely unenforced, and the regional governments are dependent on Managua for what is an inadequate level of financial support. Although tension between the indigenous and mestizo populations is slight, central government neglect of the region has begun to stir up some separatist feeling.
Copyright 2006 Economist Intelligence Unit
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