2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Nicaragua

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Nicaragua

Context and Recent Economic Developments

1. In April 2018, social protests triggered by the announcement of pension reforms unleashed a wave of violence and a deterioration in confidence. Since then, and despite efforts by the international community, finding a solution to the political discord has remained elusive. Some countries have imposed sanctions on the government and specific individuals, which in turn has sharply reduced Nicaragua’s access to external financing.1

2. The social unrest and its aftermath caused an abrupt economic contraction in 2018 and 2019. In 2018, real GDP contracted by 3.8 percent (following annual average growth of almost 5 percent during 2013–17) as widespread violence and road blockades almost paralyzed the country during the second and third quarters. In 2019, the economy is projected to shrink by a further 5.7 percent owing to the deterioration in confidence, strong fiscal consolidation, and sanctions, which have aggravated financial constraints and caused a reduction in formal employment, which in turn have compressed private consumption and investment. The sectors most affected were tourism, construction, and retail. Job losses in the formal sector are estimated at 180,000 (20 percent of formal employment) during March 2018-September 2019. Inflation is projected at 6.4 percent by end-2019 (as compared to 3.9 percent in 2018), a spike that reflects the transient effect of tax measures adopted in March 2019.

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Real GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Source: National authorities a nd IMF staff calculations.

3. The loss in confidence also affected financial markets and contributed to a rapid decline in reserves. Considerable uncertainty caused bouts of liquidity hoarding and higher demand for foreign exchange, which stressed banks’ funding sources and the pegged exchange rate regime.2 As a result, between April 2018 and September 2019, bank deposits and net international reserves shrunk by more than thirty percent. In recent months, deposits and reserves have stabilized, possibly indicating that the portfolio rebalancing in response to the confidence shock is nearing completion.

4. The fiscal position deteriorated sharply in 2018, but a determined policy response led to a marked improvement in 2019. In 2018, the Non-Financial Public Sector (NFPS) deficit widened to 4.1 percent of GDP because tax collection plummeted, the pension system required budgetary support, and external financing dwindled. In early 2019 the government adopted a fiscal package of tax and pension reforms which, despite the erosion in the tax base and declining economic activity, are projected to yield about 4.2 percentage points of GDP.3 As a result, the NFPS deficit is estimated at 2 percent of GDP in 2019. On the financing side, the reduction in external flows (1.5 and 1 percent of GDP in 2018 and 2019, respectively), forced the government to draw down its stock of bank deposits (from around 8 percent of GDP at end-2017 to 6 percent by end-2018). The financial situation of the Nicaraguan Institute of Social Security (INSS) has deteriorated over the past five years because of demographic dynamics and lenient rules for access to reduced pension benefits. In 2018 the INSS exhausted its liquid reserves, and its financial position deteriorated further owing to a reduction in contributions resulting from the economic contraction and job losses, requiring the central government to transfer the equivalent of 1.2 percent of GDP in 2018, and an estimated 0.7 percent of GDP in 2019, against accumulated central government arrears to INSS.4

Operations of the Non-Financial Public Sector

(Percent of GDP)

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Sources: National authorities and IMF staff calculations.

5. The economic contraction resulted in a current account surplus in 2018 and 2019. Despite the collapse in tourism revenues, a demand-driven import compression and steady growth in remittances improved the current account to a modest surplus of 0.6 percent of GDP in 2018 and 1.5 percent of GDP estimated for 2019 (from a deficit of 4.9 percent of GDP in 2017). The current account improvement, however, was more than fully offset by a deterioration in the financial account of about 10.5 percent of GDP (from 8.3 percent of GDP inflows in 2017 to 2.2 percent of GDP outflows in 2018 and 1.5 percent of GDP in 2019). Most of the reversal represented flows highly sensitive to confidence effects and to the slowdown in real activity, such as portfolio flows and FDI. Capital outflows, however, decelerated in the second half of 2019, aided by external bilateral and multilateral disbursements, e.g., from the Central America Bank of Economic Integration (CABEI). Overall, gross international reserves (GIR) decreased by US$512 million in 2018 and are projected to decrease by US$9 million in 2019, which places GIR at 4.9 months of non-maquila imports, somewhat below the suggested range of 5 to 10 months of non-maquila imports estimated using Fund’s adequacy metric for LICs with a pegged exchange rate regime.

Selected Fiscal Policy Decisions Taken Since April 2018

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Sources: National authorities and IMF staff calculations.
Figure 1.
Figure 1.

Nicaragua: Economic Performance Since the 2017 Article IV Consultation 1/

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Source: National authorities and IMF staff caclulations.1/ See also Annex I for a description of the progress on implementing the 2017 Article IV recommendations.

6. Nicaragua’s external position in 2018 and the projection for 2019, are assessed to be moderately weaker than levels consistent with fundamentals. While in 2018 the REER remained broadly unchanged from the level in 2017, the external sustainability (ES) approach estimates a moderate REER overvaluation of 7.4 percent. The net international investment position (IIP) was negative at about -125 percent (lower than the regional average by 50 percent of GDP). (See Annex II).

7. In response to the challenging macroeconomic situation, monetary and financial sector policies eased during 2018–19. Since March 2018, a combination of efforts by the banks to enhance their liquidity buffers, mostly by reducing lending operations, and of the authorities by introducing repos, reducing reserve requirements, and phasing-in regulatory provisioning managed to stabilize the financial sector (Box 1). To signal a commitment to low inflation, in 2019 the authorities announced a reduction in the rate of the crawl from 5 percent to 3 percent.

Selected Monetary and Financial Policy Decisions Since April 2018

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Source: National authorities.

8. Vulnerabilities in the financial sector are nevertheless growing. The economic downturn and loan recalls have imposed a heavy toll on bank asset quality and profitability. In recent months, however, the outflow of bank deposits appears to have bottomed out and flows of new non-performing and restructured loans have been contained (broadly, the nominal amount of these assets, after including “aliviados,” seems to have stabilized in 2019, Q3). Through end-September 2019, the officially reported NPL ratio was 3.8 percent, while a broader measure of borrowers experiencing some sort of distress accounts for 18 percent of total loans.5 A decline in bank profitability to 4.4 percent of system equity in September 2019, from 18.0 percent in March 2018, is largely explained by the sizeable contraction of the loan portfolio, and large holdings of low yield liquid assets. Remaining profitability is explained predominantly by accounting profits from the banks’ long foreign exchange positions. The declared level of liquidity (47 percent of total deposits) and solvency (almost 22 percent of risk-weighted assets, more than twice the minimum capital requirement ratio) through September 2019 suggest the banking system still holds cushions to withstand a further decline in confidence and economic growth.

Financial Soundness Indicators

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Sources: National authorities and IMF staff calculations.

Adding restructured, refinanced and forborne loans to NPLs.

Annualized data.

Excluding loans from other Financial Institutions with a maturity over 12 months.

Credit Crunch and Liquidity Management During Financial Stress

The financial system was subject to unprecedented stress during the last nine months of 2018 and in 2019. During this period, banks dealt with a run of retail deposits of 31 percent or US$1.6 billion (about 25 percent, or US$1.4 billion in 2018). Wholesale funding remained relatively stable.

Banks responded to the shock by adjusting their balance sheets. During 2018, banks temporarily used part of their available liquid assets and extraordinary efforts to reduce their loan portfolio. By September 2019, banks’ holdings of liquid assets and investments were regularized at similar levels of those registered in April 2018, whereas collected loans amounted to about US$1.2 billion, which translates into a reduction of almost 24 percent of their gross credit portfolio in 18 months.

The Central Bank of Nicaragua (CBN) took measures in parallel to support the liquidity of the banking system. The CBN eased their reserve requirements and adopted a new scheme of daily monetary operations to ensure access by banks to daily liquidity from the central bank. The CBN also redesigned its lines for financial assistance to provide emergency liquidity assistance (also known as LAF) in June 2018 (although there are still operational and legal challenges that could hamper access to these lines in the case of a bank face liquidity crisis).

As a result of the joint effort by banks and the monetary authorities, no bank failures were registered in 2018, and to date. However, after the liquidity of banks stabilized in 2019, banks’ asset quality and profitability weakened due to the reduced working capital and cashflows of borrowers (mainly resulting from the collection of loans by banks in 2018) coupled with the ongoing economic recession.

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Banking System Flow of Funds

(USD millions, March 2018 to September 2019)

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorities and IMF staff calculations.
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Real GDP and Real Credit

(Annual percent change)

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorites

9. Weaknesses in the fiscal governance and the anticorruption frameworks are also a source of vulnerabilities. The operations of the NFPS are not audited on a regular basis and the audits are not accessible to the public. Many state-owned enterprises (SOEs) are saddled with de facto activities that go beyond their de jure functions, which leads to unclear lines of responsibility as they involve a complex chain of agents, including managers, ownership entities, ministries, the government, and the legislature. Gaps in fiscal transparency create difficulties in ascertaining fiscal risks related to contingent liabilities from SOEs. A case in point is the oil cooperation agreement with Venezuela, which operated outside the fiscal accounts, undermining the integrity of public policies.6

Outlook and Risks

10. The drastic economic downturn points to a reduction in potential output growth, as the size of some industries such as tourism, construction, and financial intermediation shrinks. Potential growth is estimated to have declined to 3 percent from a previous level of 4.5 percent (estimated in mid-2017). The reduction in potential growth is consistent with a lower rate of capital accumulation (e.g., real gross capital formation decreased 48 percent in the first half of 2019 compared to the same period in 2017), lower formal sector employment, and increasing informality.7

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Potential GDP

(Percentage change)

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorites and IMF staff calculations.

11. The economy is projected to contract further in 2020, remain around zero in 2021, and grow at a slower pace over the medium term than in the past (projected to average 1.5 percent over 2022–25 well below the 5-year pre-crisis historical average of 4.7 percent). The sharp contraction in credit, limited external financing, weak FDI, and lower private portfolio flows will continue to depress investment, thus limiting recovery prospects in 2020–21. Subsequently, rising labor productivity and more credit availability would increase output, exports, and investment, fostering labor demand and private consumption. However, tight external financing will continue to constrain public investment, while spending for upcoming elections is expected to boost public consumption in 2021–22. With considerable slack, inflation is expected to remain under 4 percent in 2020 and over the medium term.

uA01fig05

Real GDP

(Billions of Cordobas)

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorities and IMF staff calculations.

12. External financing. The external position is expected to strengthen gradually over the medium term. The current account surplus generated primarily by the sharp import compression will decline progressively starting in 2020 until reaching a 0.5 percent of GDP deficit in 2024, following the projected bottoming out of activity, which will be reflected in increasing import demand. The financial account is projected to strengthen moderately, as FDI increases marginally over 2020–24 (averaging 2.7 percent of GDP, about half of its 2017 level), and external financing is projected to remain below historical levels, but more than required to finance the small current account deficit in 2024.

13. Fiscal Financing. Based on the already-implemented as well as the announced tax and pensions system reforms, staff projects the fiscal position to deteriorate in 2020 and over the medium term. The NFPS deficit in 2020 is projected to increase to 2.6 percent of GDP, as the economic contraction reduces tax revenues and the initial effect of higher excises on revenue collection, mainly on cigarettes, partially dissipates because of increased contraband. The INSS deficit for 2020 is also projected to widen in tandem with lower growth and continued weaknesses in formal employment; INSS expenditures, however, are projected to stabilize in 2020 because of the parametric changes introduced by the reform; the INSS deficit is projected to be covered by additional transfers from the budget.8 External financing for the NFPS is assumed to remain below historical levels, but financing from the CABEI is projected to increase over 2020–24, partially offsetting the reduction in financing from other multilaterals.9 Given the estimated NFPS deficit path for 2020–24, which incorporates additional revenues from the 2019 tax reforms, a drawdown of the remaining stock of government deposits, and no additional measures, the estimated level of public financing available would be insufficient to satisfy rising NFPS deficits beyond 2024.

Medium-term Macroeconomic Framework

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Sources: National authorities and IMF staff calculations.

The 2020 Budget Proposal

The submitted budget for 2020 shows a modest reduction in the central government’s deficit. Revenues are projected to increase slightly in nominal terms, while expenditures contract by 1.6 percent in nominal terms. The budget proposal includes a reduction in transfers to local governments and the INSS and a lower extent in capital expenditures. A reduction in the wage bill relative to GDP reflects a freeze on public wages and of hiring of new public servants (excluding in the education and health sectors), which more than offset an increase in government’s employer contributions to the INSS (due to the 2019 pension reform’s increase in the rate of employer pension contributions). The budget proposal assumes real GDP growth of 0.5 percent in 2020.

Staff projects an increase in the 2020 deficit owing to the economic contraction and higher INSS expenditures against a zero-balance assumed in the budget. Staff’s projections of revenue and pension contributions are less optimistic than the authorities because of the staff’s economic contraction projected for 2020. Furthermore, increased contraband is projected to affect excises on cigarettes and alcoholic beverages. On the expenditure side, staff projects higher capital spending and transfers to SOEs, as well as higher transfers from the government to the INSS.

Central Government Operations

(Percent of GDP)

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Sources: National authorities and IMF staff calculations.

Revenues include external grants.

Total and current expenditures include central government transfers to the National Institute of Social Security (INSS), which are not reflected above the line in the budget.

Includes reclassification of items reflected in the budget as current expenditure into capital expenditure, including: capital transfers and other expenditures on capital of utility companies.

14. Nicaragua is assessed at moderate risk of debt distress. Nicaragua’s risks of external and public debt distress are assessed as moderate because maturities are long, and debt carries concessional interest rates. Most debt burden indicators remain below the threshold over the 10-year projection horizon under the baseline, except in the Albanisa contingent liability and growth shocks, where debt levels breach the threshold.10

15. Risks to the medium-term outlook are mainly on the downside.

  • Domestic risks are related to the continuation of political frictions that further erode confidence, fueling additional outflows of bank deposits and international reserves; and additional asset quality deterioration in the loan portfolios of financial institutions, which would further depress credit and, in turn, economic activity. Ongoing concerns on AML/CFT framework could exacerbate CBR pressures, and confidence could also be impacted by governance vulnerabilities.

  • External risks are related to the effects of additional sanctions in reducing further external financing or in limiting benefits from existing regional trade agreements, such as the Central American Free Trade Arrangement (CAFTA). Intensification of regional geopolitical tensions and security risks could also generate additional social unrest and negatively affect the investment climate and recovery prospects.

  • Against this background, the stabilization of financial flows in recent months could be an indication of a turning point for renewed confidence, which could elicit a faster economic recovery. Also, there is the possibility that a quick reduction in political tensions could prompt key trading partners to lift sanctions, which in turn would widen the policy alternatives to support growth.

Authorities’ Views

16. The Nicaragua authorities consider that the strong buffers accumulated over years of sound policies and the policy response in the context of the recent shocks to the economy have safeguarded macroeconomic stability.

17. While concurring that growth potential will be slower going forward than in the past, the authorities were more sanguine about the outlook and downside risks. The authorities agreed that lower investment and the reduced level of financing available for the public and private sectors would dampen growth prospects. However, they saw the rebalancing of the current account (which went from -4.9 percent of GDP in 2017, to a 0.6 percent of GDP surplus in 2018), and the recent increase in reserves and bank deposits as signs that the economy has already adjusted to the new, lower level of activity. Going forward, they expect credit to the private sector to begin to grow moderately, mostly towards export sectors, which will help generate employment and underpin higher real GDP growth. The authorities nevertheless stressed the need for external financing to provide additional space for fiscal policy to support growth and to strengthen the social safety net. They also expressed concern about the effect that the imposition of sanctions has had on increasing investor uncertainty, which has raised the cost of capital and constrained firms from expanding production.

Policy Discussions

A. Safeguarding Fiscal Sustainability

18. Given the tight financing envelope, fiscal policy should address fiscal sustainability while minimizing adverse impacts on economic activity and social outcomes. The fiscal consolidation achieved during 2019 signaled the authorities’ determination to contain the growing fiscal imbalances. Moreover, based on the implementation of the announced fiscal and pension measures and assuming no additional measures are taken, the available financing in 2020 will allow fiscal policy to begin offsetting some of the underlying headwinds to economic activity—a reversal from the unavoidable contractionary stance taken in 2018–19. Hence, the moderate widening of the fiscal deficit projected by staff in 2020 appears broadly appropriate. Nevertheless, the impact of tax reforms on growth should be evaluated to ensure their sustainability.

19. Raising the quality of public spending and adjusting its composition would help to mitigate the social impact of economic contraction. Reversing the deterioration in social conditions produced by the economic downturn requires a recalibration in the priorities of public spending to generate space for additional spending on social programs and social safety nets, which would lead to more equitable and sustainable growth. Current expenditures have been gradually increasing over the past six years (by about 3.1 percent of GDP), while social spending has grown at a slower pace (0.5 percent of GDP).11 In particular, fiscal policy should aim at:

  • Curbing current expenditures on goods and services, subsidies, and grants (which include central government transfers to municipal governments, state-owned enterprises, and other public agencies) which at current levels aggregated represent close to one-third of total expenditures (or 8.5 percent of GDP in 2018).

  • Rationalizing capital expenditures by prioritizing projects with the highest growth-enhancing and social impact (e.g., basic infrastructure, schools, health facilities), and those that have external financing.

  • Safeguarding spending on social programs and strengthening social safety nets. For instance, in partnership with the World Bank, during 2011–2017, Nicaraguan authorities successfully implemented a conditional cash transfer program that targeted families in extreme poverty with school-aged children.12

  • Revaluating existing expenditure rigidities to ensure the budget process has enough flexibility to reflect current expenditure priorities.13 Some of the existing rigidities entail that, by increasing total expenditures, any given increase in targeted social assistance would also need to be coupled by a given percentage increase in all other types of earmarked expenditures, including, for example, transfers to universities. Staff views favorably the 2020 budgetary reallocation that has superseded some of these rigidities to satisfy existing priorities while containing spending pressures.

20. Over the medium term, the fiscal deficit will need to be gradually reduced to ensure fiscal sustainability. Under the staff’s baseline scenario, which already considers the full implementation of the announced tax and pension measures, over the medium-term underlying spending pressures will gradually erode existing fiscal buffers generating the need for additional fiscal adjustment. While the deficit of the INSS is estimated to stabilize, albeit still at a high level, transfers to state-owned enterprises are projected to remain sizeable. A medium-term strategy should aim at reducing further the current level of INSS deficit and at improving the operating efficiency and sustainability of SOEs so that they gradually graduate out of central government assistance. Social impact analysis of critical fiscal reform options should be conducted to evaluate expenditure rationalization options and ensure that the poor receive the lowest burden of the adjustment.

21. Nicaragua needs to achieve greater transparency of the fiscal accounts to be able to assess and manage fiscal risks better and enhance fiscal governance. An efficient fiscal risk management policy requires a comprehensive vision of the government’s liabilities and commitments, identification of critical fiscal risks and their potential cost, the definition of early warning mechanisms, and measures for mitigation of fiscal risks, including the adoption of budgetary tools for such purposes. To provide an accurate view of the overall fiscal position, the authorities should publish financial statements —including all financial assets and liabilities, cash flows, expenditures, and financing of all the NFPS components. Efforts to include all operations of SOEs, decentralized entities and municipalities in the measure of the overall fiscal stance need to be strengthened. Establishing a fiscal risk unit to prepare risk assessments, including on the revenue losses from tax expenditures, to be used for budget preparation and execution, and to assess SOEs institutional arrangements and corporate governance, would enhance the effectiveness of fiscal policy and support efforts to ensure fiscal sustainability. Strengthening financial governance among SOEs will reinforce overall fiscal risk management and reduce the risk of corruption.

Authorities’ Views

22. The authorities indicated that they have continued to place macroeconomic stability at the forefront of their policies and concurred with the importance of addressing fiscal sustainability while safeguarding social outcomes and supporting growth while the economy still faces headwinds. The authorities, as mandated by law, are currently evaluating the impact of the recently enacted tax reform on both revenue and economic growth. They also emphasized that fiscal policy could be more accommodative in 2020 if available financing allows it. They are also considering possibilities to strengthen their social safety nets while they pointed out that they face rigidities from a substantial number of earmarked revenues and law-mandated expenditures, that limit the re-allocation of spending in the short run. They also agreed with the need to continue with structural reforms to ensure fiscal sustainability over the medium term. The authorities welcomed the staff’s suggestions to mitigate fiscal risks.

B. Monetary and Financial Sector Policies

23. The banking system has adjusted, in terms of liquidity and solvency, to the lower level of activity. If banks were to increase the provisions of their distressed loans (18 percent of total loans reported at end-September 2019) to reach a coverage level of 60 percent of their gross amount, the capital ratios of the banking system would decline but remain on average well capitalized (reported ratio of 18.6 percent of risk-weighted assets). Furthermore, under a stress scenario, there would be room for keeping the provisions with a coverage level of 60 percent if a new wave of problem loans materializes, and most banks would remain above the minimum capital requirement of 10 percent of risk-weighted assets. Contingency plans to deal with the possible failure of financial institutions should be developed. Enhancing the framework for bank resolution and strengthening the financial safety net would increase the resilience of the financial sector and protect it against downside risks. Actions could include ensuring market-oriented rules to facilitate private bank mergers, making operational the emergency liquidity assistance facilities established in June 2018, and reforming the legal framework to facilitate debt-workouts.

24. Going forward, further actions to enhance the timely identification and provisioning of distressed assets is a priority. As borrowers (performing and restructured) adjust their operations to the new and lower level of economic activity, additional loan quality deterioration needs to be avoided. Ongoing efforts by the bank superintendence to verify in-situ banks’ proper loan classification and provisioning by assessing with a forward-looking approach the borrower’s repayment capacity are critical. Supervisory work on credit risk could be enhanced by expanding the scope of loan-inspections handled by the bank superintendence and requiring banks (according to a well-defined criteria) to conduct semi-annual independent asset quality and collateral valuation reviews to support the bank superintendence’s work, and by introducing regulatory incentives for banks to monitor closely the foreign exchange position of their large non-exporter borrowers (as they account for not less than 50 percent of total foreign currency- denominated loans). Additionally, regular financial reporting by the rural credit and savings cooperatives should be enforced to allow for the monitoring of their financial situation by the authorities.

25. Pressures on correspondent banking relations (CBR) need careful monitoring. To minimize the impact of sanctions over CBRs, some financial institutions have terminated business relationships with individuals and entities deemed risky. While the authorities report that CBRs have so far remained stable, they noted an increase in the submission of suspicious transactions reports and an increase in the level of scrutiny and monitoring visits from correspondent banks to local institutions. Market participants expressed concerns over the impact of additional compliance requirements on operational costs, increased scrutiny of transactions, particularly for the export sector, and the consequent setback to increase financial inclusion.

26. Adopting the recommendations of the 2017 Financial Action Task Force (FATF) Mutual Evaluation Report (MER) is necessary to protect the integrity of financial transactions and mitigate the exposure to illicit flows. Ongoing concerns over Nicaragua’s AML/CFT framework could negatively affect the financial sector, increase pressures over correspondent banking relations, and more generally deteriorate the business climate. Nicaragua is currently under FATF’s observation period and its progress in complying with the AML/CFT international standards and improving its effectiveness in the areas with strategic deficiencies identified in the MER will be assessed in February 2020. Since July 2018, Nicaragua has made overarching reforms to its AML/CFT legal framework, which have translated in significant re-ratings for technical compliance. However, implementation is still in its early stages. As the recently created AML/CFT Coordinating Commission leads the implementation of the AML/CFT framework, ensuring that this is done following the spirit and purpose of the FATF standards will be crucial. Some areas for further progress include: updating Nicaragua’s ML/TF National Risk Assessment, incorporating all relevant sectors (public and private), and developing analysis on the effect of informality and financial exclusion; ensuring registration of all financial institutions that became reporting entities and building their reporting capacity; implementing risk-based supervision and sanctioning non-compliance; collecting up-to-date beneficial ownership information and facilitating access to this information regardless of the complexity of the corporate structure; and strengthening the prevention, investigation, and prosecution of money laundering cases including proceeds of corruption.

27. Maintaining the resilience of the crawling peg exchange rate regime requires a stronger external position over the medium term. Tighter external financing, weaker fiscal situation, and sanctions have put additional pressures on the external position. To mitigate these pressures and given the high degree of dollarization and exposure to volatile terms of trade and FDI flows, raising the reserve coverage ratio to a range between 5 to 10 months of non-maquila imports—compared to the projected average level of 4.8 months for 2020–24– would be prudent. While the November 2019 reduction in the rate of crawl from 5 to 3 percent could alleviate inflationary pressures, its impact on the external position would need to be carefully monitored. Staff identified an exchange restriction arising from Nicaragua’s participation in the SUCRE (Sistema Unitario de Compensación Regional de Pagos) regional payments arrangement.14

Authorities’ Views

28. The authorities highlighted the resilience of the banking sector to the severe economic downturn. They stressed the importance of the resolute and timely actions of the Central Bank to enhance banks’ liquidity buffers to face the severe economic headwinds, as well as the cumulative effects of at least a decade of record bank profits. At the time of the Article IV visit last November, the liquidity and solvency ratios of the Nicaraguan banks were significantly higher than regional levels. Furthermore, the authorities reported a significant increase in the Bank Superintendence’s (SIBOIF) in-situ loan-quality assessment, and in the number of examinations per institution. The authorities ruled out any further regulatory forbearance action affecting the timely recognition of loan-loss provisioning. They acknowledged the need to enhance further their ongoing efforts to increase loan-loss provisions and identify potential sources of further asset distress, including the valuation of collateral, as well as the importance of enhancing the financial safety net.

29. The authorities appreciated the suggestions to enhance the effective implementation of the AML/CFT framework. They pointed to the adoption of a new AML/CFT law and a new law for the Financial Intelligence Unit as evidence of their commitment to the AML/CFT reform agenda.

C. Competitiveness and Governance

30. Restoring business confidence and addressing supply-side bottlenecks are crucial elements to promote sustainable economic growth. Policies to bring back private sector confidence, including a frank evaluation of the impact of the recent tax measures, are essential to promote economic recovery and offset an increase in poverty. In the medium term, Nicaragua needs to continue efforts to improve infrastructure, invest in human capital, address labor skills bottlenecks, and upgrade technological readiness, all of which would contribute to enhancing the economy’s competitiveness and growth potential (Annex II, paragraph 5). A long-term strategy aimed at strengthening government institutions in the areas of contract enforcement and the efficiency of the legal framework in settling disputes, protection of property rights, investor protection, registering property, and resolving insolvencies could significantly improve the country’s competitiveness.

31. Addressing anti-corruption policy weaknesses could boost confidence, competitiveness, and growth. Improving the understanding of corruption risks among public officials and the private sector, updating related policies and strategies, and enhancing dialogue and institutional coordination for increased prevention, investigation, and prosecution of cases would help to fight corruption. Also, international good practices suggest the need to strengthen the existing asset declaration regime for high-level public officials as well as further efforts targeted at politically exposed persons. The asset declaration regime, particularly for high-level officials, could: (i) finalize migration to electronic submission; (ii) expand categories of information requested to ensure it also covers interests and assets beneficially-owned; and (iii) streamline public access, ensuring that relevant information from the declaration is accessible on-line, without requiring a prior consultation process. Stronger anti-corruption measures could also help collect more tax revenues, improve resource allocation, upgrade fiscal risk management, and provide better quality and quantity of social and physical infrastructure.

Authorities’ Views

32. Safeguarding macroeconomic stability and guaranteeing public capital spending are paramount for reestablishing business confidence. The central bank’s efforts to support commercial banks’ liquidity played an important role in restoring financial stability, as demonstrated by the recovery of bank deposits. Similarly, the government’s efforts to access external financing for infrastructure spending shows the government’s commitment to improve competitiveness and promote long-term growth. In the same vein, the revision to the budget late last year aimed to reallocate additional tax resources from the fiscal reform to the improvement and construction of roads across the country, and the improvement of two key customs posts essential for regional trade. These efforts have helped underpin a recovery in confidence that has been reflected, in recent months, in a rebound in bank deposits and private sector credit.

33. The authorities emphasized that they are strongly committed to tackling corruption, as demonstrated by the Comptroller General and the General Attorney’s office efforts in the areas of transparency and government procurement. The authorities agreed that there is scope to strengthen the existing asset declaration regime for high-level public officials but stressed that most of the identified cases refer to low ranking officials. Similarly, their efforts to implement recommendations from AML/CFT bodies attest to the commitment of the government to follow international good practices.

D. Statistics and Capacity Development

34. Macroeconomic data are broadly adequate for Article IV surveillance purposes but remain insufficient for more intensive surveillance. Further efforts are needed to improve source data in the real sector, particularly for tourism, manufacturing, and retail; incorporate the results of the household survey in the national accounts; harmonize public sector debt with external sector debt data; monitor assets and liabilities of public enterprises; and improve coverage of FDI statistics. Resuming the timely publication of data, in particular IMAE, inflation, fiscal position and external debt, is critical to maintain business confidence and ensure policy credibility (see Informational Annex, Statistical Issues).

35. Capacity development. Since the 2017 AIV consultation, most Technical Assistance (TA) has focused on domestic public financial management, revenue administration, diagnosis of financial sector stability, and statistics (Informational Annex, TA schedule). For the next 12 months, planned TA is well aligned with the surveillance priorities and include strengthening fiscal reporting and the institutional framework for financial stability, BOP and fiscal statistics. Furthermore, adherence to the multi-year roadmap of financial sector related TA, as developed under the Financial Sector Stability Review, would facilitate timely identification of risk-mitigating policies in this area.

Authorities’ Views

36. The authorities remain committed to the timely provision of good quality macroeconomic data. They reported that some delays (e.g., the monthly indicator of economic activity) have occurred in response methodological changes, which are being addressed. They reiterated their intentions to continue building on the Fund’s technical assistance to improve the quality and consistency of statistics.

Staff Appraisal

37. The main challenge for 2020 and beyond is to stay on course to preserve macroeconomic and financial stability. Reflecting the sharp decline in bank credit and financing flows over the past two years, the outlook is for a further but more moderate contraction in economic activity in 2020 before gradual recovery to low growth over the medium term. Restoring confidence and external financing flows is critical to avoid a renewed contraction in credit and jobs, which would further hold back investment and consumption. Policies to prevent the occurrence of negative feedback loops related to credit contraction are essential to promote economic recovery.

38. The moderate fiscal easing projected in 2020 is broadly adequate as it would support the economic recovery. Available financing in 2020 would allow fiscal policy to begin offsetting some of the underlying headwinds to economic activity. Fiscal policy should strive to mitigate the increase in poverty and the social impact of the economic downturn. Rebalancing the expenditure is a priority to generate fiscal space for increased spending on social programs and safety nets and to generate more inclusive growth. Over the medium term, the fiscal deficit should be gradually reduced to ensure fiscal sustainability.

39. Addressing medium-term fiscal challenges through structural reforms—which are unavoidable to safeguard fiscal sustainability—will require obtaining broad public support. Social impact analysis of critical fiscal reforms (e.g., the pending implementation of announced pension reforms, and of SOEs more broadly) should be conducted to evaluate expenditure rationalization options to ensure that the poor receive the lowest burden of the adjustment.

40. Nicaragua’s external position is assessed to be moderately weaker than fundamentals. In this regard, the international reserve coverage should be increased to support better the crawling peg exchange regime and increase Nicaragua’s resilience to shocks. Over the medium term, Nicaragua’s external competitiveness should be improved by enhancing structural reforms to boost productivity growth while keeping inflation low. Staff does not recommend approval of the exchange restriction arising out of Nicaragua’s participation in the SUCRE regional payments arrangement because it is discriminatory.

41. Nicaragua is assessed at moderate risk of debt distress. Most debt burden indicators remain below the threshold under the baseline, except in scenarios of shocks that lower GDP growth or from contingent liabilities.

42. The authorities should take further actions to enhance the timely identification and provisioning of distressed assets to ensure that banks are well prepared for potential additional loan quality deterioration. Enhancing crisis preparedness and the financial safety net and strengthening coordination for resolution activities would protect the financial system against downside risks.

43. Continuous progress on strengthening the AML/CFT framework is necessary to protect the integrity of financial transactions and mitigate the exposure to illicit flows and reduce risk of CBR pressures. Since July 2018, Nicaragua has made overarching reforms to the legal framework, but implementation efforts should be strengthened.

44. Addressing anti-corruption policy weaknesses, restoring business confidence, and improving the business climate are crucial to promote sustainable economic growth. Policies to bring back private sector confidence, including an evaluation of the impact of recent measures is essential to promote economic recovery and offset an increase in poverty. Strengthening government institutions and continuing efforts to improve infrastructure, invest in human capital, address labor skills bottlenecks, and upgrade technological readiness would improve competitiveness. Anti-corruption efforts should rely on a prioritized policy and enhanced institutional coordination and exchange of information to effectively prevent and prosecute corruption offenses. Improving fiscal transparency for all NFPS components and strengthening the asset declaration regime for high-level public officials could help reduce vulnerabilities to corruption and enhance fiscal outcomes.

45. Staff encouraged the authorities to make progress in strengthening the quality and timeliness of data provision. Past progress in widening and disseminating economic statistics needs to be preserved. The mission recommends resuming the timely publication of data, which is critical to business confidence and policy credibility.

46. Staff expects that the next Article IV consultation with Nicaragua will take place on the standard 12-month cycle.

Figure 2.
Figure 2.

Nicaragua: Indicators of Real Sector Activity

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorities and IMF staff calculations.
Figure 3.
Figure 3.

Nicaragua: Fiscal Developments

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorities and IMF staff calculations.1/ In 2018 central govenment expenditure does not include a transfer to INSS for 1.2% of GDP, as partial payment of central government’s historical debt to the INSS.
Figure 4.
Figure 4.

Nicaragua: External Sector

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorities and IMF staff calculations.
Figure 5.
Figure 5.

Nicaragua: Monetary Sector Developments

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorities and IMF staff calculations.
Figure 6.
Figure 6.

Nicaragua: Financial Sector Developments

Citation: IMF Staff Country Reports 2020, 059; 10.5089/9781513532622.002.A001

Sources: National authorities and IMF staff calculations.
Table 1.

Nicaragua: Selected Social and Economic Indicators, 2015–24

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Sources: National authorities; World Bank; and IMF staff calculations.

Central government deficit and INSS revenue in 2018 include a 1.2 percent of GDP for repayment of INSS historical debt. Similar transfers are projected in 2019–24 (specific amounts reported in Table 3a and 3b).

Excludes the Deposit Guarantee Fund for Financial Institutions (FOGADE).

Excludes resources from the Deposit Guarantee Fund for Financial Institutions (FOGADE), and reserve requirements for FX deposits.

Assumes that HIPC-equivalent terms were applied to the outstanding debt to non-Paris Club bilaterals. Does not include SDR allocations. From 2016 onwards includes preliminary data on the domestic debt of SOEs and municipalities. Prior to 2016, the stock of domestic debt of SOEs and municipalities is based on the capitalization of flows.

Includes short-term commercial debt.

Table 2a.

Nicaragua: Operations of the Budgetary Central Government, 2015–24 (GFSM 2001)

(In Millions of Cordobas)

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Sources: National authorities and IMF staff calculations.

Includes revenue from electricity distributors arising from changes in the electricity tariff.

Excludes VAT rebates granted as subsidies in the electricity sector.

Compensation of employees in 2018 includes US$150 million (1.2% of GDP) of central govenrment transfers to the INSS, as repayment of a historical debt. Projections for 2019–24 assume that central government will continue to transfer resources to the INSS in order to close the pension system deficits.

Interest projections assume that HIPC-equivalent terms were applied to the outstanding debt to non-Paris Club bilaterals. Does not include SDR allocations. Debt service is recorded on payment basis after debt relief.

Table 2b.

Nicaragua: Operations of the Budgetary Central Government 2015–24 (GFSM 2001)

(In Percent of GDP)

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Sources: National authorities and IMF staff calculations.

Includes revenue from electricity distributors arising from changes in the electricity tariff.

Excludes VAT rebates granted as subsidies in the electricity sector.

Compensation of employees in 2018 includes US$150 million (1.2 % of GDP) of central govenrment transfers to the INSS, as repayment of a historical debt. Projections for 2019–24 assume that central government will continue to transfer resources to the INSS in order to close the pension system deficits.

Interest projections assume that HIPC-equivalent terms were applied to the outstanding debt to non-Paris Club bilaterals. Does not include SDR allocations. Debt service is recorded on payment basis after debt relief.

Table 3a.

Nicaragua: Operations of the Consolidated Public Sector, 2015–24 (GFSM 2001)

(In Millions of Cordobas)

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Sources: National authorities and IMF staff calculations.

Includes the state-owned airport (EAAI); ports (EPN); oil (PETRONIC); electricity generation, transmission and regulation (ENATREL, ENEL and INE); water and sewer (ENACAL); food (ENABAS); trade and public enterprise corporation (ENIMPORT and CORNAP); telecommunications (TELCOR); technological institute (INATEC); post (CORREOS); and lottery (LOTERIA).