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					                                     Nicaragua:

                          Debt relief/ HIPC vs Poverty




                                    By Néstor Avendaño
                                        Economist
                                        April 2003




Study commissioned by Quaker Peace and Social Witness, London, England
1.    Introduction

By the end of 1990, Nicaragua, with a heavy foreign debt burden of US$10.715
billion, equal to seven times the Gross Domestic Product (GDP), appealed to the
International Community as it was not able to pay its contracted obligations, and
asked for a pardon and restructuring of the balance due. Before the Highly
Indebted Poor Countries Initiative (HIPC), which emerged in October 1996, the
world wrote off US$6.640 billion in the period between 1990-1996. Later, with the
HIPC Initiative, between 1997 and 2002, Nicaragua received a pardon of
US$1.550 billion. All of this, along with new concessional debt, largely multilateral
in origin, led to a foreign debt balance for Nicaragua of US$6.563 billion by the end
of 2002, equal to 2.3 times the GDP of that year.

Now, at the beginning of the first decade of the twenty-first century, Nicaragua is
facing an onerous and heavy burden due to the internal debt. At the end of 2002,
Nicaraguan taxpayers owed domestic creditors a total of US$4.122 billion, of which
US$1.470 billion is owed to the private sector and the remaining US$2.652 billion
to the public sector, principally to the Central Bank of Nicaragua.

This internal debt, which represents 1.6 times the GDP for 2002, has a number of
illicit sources, such as the unjust confiscations of property in the 1980s, although
there were also just confiscations, the fraudulent bank failures in the 1990s, and
the arbitrary management of auctions of bonds issued by the monetary authority of
the country during the last administration, which led to large losses in the Central
Bank.

In 2003, the government‟s fiscal-monetary scheduling, established with the
International Monetary Fund, places priority on the payment of the domestic debt
over the reduction of human poverty in the country. During this year, 85 cents of
each cordoba paid in taxes to the Central Government will be used toward the
interest and principal of the internal and external public debt. The latter already
enjoys relief (cancellation of the payment) equal to 65% of the contracted payment
of its service.

This current pressure on the administration of public finances, which is caused by
the debt associated with the auctioning of Central Bank bonds, will worsen in 2004,
when the government confronts the payment of the bonds issued for the bank
failures. It is estimated that for each cordoba of tax income that the Central
Government collects in 2004, 90 cents will go to pay off the public debt.

Bankers and public officials have pointed out some actions to solve the problem of
the internal debt, such as contracting a new official foreign debt or the placement of
Nicaraguan Government bonds in the international financial market to pay it off,
ignoring the fact that Nicaragua is a highly indebted poor country and does not
have the capacity to contract debt in the capital markets, and that the internal debt
is affected by its illicit sources. These proposals constitute nothing more than an
exchange of the domestic debt for foreign debt, and that really does not solve the
problem.

Among economists, the sovereign exchange of the internal debt has also been
proposed, that is, its restructuring on the basis of national efforts, lowering the
onerous interest rates and extending, if necessary, the term for the payment of the
principal. However, this proposal does not have the political support of the
government, which is insisting on immediate payment.

Now there is a danger that part of the interim relief from the Highly Indebted Poor
Countries Initiative granted by the Paris Club will be diverted for the payment of the
internal debt. In other words, there is no apparent assurance that the funds freed
up from the payment of the foreign debt are being allocated exclusively to poverty
reduction, as the Group of 7 (G-7) had instructed be done in Cologne, Germany in
June 1999, nor is the governmental agreement with the Paris Club being
implemented. Under that agreement, the resources freed up by the exceptional
treatment of the debt with that group of creditors would be allocated to the areas
identified as priorities in the country‟s poverty reduction strategy.

The following analysis describes the problem of Nicaragua‟s domestic debt,
identifies the interim relief of the external debt and its connection with the budget
for the fight against poverty, presents the conditions for the for the country to move
to the “Floating” Completion Point of the Highly Indebted Poor Countries Initiative,
and predicts the budgetary restrictions which will be caused by the internal debt in
2004. In the conclusion, some suggestions are presented which would contribute
to a solution of the national budget problem.
2. Interim Foreign Debt Relief for Nicaragua in 2003

On December 4, 2002 the International Monetary Fund (IMF) approved the
“Poverty Reduction and Growth Facility” (PRGF) Program for Nicaragua, with
which the country was able to conclude the fourth round of negotiations with the
Paris Club on December 13, 2002.

That agreement, based on the “Cologne Terms”, stated that the Paris Club will
write off 90% of the “pre-cutoff date” commercial debt of Nicaragua which comes
due after September 30, 2002, taking into account previous debt cancellations
promised by the creditors of the Paris Club. The remaining 10% will be restructured
over 23 years, with a six-year grace period, at the market interest rate. The ODA
loans (Official Development Assistance), which total US$19 million, will be
restructured over 40 years including a 16-year grace period.

In broad strokes, the amount of the restructured debt is US$579 million, of which
US$560 million are related to the “pre-cutoff date” commercial debt which is due
between October 1, 2002 and September 30, 2005.

This interim debt relief will lead to the immediate cancellation of approximately
US$405 million of the external debt of Nicaragua on the part of the Paris Club
creditors. This is consistent with the implementation of the HIPC Initiative. These
measures envision the reduction of debt service (or payments on the principal and
interest) from US$657 million to approximately US$90 million to the Paris Club
creditors between October 1, 2002 and September 30, 2005. The other payments
mainly consist of interest on the amounts restructured and the “post-cutoff-date”
debts coming due.

Nicaragua, for its part, has promised to use the funds freed up by this current
exceptional treatment of the debt for areas prioritized in the poverty reduction
strategy of the country. Finally, the creditor countries of the Paris Club expressed
good will regarding reduction of the balance of the Nicaragua‟s debt as soon as
Nicaragua reaches the completion point of the HIPC Initiative.


2.1 Interim Foreign Debt Relief Expected for 2003

Nicaragua has received relief in the payment of its external debt of US$49 million
in 2001 and US$73 million in 2002, through donations from the World Bank (WB),
the Interamerican Development Bank (IADB), the Central American Bank for
Economic Integration and the Organization of Petroleum Exporting Countries
(OPEC).

The total funds of US$115 million for this interim debt relief have been used to
finance spending aimed at poverty reduction in health, education and the programs
in the social welfare network.
According to data from the Government of Nicaragua, the foreign debt service prior
to the deduction of the interim relief of the HIPC Initiative, or the contracted
payment of interest and payments on the debt of Nicaragua, reached US$331
million for 2003.

The total relief on the payment of the debt identified and to be granted by the Paris
Club and the multilateral financial institutions adds up to US$213.9 million, which
should finance the fight against poverty. The recipients of this relief are the
Government of Nicaragua, with US$199.2 million, and the Central Bank of
Nicaragua with US$14.7 million (to be transferred to the Central Government).

The sources of this relief for 2003 are the following: (a) the Paris Club, with
US$137 million, with the principal creditors being Germany, Spain, France and
Italy, in that order; and (b) the multilateral financial institutions, with US$76.9
million, through the IADB, US$39.3 million; the Central American Bank for
Economic Integration (CABEI), US$20.7 million; the WB/International Development
Association, 8.5 million; OPEC, US$4.3 million; and the IMF, US$4.1 million.


                           HIPC INTERIM DEBT RELIEF
                              MillIions of US Dollars

  250


  200

                                72.9               76.9
  150                                                                 80.8


  100

             48.1                                 137.1
                               133.3
   50
                                                                     116.1

             50.3
    0
             2001               2002               2003              2004



                         PARIS CLUB                  MULTILATERAL

In accord with the Expanded HIPC Initiative redesigned by the G-7 in Cologne,
Germany in June 1999, the interim external debt relief for highly indebted poor
countries should be exclusively directed to finance poverty reduction projects. The
reduction of the foreign debt and the reduction of human poverty in poor countries
is conditioned on the transparent use of the resources of the national budget and a
growing participation of civil society in the solution of the economic and social
problems in these countries.

2.2 Conditions for reaching the Completion Point of the HIPC Initiative.
Nicaragua arrived at the Decision Point of the Highly Indebted Poor Countries
Initiative (HIPC) on December 21, 2000. Now, within the new framework of the
current three-year economic agreement with the IMF, the Nicaraguan
governmental authorities are attempting to arrive at the “floating” Completion Point
of the HIPC Initiative in December 2003.

Apparently, the expanded version of the HIPC Initiative, which emerged out of the
reforms introduced by the G-7 in the German city of Cologne in June 1999, allows
a country to arrive at the Completion Point more quickly than its original version of
October 1996.

In the original version of the HIPC Initiative, a country could arrive at the
Completion Point in six years, after having complied with two three-year economic
agreements with the IMF. Now a country has a minimum period of three years,
with a “floating” Completion Point, and everything depends on the speed with
which a country complies with all of the structural reforms, while making progress
in the implementation of the poverty reduction plan, requiring greater investment in
the social sector, and maintaining macroeconomic stability.

Initially, the Government of Nicaragua had to comply with the following structural
reform measures, after the final version of the Poverty Reduction Strategy (PRSP)
was approved in August 2001:

·     Transparent use of the budgetary savings as a result of interim relief on the
      payment of the debt within the framework of the HIPC Initiative, to be
      reported and identified within the PRSP process.

·     Maintainance of macroeconomic stability through satisfactory compliance
      with the agreements contained in the Poverty Reduction and Growth Facility
      (PRGF).

·     Increased social spending in education and health, with protection for the
      most vulnerable population groups.

·     Approval of a law for School Autonomy which would strengthen and
      increase participation of parents in education.

·     Approval of a general health law to strengthen the regulatory and normative
      roles of the Ministry of Health, and to establish a solid legal basis for the
      program for the modernization of that sector, granting more autonomy to
      hospitals and local health systems.

·     Adoption of an action plan for introducing an effective social protection
      program, based on the results of the pilot program begun in 2000.

·     Strengthening of governability through the approval of civil service laws,
      improved transparency in the use of public funds, increased efficiency of the
      Comptroller General of the Republic, and approval of laws governing penal
      processes and the public prosecutor‟s office (the latter has already been
      approved).

·     Approval of the law for the creation of the Superintendency for Pension
      Funds (already approved), implementation of privatized administration of the
      social security pensions, and restructuring of the Nicaraguan Institute for
      Social Security.

·     Privatization of all ENEL plants which generate electric energy, as well as
      the telephone company ENITEL (partially completed).

*INSERT GRAFICO – CREC PIB

Within the framework of the negotiations for the new three-year agreement
between the Government of Nicaragua and the IMF, “PRGF 2003-2005", the
following new measures of structural reform were added. The implementation of
these will also be required for the country to reach the Completion Point of the
HIPC Initiative.


2.2.1 National Financial System Reforms

·     Approval of new prudential norms by the end of March 2003, in order to limit
      the risk derived from maturity differences between assets and liabilities.

·     Submission to the National Assembly, by the end of September 2003, of the
      required legal amendments to comply with the Basel Core Principles for
      effective bank supervision (modification of the norms for the classification of
      assets, provisioning, and the proportion of capital adequacy to bring them
      up to international standards).

·     By mid-2003, the National Assembly will receive, from the Executive
      Branch, a bill for eliminating bank secrecy on assets; the Superintendency
      of Banks will begin holding regular in situ inspections in all banks, and will
      establish a new unit in the Deposit Guaranty Fund (FOGADE) for
      administering and liquidating the assets in eventual bank interventions.

·     Management and recovery of the assets of the banks which were
      intervened.

            Acceleration of the recovery process, transferring the assets acquired
            by the liquidation boards to FOGADE and subcontracting a
            specialized company from the private sector with a mandate to sell all
            the transferred assets by September 2003.

·     Approval of a Capital Market Law.
·     Legalization of the closing of the Banco Popular.


2.2.2 Public Sector Reforms

·     Submission to the National Assembly, by the end of March 2003, of an
      appropriate tax reform packet with an annual yield of 1.0% of the GDP.

·     Approval of a second stage of the Tax Reform by the end of June 2003, and
      its incorporation into the 2003 Budget, and the implementation of fiscal
      income measures to create marginal income equal to 1.0% of the GDP
      annually, including a significant reduction of exemptions, exonerations and
      special regimes.

·     Approval of the 2003 National Budget which, with the expected yield from
      the 2003 tax packet, would be consistent with the objective of reaching a
      combined public sector deficit (after donations) equal to or less than 6.3% of
      the GDP by December of 2003.

·     Adoption of an action plan for strengthening the administration of taxes by
      the General Revenue Office and the General Customs Office for the period
      2003-2005, by the end of June 2003.

·     Extension of the coverage of the Consolidated Account of the Central
      Government to the Central Bank for all national receipts including debt
      issued by the Central Government and all income received by the units of
      the Central Bank, as well as for all external loans and donations.

·     Application of appropriate remuneration for the deposits of the Central
      Government in the Central Bank and the charging of interest on all Central
      Government loans.

·     Nomination for the Superintendent of Pensions and the transfer of all eligible
      contributors from the social security system to the new pension system.

·     Privatization of the remaining public enterprises. Sale of 49% of the shares
      of the Nicaraguan Telecommunications Enterprise (ENITEL) to new
      investors by the end of September 2003.


2.2.3 Governability and Transparency Reforms

·     Approval of the Probity Law for Public Servants.

·     Approval of the reform of the Civil Service Law, and a pairing of the skill
      profile of public sector personnel with the competencies required for each
      position in all public entities.

·     Introduction of a satisfactory management and inspection system for the
      bidding process for goods and services provided to the government.

·     Strengthening the efficiency of the Comptroller General‟s Office, with
      technical assistance and financial support from the Interamerican
      Development Bank.

·     Implementation of a comprehensive program to modernize the Comptroller
      General‟s Office.

·     Institutional strengthening of the Judicial Branch, based on
      recommendations made by the Commission for Judicial Reform in 2002.

·     Approval of a law governing the internal and external debt of the public
      sector.

·     Approval of a law for strengthening the decentralized property registry, with
      the assistance of the World Bank.



2.2.4 Mechanism for Follow-up on Poverty Reduction Expenses

·     Codification of all spending related to poverty and its financing in the 2003
      Budget

·     Creation of a system for evaluating performance and monitoring the impact
      of spending on poverty reduction


2.2.5 Macroeconomic Statistics

Publication and official adoption by the Central Bank of the revised national
accounts for 1994-2000 in March 2003. It is estimated that the Gross Domestic
Product of Nicaragua is currently undervalued by 38.8%

Finally, the “PRGF 2003-2005" Program states that, at the Completion Point, the
balance of the debt will be reduced 72.2% in net present value terms.
3. The National Budget and the Poverty Reduction Program in 2003.

Governmental authorities have reiterated that their principal objective is to promote
high economic growth with low and stable inflationary pressure for the purpose of
reducing human poverty. Thus, the economic “strategy” seeks to reduce fiscal and
external imbalances, use the interim relief from the Highly Indebted Poor Countries‟
Initiative for the poverty reduction programs, seek greater efficiency in public
spending through the implementation of the structural reforms which are still
pending, and facilitate greater internal and external private investment.

Within this general framework, the fiscal policy for 2003 is as follows:

·      The Executive Branch will present the second stage of the so-called tax
       “reform” to the National Assembly in March 2003 for the purpose of raising
       the tax burden by one percentage point of the GDP annually.

·      The Government will attempt to create a national consensus for expanding
       the tax base and for reducing distortions in the tax system, such as
       exemptions on imports, and taxing basic consumer goods which enjoy a
       zero rate in the application of the general value (sales) tax (IGV).

·      The cost of the partial transfer of the administration of pensions under the
       social security system to the private sector is slightly more than 2% of the
       GDP in 2003-2004.

·      A slight rise in spending for poverty reduction, which would increase from
       15.6% of the GDP in 2002 to 15.8% of the GDP in 2003.

·      Excluding the payment of interest on governmental debt, total primary
       spending represents 27% of the GDP in 2003, which could be further cut if
       the goals for tax collection are not met.

·      Contribute to the reduction of the deficit of the “combined” public sector after
       recording the external donations (that is from the non-financial public sector
       and from the central bank), from 9.2 % of the GDP in 2002 to 6.3% of the
       GDP in 2003.

In specific terms, the fiscal goals contained in the 2003 National Budget are:

·      Before estimating the impact of the new tax reform, the government
       budgeted income from taxes at C$8,754.7 million, equal to US$580 million
       in 2003, and approximately equal to 21.8% of the GDP.

*INSERT GRAFICO – CARGA TRIBUTOS

·      Taking into account the economic classification of the spending and
       payments on the governmental debt, 38% is absorbed by the operations of
    the government apparatus (salaries, purchases of goods and services for
    consumption and current transfers), 37.3% is for contracted service (interest
    and payments) on the external and internal government debt, and 24.7% is
    for capital expenses (direct real investment and capital transfers).

·   Due to the functional structure of the spending and the payments on the
    governmental debt, the budgetary resources are directed at the following
    purposes, in order of importance: 37% for payment of the contracted
    service of the internal and external debt; 32% for the social sector
    (education, health care, social services and social assistance, housing,
    recreation and culture); 13% for economic services (agricultural, industrial,
    transportation, road infrastructure, natural and environmental resources and
    decentralized entities); 2.7% for the Ministry of Defense; 3.8% for the
    Ministry of the Interior; 2.6% to the Supreme Court; and 9% for the
    administration of the government.

·   The spending for poverty reduction is budgeted at C$5,887.3 million, 65% of
    which is financed with external resources (HIPC interim debt relief,
    donations tied to programs and loans on concessional terms). It is worth
    remembering that a third of total spending, including payment on the interest
    of the debt, is financed with donations and external loans less payments.

*INSERT GRAFICO – BUDGET POVERTY

·   The contracted service on the foreign debt which reaches a total of
    C$4,286.3 million, and is nearly 70% of total contracted service, is subject to
    the interim relief of the HIPC Initiative, which is nothing more than the
    pardon of 80% of the payment of the interest and payments of the pre-cut-
    off-date debt with the Paris Club (that is, the debt subject to negotiation,
    which is what was contracted up to October 31, 1988), and the partial
    pardon of the payment of the interest and payments to the international
    financial institutions which may be financed by the wealthiest countries of
    the world. But this relief will be effective if and only if the Government of
    Nicaragua complies with the agreements established in the PRGF program
    of the International Monetary Fund.

·   The “expected” interim relief in the payment of the foreign debt in 2003 is
    nearly US$214 million, or almost 65% of the total contracted service of the
    foreign creditors in this year, but the only amount budgeted was a donation
    of C$1,486.5 million, equal to US$98.4 million in the Poverty Reduction
    Strategy which appears in the 2003 National Budget, or only 46% of the
    total relief granted by the International Community. In other words,
    US$115.5 million of interim relief on payment of the external debt was not
    allocated to the projects under the National Poverty Reduction Strategy
    contained in the 2003 National Budget.

·   The contracted service on the domestic debt totals C$1,961.7 million. This
      debt does not enjoy any relief due to its illicit origins (unjust confiscations of
      property in the 1980s and the fraudulent failures of the government and
      private banks in the 1990s), and it was maximized with the payment of
      elevated rates of interest on the open market operations administered by the
      Central Bank under Dr. Arnoldo Aleman‟s Administration, especially with
      placement of Negotiable Investment Certificates (CENIS) in auctions for the
      amount of C$1,100 million at interest rates of between 18 and 20% in
      dollarized amounts in November and December of 2001.

·     Without relief in the payment of the foreign debt in 2003, C$0.49 of each
      cordoba paid by Nicaraguan taxpayers to the National Treasury would go to
      external creditors and C$0.22 would go to internal creditors. In summary,
      without HIPC interim debt relief, the payment of the contracted service of the
      external and internal debt of the Central Government represents 71% of the
      projected tax income for 2003.

·     Taking into account only the amount of interim relief that the international
      community has granted to the Central Government, US$199.2 million or
      C$3,010 million, C$0.15 from every Cordoba of taxes will be used as
      ”relieved” service to external creditors. But since the budget does not
      include the total relief granted to the Central Government, this “relieved”
      service rises to C$0.32 for each Cordoba of taxes.

·     Thus, of each Cordoba paid as taxes in 2003, 54 cents would be used for
      the payment of the “effective” service of the domestic and foreign debt of the
      Central Government. This burden is unbearable and intolerable in budgetary
      terms for a highly indebted poor country like Nicaragua.

Among the observations on the fiscal policies described above for 2003, the
following must be pointed out:

·     Tax reform should be associated with the strategy and policies for growth
      and economic development of the country. These considerations are
      absent from the framework of negotiations between the Government of
      Nicaragua and the International Monetary Fund. It seems that the
      government‟s intention to increase the tax burden is only to increase tax
      revenue in response to the new burden of the internal debt service, which is
      not explicitly treated in the framework of the fiscal policy.

·     Continuing to increase the tax burden in a situation of national economic
      recession is fiscally irresponsible, because it tends to deepen the economic
      recession existing in the country since March 2001. In 2002, the tax burden
      of the Central Government was 22.2% (that is, out of each cordoba for
      production the government took 22.2 cents in taxes), and it is estimated to
      be close to the 25% in 2003, due to the second phase of the tax reform
      expected to start next July 1.
·      It would be more advisable for the government to learn how to collect the
       taxes already established, especially those which tax the income of the
       higher-income strata of businesses and the population, to try to reduce the
       regressive nature of the tax structure (in 2002, 80.2% of the taxes collected
       by the Central Government were indirect taxes) and to eliminate tax evasion
       and avoidance.

·      The burden of the contracted service on the Central Government‟s internal
       and external debt, or, in other words, the interest and payment of principal to
       foreign and domestic creditors, is more important than spending for
       investment, and is as important as the operational expenses of the
       governmental apparatus in 2003.

·      The contracted service on the external and internal governmental debt,
       equal to 37% of total spending (including payments) budgeted for 2003,
       constitutes a serious limitation to poverty reduction, and a serious risk which
       may lead to an “exchange” of domestic debt for foreign debt; in other words,
       part of the interim relief of the external debt, instead of financing the
       spending for poverty reduction, would be used to finance the payment of
       interest on the internal debt.

·      For purposes of comparison, public spending to fight poverty represents
       35% of total spending, including the payment of interest and principal on the
       governmental debt, while the payment of the contracted service of the debt
       of the government with its internal and external creditors represents 37%.
       The payment of the internal and external governmental debt continues to
       hold greater importance than the fight against poverty, as was the case
       under the old ESAF program (Enhanced Structural Adjustment Facility),
       today renamed PRGF (Poverty Reduction and Growth Facility).


3.1 Why does the 2003 Budget indicate a lesser amount for interim relief on
the payment of the external debt than what was granted by the Paris Club
and than what was expected from the multilateral financial institutions?

The response to this question is under the jurisdiction of the IMF, which is the
entity responsible for the coordination requested by the G-7 in order to link poverty
reduction with the reduction of the foreign debt.

In order to explain that all the interim relief on the payment of Nicaragua‟s external
debt was not assigned to the poverty reduction programs and projects, one of the
arguments has been that Nicaragua never honored all the contracted service on
the debt known as “pre-cutoff-date with the Paris Club”, the debt subject to
restructuring with the Club, which Nicaragua contracted with that group of creditors
up to October 31, 1988.
Another argument is that the Central Government of Nicaragua has always paid
the foreign debt by buying dollars in the Central Bank of Nicaragua with Treasury
Bonds, given their insufficiency of Cordobas. Another less credible argument is that
Nicaragua does not have enough capacity to spend the resources freed up from
the payment of the foreign debt in projects which would tend to reduce poverty.

What has been omitted from all these arguments is that the principal structural
problem of government spending, which is the onerous and heavy burden of the
internal public debt, is the reason that there is a smaller budget for the fight against
poverty. Without this burden, the Budget of Nicaragua would not currently be
running a deficit.

Part of this debt was caused by the inadequate policy of the open market
operations of the Central Bank of Nicaragua - which have resulted in losses of
US$280 million in the last six years and which must be paid to the Central Bank of
Nicaragua by the Central Government through taxes- with the remainder in large
measure attributed to two other illicit sources: the unjust confiscations of properties
in the 1980s and the fraudulent bank failures in the 1990s. The payment of this
debt diminishes the government‟s effort to save 25% of the Nicaragua population
from severe poverty.

*INSERT GRAPH – PERDIDAS BCN

In 2003, the pressure of this internal debt is heightened by the auctioning of
securities of the Central Bank of Nicaragua. In 2004, the situation worsens with
payments for the bank failures. Between 2007 and 2020, payments are due for
compensation bonds to the owners of properties confiscated during the 1980s.


3.2 The Domestic Public Debt of Nicaragua as of December 31, 2002

Apparently the IMF is only interested in the payment of the internal public debt with
the private sector, with the principal creditors being the commercial banking
system, foreign financial investors, especially from Central America, and
Nicaraguans who had their properties confiscated in the 1980s. The debt of the
Central Government with the Central Bank of Nicaragua is not taken into account
for payment over the long term.


3.2.1 The Domestic Public Debt with the Private Sector

This component of the internal debt is what the Government of Nicaragua owes to
the private sector, which is represented by the following bonds:

(i) Compensation Payment Bonds (BPIs, by their acronym in Spanish) issued by
the Central Government through the Ministry of the Treasury and Public Credit, for
the purpose of compensating people whose real estate and goods were unjustly
confiscated during the 1980s, add up to a total equal to US$745 million.

(ii) Negotiable Investment Certificates (CENIs), placed by the Central Bank of
Nicaragua (CBN) in auctions, and associated with the increase in official
international reserves, reflect a balance of C$2,882.3, equal to US$202 million as
of December 31, 2002 and representing 73% of the net international reserves of
the CBN. It is worth recalling that the Administration of Ms. Violeta Barrios de
Chamorro left a debt of US$46 million in CENIs to the administration of Dr. Arnoldo
Aleman.

*INSERT GRAPH – DEUDA INTERNA

(iii) At the end of last year, the CENIs issued by the CBN for the recovery of the
banks which failed due to fraud reflected another balance of C$5,280.3 million,
equal to US$369 million and 134% of the net international reserves of the CBN.
These documents do not earn high rates of interest, and the total cost of the bank
failures is close to US$530 million, which will be paid for with the taxes of the
Nicaraguan taxpayers.

(iv) The CENIs issued by the CBN to cover the obligations of the coffee producers
with the National Financial System, whose balance was C$133.1 million, equal to
US$9 million at the end of 2002.

(v) Special Investment Bonds (TEIs) also issued by the CBN, with which the
monetary authorities acquire resources from the social security payments of the
workers and employers which are placed exclusively in the Nicaragua Institute of
Social Security (INSS), and whose balance was equal to C$1,208.5 million, equal
to US$85 million as of the end of last year.

(vi) Special Liquidity Bonds (TELs), also issued by the CBN to pay the bankers the
interest earned for the marginal increase of three percentage points which the legal
reserve rate experienced on deposits in cordobas and dollars during the second
semester of 2001, shows a balance of C$705.7 million, equal to US$49 million as
of December 31, 2002.

(vii) Foreign Currency Bonds (BOMEXs), also forcibly placed by the CBN in the
private banking sector for terms of a few days at the end of each quarter, for the
purpose of showing less non- compliance with the goal to increase international
reserves, and which the private banking sector purchases with resources from the
reserve in foreign currency, indicated a balance of US$10 million.

In summary, the short term debt generated by the CBN in the placements of its
bonds totaled US$724 million as of December 31, 2002, equal to 28.2% of the
GDP for 2002. Added to this is the debt of BPIs issued by the Ministry of the
Treasury and Public Debt, which represents 29% of the GDP. In total, the internal
public debt with the private sector added up to US$1,469 million, equal to 57.2% of
the GDP for 2002.


3.2.2 The Internal Public Debt with the Public Sector

The other component of the internal debt is what the Government of Nicaragua
owes the public sector, that is, bonds in the name of the CBN as writedowns of the
portfolios of the government banking sectors, operational losses and exchange
rate losses of the CBN, payment of the service on the foreign debt, and
compensation bonds in the hands of the monetary authority.

Most of these bonds do not enjoy value maintenance, are long term and have very
concessional interest rates. As of December 31, 2002 the total for these bonds
yielded a debt of C$37,947.7 million, equal to US$2,653.4 million, and to 103.2% of
the 2002 GDP. This is the intersectoral public debt, or the Central Government
debt with the Central Bank of Nicaragua.


3.2.3 The Total Domestic Public Debt

In summary, as of December 31, 2002 the total domestic public debt is US$4,122.4
million, nearly 160% of the 2002 GDP. The payment of what is owed to the private
sector is beginning to hit harder, first, the deteriorated finances of the Central
Government - which in 2002 registered a fiscal deficit equal to 9% of the GDP;
secondly, the “fictitious” position of the official international reserves - as of
December 31, 2002, the short term debt of the CBN for the issues of bonds,
excluding those associated with the bank failures and the coffee crisis, represented
125% of the balance of net international reserves of the CBN; and thirdly, the
fragile monetary balance - as of December 31, 2002, one dollar of net international
reserves, without taking into consideration the massive short term debt of the CBN,
provided backing for 13.16 cordobas of the monetary base, while the official
exchange rate was C$13.84 per US dollar.


3.2.4 General Considerations on the Domestic Public Debt

It is highly unlikely that the Donor Community would be willing to loan or donate
resources to finance the payment of this debt, even less so because of the illicit
acts which lie behind it, especially the BPIs for property confiscations and the
CENIs for bank failures.

Recently, during his trip to Washington, President Enrique Bolanos claimed
success in his negotiation for refinancing the payment of the internal public debt in
the Department of the Treasury of the United States, because of the support this
US institution displayed for the placement of the bonds issued by the Government
of Nicaragua in the international market despite IMF prohibitions on non-
concessional lending to Nicaragua in that same market.

It must also be remembered that, at the Iberoamerican Summit held in the
Dominican Republic last year, President Enrique Bolanos presented another
request for refinancing the internal public debt of Nicaragua with the private sector
to the President of the Interamerican Development Bank. Both negotiations, of
course, seek to work out an exchange of the domestic debt for foreign debt, at a
time when the country is trying to free itself from debt with the help of the Highly
Indebted Poor Countries Initiative.

It is obvious, from all of the above, that a latent and troubling risk is the possible
deviation of resources freed up from the payment of the external debt toward the
paying of the internal debt, to the detriment of the fight against poverty.

The international community, represented by the Paris Club and the multilateral
financial institutions, has opened the way for Nicaragua to opt for interim relief on
the payment of the external debt, and this will be the main international aid which
Nicaragua will have in 2003, no longer paying an amount of US$214 million to
foreign creditors. With this, the representatives of Nicaraguan civil society in the
National Council for Economic and Social Planning (CONPES) must be concerned
about establishing an effective control mechanism, up to now represented by the
Social Supplementary Fund, for the allocation of this aid and to prevent the
diversion of US$115.5 million from the interim relief of the external debt to the
payment of the internal public debt with the private sector.
 4. The Restriction of Service on the Public Debt in 2004

 The internal public debt will greatly affect the administration of governmental
 finances in 2003, when the executive branch will attempt to pay off the Negotiable
 Investment Certificates (CENIs) issued for the bank failures.

 For 2004, the (contracted) service on the domestic debt as well as the foreign debt
 (after the interim debt relief of the HIPC Initiative) of the Central Government and
 the Central Bank of Nicaragua will reach approximately US$718 million, equal to
 25.6% of the expected Gross Domestic Product for 2004, to 102.7 % of total tax
 income projected for the Central Government for 2004, and to 75.3% of the value
 of exports of non-factorial goods and services predicted for 2004.
 NICARAGUA: SERVICE ON THE PUBLIC DEBT 2001-2005
                 Item                         2001                                   2002            2003             2004         2005

                                                                                            Millions of Dollars

 Total Service on the Public Debt                                       412.9           438.3            546.2          717.9        422.1
  Repayment                                                             289.9           316.9            343.2          411.0        250.3
  Interest                                                              123.0           121.4            203.0          306.9        171.8

 Service on the Foreign Public Debt                                     153.3           154.9            118.2           91.9        100.1
  Repayment                                                             106.2           113.9             54.2           33.0         34.3
  Interest                                                               47.1            41.0             64.0           58.9         65.8

 Service on the Domestic Public Debt                                    259.6           283.4            428.0          626.0        322.0
  Repayment                                                             183.7           203.0            289.0          378.0        216.0
  Interest                                                               75.9            80.4            139.0          248.0        106.0

                                                                                                  Percentages
 Total Service on the Public Debt
  As a Percentage of GDP                                                  16.2            17.0            20.5           25.6         14.1
  As a Percentage of Central
   Government Tax Revenues                                                75.5            77.5            84.8          102.7         56.7
As a Percentage of Exports of
   Non-factorial Goods and Services                                       50.0            55.0            62.6           75.3         40.9

 Service on the Foreign Public Debt
 As a Percentage of GDP                                                    6.0              6.0             4.4              3.3          3.3
 As a Percentage of Central
  Government Tax Revenues                                                 28.0            27.4            18.4           13.2         13.4
 As a Percentage of Exports of
  Non-factorial Goods and Services                                        18.6            19.4            13.5               9.6          9.7

 Service on the Domestic Public Debt
 As a Percentage of GDP                                                   10.2            11.0            16.1           22.3         10.8
 As a Percentage of Central
  Government Tax Revenues                                                 47.5            50.1            66.5           89.6         43.3
 As a Percentage of Exports of
  Non-factorial Goods and Services                                        31.5            35.6            49.0           65.6         31.2

 Note                                                                                     Millions of Dollars
 Gross Domestic Product                                               2,546.9         2,571.4       2,661.4            2,806.4      2,989.3
 Central Government Tax Revenues of                                     547.0           565.7         644.1              698.8        744.3
 Exports of Non-factorial Goods and Services                            825.1           797.1         873.0              953.9      1,033.1
 Source: Central Bank of Nicaragua, Ministry of the Treasury and Public Credit and the International Monetary Fund.
By the end of 2002, the nominal debt of the public sector of Nicaragua added up to
approximately US$7,832 million; that is, close to three times the value of the Gross
Domestic Product of that year, of which US$6,363 million (247% of the GDP) was
external debt and US$1,470 million (57% of the GDP) was internal debt.

In order to reduce the internal debt, the government will try to (i) reduce the deficit
of the public sector before external donations from 16.5% of the GDP in 2002 to
7.5% in 2005; (ii) use the resources from privatizations, the recovery of the assets
of the intervened banks, and the support for the balance of payments to pay off
US$160 million of the internal debt in the period from 2002-2005; (iii) standardize
the terms of new issues of Negotiable Investment Certificates with the other
countries of Central America, in order to facilitate the roll over policy of the
redemptions; and (iv) strengthen the prudential norms which regulate the national
banking system.

With these public indebtedness policy actions, the total balance of the public debt,
in nominal terms, could be reduced to an amount equivalent to an annual GDP
between 2002-2005.


NICARAGUA: BALANCE OF THE PUBLIC DEBT 2001-2005
                Item                        2001                                    2002            2003              2004       2005

                                                                                           Millions of Dollars

Total Balance of the Public Debt                                     7,898.0          7,831.6         6,403.2          6,312.9    6,242.9
 Balance of the Foreign Debt                                         6,374.0          6,362.6         4,916.2          4,951.9    4,981.9
 Balance of the Domestic Debt (with the private sector)              1,524.0          1,469.0         1,487.0          1,361.0    1,261.0

                                                                                           Percentages of the GDP

Total Balance of the Public Debt                                       310.1            304.6           240.6           224.9      208.8
 Balance of the Foreign Debt                                           250.3            247.4           184.7           176.5      166.7
 Balance of the Domestic Debt (with the private sector)                 59.8             57.1            55.9            48.5       42.2
Source: Central Bank of Nicaragua, Ministry of the Treasury and Public Credit, and the International Monetary Fund.




5. Recommendations

It is difficult to administer not just fiscal policy but also the fight against poverty in a
situation where the taxes collected by the Central Government are absorbed by the
payment of interest and principal to the domestic and foreign creditors of the public
sector of the country.

The Government of Nicaragua has insisted on honoring the onerous burden of the
domestic debt through the diversion of resources freed up from the payment of the
foreign debt, and has relegated poverty reduction to a lower level of priority. This is
not possible, even though the International Monetary Fund may support it, since it
contradicts both the political will of the G-7 to link the reduction of the foreign debt
with poverty reduction in the highly indebted poor countries, and the conditions
established by the Paris Club in the IV Round of Negotiations of the Foreign Debt
of Nicaragua.

The argument that Nicaragua has not had enough of its own resources in its
national budget to honor the payment of the foreign debt is not valid. During the
implementation of the second three-year agreement with the IMF, “ESAF 1997-
2001”, Nicaragua was able to honor the payment of interest and principal to the
Paris Club and the multilateral financial institutions because not falling into arrears
in these prioritized payments was one of the conditions of the agreement. It did not
fall into arrears at any time during that period, except in 1999.

[INSERT GRAPH: “Public Sector Domestic and External Debt Service”]
*INSERT GRAFICO: DEBT SERVICE

A unilateral decision was made by the Paris Club that, because of the damage
caused by Hurricane Mitch in October of 1998, Nicaragua would enjoy a
moratorium in the payment of the debt service with the Paris Club between
December 1998 and February 2001.

But it is also worth pointing out that between March and December 2001, the
Alemán Administration did not comply with the “pre-cutoff-date” debt service and
was in serious non-compliance with the economic program (not even receiving
approval for an interim program for the second semester of 2001). Also, the
Bolaños Administration did not pay the service on that same debt because of the
critical situation with the official international reserves (not the tax income), which it
faced throughout 2002, as it did not receive resources for supporting the balance of
payments from the World Bank and the Interamerican Development Bank, due to
the absence of an IMF economic program.

In light of all of the above, we present the following recommendations in order to
improve the administration of Nicaragua‟s public finances:

      Prepare a strategy for the “sovereign” exchange of the domestic debt within
the National Council for Economic and Social Planning (CONPES). This exchange
implies reducing the payment of interest and deferring the payment of principal
facing Nicaragua, given the insufficient resources in the National Treasury.

      The „sovereign exchange” of the domestic debt is nothing more than
replacing the current certificates, which are earning high interest rates, with new
bonds that have interest rates that are lower, but that are guaranteed, in principle,
by tax collection.

       The sovereign exchange of the domestic debt would be “voluntary” in that
the Government would not formally declare the end of payments on the domestic
debt so that creditors would not carry out judicial action, alleging that there are
sufficient reserves in the CBN. One thing is clear: to the extent that the Central
Bank of Nicaragua redeems its short term certificates, its international reserves will
fall; that is, the balance of reserves on dollar deposits and the “untouchable” loan
facilitated by the IMF, placing the free convertibility of the cordoba at risk.

      In order to reduce spending by the governmental apparatus and to free up
tax resources, first, for the fight against human poverty through investments, and
secondly, to pay a “restructured” domestic debt, it is important to:

      Prepare and approve, in an expedited fashion, a law to regulate salaries and
       pensions for retirement and resignation in the public sector (branches of
       government, autonomous financial and non-financial entities, and
       government enterprises) which will take effect beginning with the next
       budget exercise, and which will be incorporated into the Civil Service Law.

      Regulate the use of the fleet of vehicles and fuel in the public sector
       (branches of government, autonomous financial and non-financial entities,
       and government enterprises), prohibiting the assignment of vehicles, except
       for the posts of Minister, Vice Minister, Secretary General and the
       Magistrates.

      Regulate the use of mobile telephones, credit cards, trips and official
       missions outside the country in the public sector (branches of government,
       autonomous financial and non-financial entities, and government
       enterprises).

      Due to the G-7‟s condition to establish greater transparency in the
       management of public resources, the internal relief from payment of the
       foreign debt should be clearly identified in the budget in the section for
       income as grants from the donor community, and in the expenses section as
       projects for poverty reduction.

      Request that governmental authorities establish an adequate mechanism for
       assuring the transparent use of the tax resources freed up from paying the
       foreign debt in order to avoid the use of these resources for other purposes.
       An exclusive account of the National Treasury should be established in the
       Central Bank of Nicaragua which would be used for all the resources freed
       up from the payment of the foreign public debt, including the transfers which
       the Central Bank of Nicaragua would have to make to the Central
       Government under this budget category.

      Request that the main granters of the interim relief on payment of the
       foreign debt, Germany, Spain, France and Italy, evaluate the assignment
       and use of their resources donated for this relief, both in budget preparation
       and implementation, as well as in the implementation of the projects in the
       prioritized areas of the poverty reduction strategy.
*INSERT GRAFICO – DEUDA EXTERNA
[INSERT GRAPH: “Nicaragua’s External Debt at December 2002”]

				
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