This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 MANAGUA 001604 
 
SIPDIS 
 
SENSITIVE 
 
DEPARTMENT FOR WHA/CEN 
DEPARTMENT PASS USTR, OPIC AND EX-IM BANK 
 
E.O. 12958: N/A 
TAGS: ECON EFIN NU IMF
SUBJECT: PRESSURE INCREASES ON NICARAGUA TO RESOLVE IMF 
ISSUE 
 
REF: A. 04 MANAGUA 3562 
     ¶B. MANAGUA 1011 
 
¶1. (SBU) SUMMARY.  A strong message from European donors has 
increased the pressure on the GON to take action to awaken 
the "dormant" IMF program or jeopardize losing USD 120 
million in aid, including direct budget support.  This echoes 
similar comments from Carlos Castaneda, IDB Executive 
Director for Central America, who on May 23 called for an IMF 
agreement to help Nicaragua maintain its macroeconomic 
stability.  Because the IMF program is on hold, Nicaragua has 
lost USD 71 million in planned disbursements from the IDB and 
IMF to date.  In order for an agreement, that would extend 
the current program through 2006 to be presented to the IMF 
Board in August, the GON needs to finalize budget reform and 
reach consensus with the National Assembly on structural 
reform immediately.  If the GON fails to submit the program 
by the first week in June, the GON will have to start 
negotiations over with the IMF in 2006.  The GON estimates 
that USD 175 million in aid is at risk for 2005.  The fiscal 
reform package continues to be held hostage to the political 
debate between the National Assembly and the Executive.  END 
SUMMARY. 
 
BACKGROUND: THE IMF PROGRAM 
--------------------------- 
 
¶2. (SBU) At a May 4 International Donors Meeting ("Mesa 
Global"), Finance Minister Mario Arana provided background on 
the current budget reform impasse for major donors.  He 
recalled how in December 2004, the National Assembly 
increased spending by about 700 million cordobas (about USD 
42 million), or 0.8 percent of GDP, above the IMF guidelines 
(ref A).  The spending gap came from salary increases for 
health and education workers, increased transfers to other 
branches of government, and increased transfers to 
municipalities (estimated at 180 million cordobas).  However, 
the National Assembly was quickly persuaded that the IMF 
would not accept this, and negotiations began on how to cover 
the spending gap.  In April, the Executive and the National 
Assembly reached an agreement on a fiscal package of around 
300 million cordobas in new revenues by ending special tax 
treatment for banks, introducing taxation on casinos, and 
reducing tax exonerations, especially for luxury goods.  With 
revenue projections restated for another 250 million 
cordobas, the gap was almost closed. 
 
¶3. (SBU) Arana explained that although the tax reforms 
passed, the National Assembly added a provision that had not 
been discussed or agreed to by the Executive, implementing a 
constitutional reform to permit taxation of media inputs and 
capping the media's tax exonerations (ref B).  When the 
Executive reviewed the law they determined that the media 
amendment had not been agreed, was controversial and 
politically sensitive, and had not been discussed with the 
affected sector.  The President vetoed this article with the 
hopes of opening the way to an alternative tax proposal 
acceptable to the media sector - a positive list of 
tax-exempt inputs.  Arana explained that although initially 
both the FSLN and the PLC indicated that they would be open 
to a discussion, they backtracked and argued that the 
President should first remove his veto before any discussion. 
 The situation has been at an impasse for over a month. 
 
MACROECONOMIC SITUATION 
----------------------- 
 
¶4. (SBU) In response to Arana's May 4 presentation on the 
political background surrounding the IMF program, Humberto 
Arbulu, IMF Resident Representative, provided his perspective 
on the situation for the donors.  He indicated that Nicaragua 
was on track as far as statistical figures based on the 
current macroeconomic situation.  He added that 2004's 
economic growth was stronger than expected, and inflation was 
under double digits.  On the fiscal side, Nicaragua enjoyed 
increases in tax revenue and more social spending.  On the 
monetary side, there was more reserve growth than expected 
last year.  In the financial system, there was a decline in 
interest rates for loans and deposits.  Banks are stronger, 
more highly capitalized and more profitable, with better loan 
loss reserves and smaller portfolios of non-performing loans. 
 On the external side, exports recovered strongly and 
remittances increased in 2004.  Regarding 2005, Arbulu felt 
that growth (measured by the IMAE indicator) remained good, 
and inflation was slightly below previous year's levels.  On 
the fiscal side, he said tax revenues were better than 
targeted and tax administration showed good results.  He felt 
that bank consolidation had strengthened the financial 
system.  Finally, on the external side, exports were growing 
at 22 percent annual rate and imports at less than 16 percent 
annual rate. 
 
¶5. (SBU) According to Arbulu, the IMF understands that the 
political situation cannot always be molded to fit the 
bureaucratic needs of the IMF.  He has stressed that the GON 
needs to get budget reform finalized and get buy-in from the 
National Assembly immediately in the hopes of presenting an 
agreement to the IMF Board in August.  However, Arbulu stated 
that Nicaragua could live without an IMF program because the 
macroeconomic indicators are satisfactory.  He reiterated 
that if nothing happens soon, the GON will miss the 
opportunity to extend the current program and will have to 
start negotiations over in 2006.  On May 23, Arana told the 
press that if the log jam could not be resolved within two 
weeks, their would be no IMF program.  Arbulu, standing by 
his side, concurred. 
 
EUROPEAN DONORS SPEAKS OUT FORCEFULLY (FINALLY) 
--------------------------------------------- -- 
 
¶6. (SBU) On May 23, Carlos Castaneda, IDB's Executive 
Director for Central America and Belize, who was wrapping up 
a four day visit to Managua with the IDB Executive Board of 
Directors, encouraged the Executive and the National Assembly 
to take action as soon as possible to reach a consensus and 
allow the IMF agreement to go forward.  In a press interview, 
Castaneda added that he saw "good will" on behalf of the 
Executive and the National Assembly to resolve the impasse 
and maintain Nicaragua's positive macroeconomic performance. 
Although he strongly encouraged the approval of the IMF 
program to maintain economic and political stability, 
Castaneda stated that, with or without an IMF agreement, the 
IDB was committed to Nicaragua and planned to invest a 
guaranteed USD 160 million in 2005 if the country maintained 
a stable macroeconomic situation.  He added that only USD 35 
million were dependent upon having an IMF agreement in place. 
 Eduardo Balcarcel, IDB Resident Representative, explained 
that IDB loans will fund 30 projects including private sector 
credit programs, road and infrastructure projects, hospital 
modernization and health care programs, and other social 
programs. 
 
¶7. (SBU) On May 24, Dutch Ambassador Kees P. Rade, speaking 
on behalf of the European donor community, stated that the 
Europeans were serious this time about suspending part of 
their aid to Nicaragua if the GON could not reach an 
agreement with the IMF.  Rade added that although many people 
have felt that the Europeans have failed to live up to 
similar threats in the past, this case was different.  In a 
press interview, Rade explained that the donor community had 
frozen budget support and announced a new donor mechanism 
which conditions further disbursements on macroeconomic and 
political stability, the development of budget mechanisms 
that guarantee confidence in the management of donor funds, 
and policies that promote economic growth and poverty 
reduction.  The Dutch have euro 9 million in budget support 
on hold for 2005 pending the IMF agreement.  Rade added that 
the Dutch government wants assurances of how its money is 
invested and they use the IMF agreement as a measurement 
instrument.  Jurg Benz, Central American Representative for 
the Swiss Development Agency (COSUDE) and the new European 
donor coordinator, made similar comments about the need for 
substantive reforms and a framework to ensure fiscal 
responsibility in the future or else the budget gap could 
grow larger in 2006 and 2007. 
 
COMMENT: 
 
¶8. (SBU) If the GON wants the IMF Board to review a revised 
program at its August meeting, they will need to reach a 
political agreement with the National Assembly on the 
substantive issues by early June.  The deadlock between the 
GON and National Assembly continues to impede an agreement on 
IMF requirements.  The budget reform measures are being held 
hostage to the standoff over the media taxation reforms.  If 
it were not for the politics, the issues would not be that 
difficult to solve, but political will is lacking to address 
some of the substantive reforms the IMF wants such as the 
financial administration law, fiscal responsibility law, and 
neutralizing municipal transfers.  The FSLN and the PLC 
continue to manipulate the negotiations to pressure the 
Executive to accept the National Assembly's constitutional 
reforms.  At this time, the IMF program is not officially 
"off track" but "dormant" in the words of Mario Alonso, 
Central Bank President.  In fact, Alonso commented to CDA on 
May 19 that Nicaragua remains in compliance with IMF targets. 
¶9. (SBU) Comment Cont.  The public statements from the 
European donors about the importance of the IMF agreement and 
fiscal responsibility in general are most welcomed and 
support the Mission's efforts to promote macroeconomic 
stability and government transparency.  Although Nicaragua's 
current macroeconomic situation is stable, the failure to 
reach an IMF agreement would have a negative impact on donor 
aid in the short term and a concomitant impact on the 
Nicaraguan budget in the long term.  On May 25, the National 
Assembly approved the General Mediation and Arbitration Law, 
which could be a positive indicator.  Meanwhile FSLN leader 
Daniel Ortega and his proxies have ratcheted up the political 
debate.  In a May 25 declaration Ortega accused the 
international financial institutions (IFIs) of doing little 
to solve Nicaragua's social problems over the past 15 years 
and said he would not give in to their pressure.  He blamed 
the IFIs for Nicaragua's energy crisis and said that 
structural reforms had actually worsened the economic 
situation for thousands of Nicaraguans who were forced to 
leave the country in search of jobs in Costa Rica and the 
U.S.  On May 26, hard-line Sandinista Omar Cabezas, National 
Human Rights Prosecutor, also took out a one-page paid 
advertisement denouncing CAFTA and the neoliberal economic 
policies of the 1990s as violations of human rights.  END 
COMMENT. 
 
BRENNAN