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

C O N F I D E N T I A L SECTION 01 OF 04 MANAGUA 001867 
 
SIPDIS 
 
DEPARTMENT WHA/CEN AND WHA/EPSC 
DEPARTMENT PASS USTR, OPIC AND EX-IM BANK 
 
E.O. 12958: DECL: 06/20/2015 
TAGS: ECON EFIN NU IMF
SUBJECT: NICARAGUAN IMF PROGRAM ON THE ROPES 
 
REF: A. MANAGUA 1604 
     ¶B. MANAGUA 1770 
 
Classified By: CDA Peter M. Brennan.  Reasons 1.4 (b and d) 
 
¶1. (C) SUMMARY.  On May 31, President Bolanos broke the 
two-month standoff over fiscal reform legislation intended to 
close the spending gap created by the National Assembly's 
2005 budget.  He yielded to the Assembly's refusal to accept 
or override his partial veto and sent the measure for 
publication with a controversial media taxation provision 
included.  However, this step is not sufficient to revive 
Nicaragua's dormant IMF program.  Pressure from the 
international donor community over the past month has failed 
to force the Executive and the National Assembly to overcome 
their political differences and reach an agreement on the 
pending package of structural reforms (ref A).  Assessing the 
current situation, the IMF Resrep stated that, even though 
the political actors all agree on the structural reform 
agenda, it is almost impossible to revive the program due to 
politically motivated procrastination.  He added, the program 
will be left to die of natural causes.  GON officials plan to 
travel to Washington the week of June 20 to meet with the IMF 
and request an extension or a new framework for negotiations. 
 At the technical level, it seems unlikely that the IMF will 
be lenient with Nicaragua.  Even if an eleventh hour 
agreement were to be reached, recent legislative actions 
regarding social security and pension reform and pending 
subsidies for transportation and electricity have further 
complicated the budget situation and raised IMF concerns 
about spending and deficits.  As reported in ref B, the 
macroeconomic situation is generally stable despite the 
uncertainty regarding the IMF and general political 
instability; however, the prospects for continued medium-term 
economic growth without an IMF program are uncertain. 
Unfortunately, the IMF program has become yet another hostage 
in the battle between the PLC-FSLN forces in the National 
Assembly and the Executive.  END SUMMARY. 
 
IMF RESREP: TOO LATE FOR NICARAGUA TO SALVAGE A PROGRAM 
--------------------------------------------- ---------- 
 
¶2. (C)  On June 10, econoffs met with Humberto Arbulu 
(protect), IMF Resrep, to discuss the prospects of reaching 
an agreement at the upcoming IMF Board meeting in August. 
Arbulu responded that, at this late date, it would be 
"impossible" for Nicaragua to be considered at the meeting. 
When questioned about the delays in reaching a consensus on 
the IMF package of budget and structural reforms, he replied 
that Pacto politics, not consensus on technical issues, was 
responsible for program delays.  Arbulu added that in his 
experience he had never been in a country where all the 
political actors generally agreed on the IMF structural 
reforms.  He added that even the Sandinista economic team 
understood the importance of the IMF, but they misunderstood 
the Fund's limited flexibility.  He asked, "why not go 
forward if everyone agrees."  Arbulu pointed out that 
Nicaragua has caused considerable debate within the IMF due 
to a history of program procrastination and that the IMF was 
frustrated with the idiosyncrasies of Nicaraguan politics. 
 
¶3. (C) Arbulu informed econoffs that Finance Minister Mario 
Arana and Central Bank President Mario Alonso planned to 
travel to Washington the week of June 20 to meet with the IMF 
staff and request an extension.  He acknowledged that the IMF 
rarely speaks in blunt terms and that the consultations with 
the IMF provide the GON some political cover; however, he 
said the IMF understanding was clear - you either have a 
program or you do not.  Arbulu said that Arana will attempt 
to persuade the IMF by citing short term positive indicators. 
 First, the GON will argue that the current macroeconomic 
situation is generally acceptable, with the exception of 
inflation, which Arbulu projected will reach 9.1 percent. 
According to Alonso, Nicaragua is not "off-track" on its 
indicators and even Arbulu agreed that "notionally" Nicaragua 
is on track.  However, Arbulu discounted the impact of this 
argument because the Nicaraguan first quarter is usually good 
due to low levels of public spending.  He acknowledged growth 
in the construction sector, increases in agricultural 
exports, and improved tax revenue collection as positive 
indicators, but he said the economy would deviate excessively 
from the IMF indicators over time. 
 
¶4. (C) Arbulu believes that Arana's second card will be 
approval of the budget reform and progress on the new tax 
code.  He said the reaction in Washington will be pressure to 
schedule an Article IV consultation in order to gauge the 
state of the economy and provide a projection for the next 
two years.  He added that the IMF is pushing to schedule the 
consultation for this fall to present to the Board in 
mid-December, along with the seventh, eighth and ninth 
program reviews, which have been pending since June of last 
year.  Arana may also cite the political-constitutional 
battle between the Executive and the National Assembly, which 
has impeded movement on the approval of structural reforms. 
Arbulu felt that the GON would be criticized for not going 
forward with the reform package almost three months ago after 
an agreement with the IMF had been reached.  Special 
Assistant to Finance Minister Luis Alejandro Matus told 
Econoff on June 20, that the Minister had attempted to use 
the preceding three months, since negotiating a reform 
package with the IMF, to push for consensus with the National 
Assembly.  Matus concluded that the Deputies had no interest 
in consensus with the Executive branch, but was unclear as to 
why the consensus option was ever considered realistic.  He 
added that other issues, including the violent transportation 
protests and the energy crisis, had intervened and deflected 
attention away from the IMF program. 
 
¶5.  (C) Arbulu was clear that the Executive's basic budget 
and structural reform were important building blocks for 
keeping the IMF program current; however, reforms pending in 
the National Assembly, which threaten spending and deficit 
limits, were also of concern to the IMF.  He specifically 
mentioned the proposed state-sponsored development bank 
("Banco de Fomento"), social security and pension reform 
measures, and government subsidies for urban transport and 
electricity.  Finance Ministry cost estimates for the reform 
measures, excluding the Banco de Fomento, add an additional 
USD 70 million to the budget in 2005. However, it is not 
known if the administration's gambit to combine budget 
allocations from several existing programs will be sufficient 
politically and financially to fund the proposed development 
bank.  Further, the USD 70 million figure will increase 
substantially in the out years for some reform categories. 
For example, costs associated with new social security 
benefits will increase incrementally over the next five 
years, until they almost double from the 2005 estimate of USD 
37 million, for a five-year total of USD 277 million. 
 
¶6. (C) At the conclusion of the meeting, econoffs asked 
Arbulu to clarify what was at stake immediately for Nicaragua 
if the GON failed to reach an agreement with the IMF.  He 
said that to date Nicaragua had lost USD 28 million in funds 
destined for international reserves from the IMF, and that 
other funds for budget support and development were 
threatened.  He estimated the total package at USD 110 
million, including budget support.  Based on the IMF's 
experience in other Central American countries, Arbulu 
guessed that around 50 percent of these funds would be 
converted into project lending by European donors and others 
if Nicaragua failed to reach an agreement with the IMF. 
 
¶7. (C) On the subject of donor aid, econoffs and Arbulu 
discussed Nicaragua's participation in the Millennium 
Challenge Account.  Arbulu stated that the MCC accounting 
procedures run afoul of the general IMF preference that each 
country manage all its donations "on the books."  However, he 
understood the USG need to manage its bilateral assistance 
off-budget and agreed that running the MCC donation through 
the budget would reduce the contribution through troublesome 
earmarks like the constitutionally mandated and violently 
defended 6 percent for universities.  (Note: In an 
interesting side comment, Arbulu quoted a World Bank study 
which found that not one student from the lowest 
socioeconomic quartile benefited from the scholarships funded 
by the 6 percent earmark for universities.  End Note.) 
 
THE EXECUTIVE RESPONDS: LAYS THE BLAME ON PACTO FORCES 
--------------------------------------------- --------- 
 
¶8.  (SBU) On June 14, Finance Minister Mario Arana used his 
monthly economic update press conference to address the IMF 
issue and lay blame for a lack of progress firmly upon the 
National Assembly.  He said the IMF negotiations had become 
another pressure point for the Pacto forces in the National 
Assembly to force the Executive to accept the constitutional 
reforms.  Arana admitted that "it was almost impossible" to 
have a program ready to present to the IMF Board meeting in 
August.  Arana announced that the Executive was sending the 
structural reform package laws to the National Assembly for 
their approval.  He stated clearly that these laws had been 
consulted with the IMF as part of the country program 
negotiations; however, conversations with the National 
Assembly's Economic Commission had broken off over almost 
three months ago. 
 
¶9. (SBU) Arana did not explain why the Executive had not sent 
the legislation to the National Assembly sooner and, oddly 
enough, this issue was not raised by the press.  Arana was 
clear that the reform package was the minimum necessary to 
move forward with the IMF program.  He said other challenges 
such as the social security and pension reforms, subsidies 
for transportation and electricity, pending debts with 
electricity distributor Union Fenosa, and the Development 
Bank threatened to take Nicaragua "off-track" and the IMF 
would want an explanation of their impact on the budget. 
Central Bank President Mario Alonso indicated that Nicaragua 
was in compliance with the structural indicators established 
by the IMF program.  Arana and Alonso announced that they 
would travel to Washington the week of June 20 to evaluate a 
new strategy with the IMF and discuss the recent G-8 debt 
forgiveness announcement. On June 21, Finance Ministry 
officials reported to Econoff that Arana and Alonso have 
tentative plans to travel to Washington on June 23 and 24. 
 
¶10. (SBU) After introductory remarks by Arana and Alonso, 
President Bolanos joined the press conference and signed the 
transmittal letter sending the reform package to the National 
Assembly.  The pending structural reforms include a tax and 
budget reform plan that guarantees a 3.2 percent deficit. 
Bolanos recalled that Nicaragua has lost its IMF program on 
three previous occasions, after which the economy had 
experienced a serious decline in growth.  Bolanos stated that 
the IMF program provides Nicaragua a strong framework for 
future macroeconomic growth and stability, without which, the 
economy will experience backsliding.  Arana added that the 
IMF program was essential for future growth, employment and 
development, and that the Bolanos administration wanted to 
leave office with an IMF program in place to ensure future 
economic stability and leave a positive legacy. 
 
THE NATIONAL ASSEMBLY RESPONDS 
------------------------------ 
 
¶11. (SBU)  In a meeting with international donor missions on 
June 18, FSLN Deputy Bayardo Arce, President of the National 
Assembly's Economic Commission, stated that, although the 
National Assembly agrees with the need to approve an IMF 
reform package, the legislation sent by the Executive on June 
14 lacked sufficient consultation and thus the Committee had 
determined that they could not be treated as urgent. (Note: 
Under the rules of the National Assembly, an urgent piece of 
legislation is sent directly to the Chair for scheduling and 
a floor vote without Committee hearings.  End Note.)  Arce 
added that the financial sector reforms did not include 
possible comments from the Association of Private Banks, 
although he did not mention which areas could be of concern 
to the banking industry.  Furthermore, Arce stated that 
several members of the Economic Committee would travel to 
Spain on an exchange program June 19 and would deal with the 
issue upon their return.  PLC Deputy Wilfredo Navarro, a 
member of the Economic Committee, said that the National 
Assembly would approve the laws, but they needed to hold 
consultations with the affected sectors because the Executive 
had failed to do so.  Navarro added that neither the PLC nor 
the FSLN wanted to inherit a country in institutional 
shambles; however, he redefined "consensus" in a novel 
fashion, by suggesting that consensus follows the will of the 
majority if all parties are not in agreement. 
 
DONOR RESPONSE AND RESPONSIBILITY 
--------------------------------- 
 
¶12. (C) Local Budget Support Group Coordinator and Swiss 
development official Jurg Benz (protect) confided in econoffs 
on June 14 that seven of nine donors that provide the GON 
budget support would likely freeze such support if the IMF 
program falters.  He believed that the British DFID and one 
of the Nordic countries are prone to a softer approach.  Benz 
added that for most of the other donors, budget support money 
will not be converted to project support, claiming that a 
general climate of scarce development resources fueled a 
responsibility among most donors to contribute to the 
significant budget needs of other countries rather than 
reward bad behavior in Nicaragua by converting budget to 
project support.  Benz also placed the Central Bank's 
macroeconomic analysis in a harsh light by stating that 
Nicaragua is doing well relative to its historically poor 
performance, but compared to the rest of the region is 
remains very weak.  Reviewing the recent track record on 
budget support, Benz reminded econoffs that only the European 
Commission had released budget support in the last year, to 
the tune of 30 million Euros.  All other multilateral and 
bilateral sources remain frozen.  Benz admitted that he was 
mystified by the Finance Minister's three-month delay on 
moving the reform package to the National Assembly, guessing 
that perhaps Arana believed that a build-up of international 
and domestic political pressure would help the package sail 
through the legislature. 
 
COMMENT 
------- 
 
¶13. (C) The Nicaraguan economy remained somewhat isolated 
from the growing political instability throughout 2004 and 
recorded moderate economic growth of 5.1 percent.  Rising oil 
prices had a significant impact on inflation, which jumped 
from 6.48 percent in 2003 to 9.26 percent in 2004.  While 
continued economic growth in the medium-term seems doubtful 
without an IMF program, indications are that the political 
instability has already had a short-term negative impact on 
direct foreign investment in Nicaragua.  Even with the 
possible loss of direct budget support hanging in the 
balance, European donors were unable to influence the 
political actors and shape a positive outcome.  It seems that 
donor threats to pull budget support rang hollow, however 
serious they might be.  Even the IMF Resrep painted a rosier 
picture on the possible conversion from budget to project 
support than some donors seem willing to swallow. 
Nicaragua's history with the IMF has demonstrated the 
benefits of the program to the country's macroeconomic 
situation.  On three occasions since 1990, Nicaragua has 
dropped an IMF program with disastrous consequences for the 
economy.  The political procrastination over the IMF reform 
package demonstrates the extent to which the Executive, the 
PLC and the FSLN will push political brinksmanship even with 
Nicaragua's economic development on the line.  END COMMENT. 
BRENNAN