VZCZCXRO9991
RR RUEHLMC
DE RUEHMU #1771/01 2041447
ZNY CCCCC ZZH
R 231447Z JUL 07
FM AMEMBASSY MANAGUA
TO RUEHC/SECSTATE WASHDC 0851
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEHCV/AMEMBASSY CARACAS 1124
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHDC
RHEHNSC/NSC WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 04 MANAGUA 001771 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR WHA/CEN, WHA/AND, WHA/EPSC, AND EEB/OMA 
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN 
3134/ITA/USFCS/OIO/WH/MKESHISHIAN/BARTHUR 
 
E.O. 12958: DECL: 07/21/2017 
TAGS: ECON EFIN ENRG EPET PGOV PREL NU
SUBJECT: NICARAGUA AND THE IMF HAVE A PRGF AGREEMENT 
 
REF: A. MANAGUA 1672 
 
     ¶B. MANAGUA 1180 
     ¶C. MANAGUA 639 
     ¶D. MANAGUA 640 
 
Classified By: Ambassador Paul Trivelli, for reasons 1.4 b&d. 
 
¶1. (C) Summary: The IMF and GON have almost completed a 
three-year Poverty Reduction Growth Facility (PRGF) 
agreement.  After finalization of some budgetary numbers, the 
PRGF will go before the IMF Board in October.  Characterizing 
the agreement as "plain vanilla," IMF ResRep Humberto Arbulu 
Neira stated it has no special or unusual components.  The 
fiscal targets all follow the patterns established by the 
last PRGF (concluded December 2006.)  The main structural 
issues include energy, capital spending controls, tax 
administration, pensions, and decentralization.  The major 
hurdle throughout the negotiation, accounting for Venezuelan 
assistance and debt, may have become a non-issue when the 
ALBA oil deal was revised as a simple commercial credit 
program.  Given the lack of any other coherent economic 
program from the Sandinistas, donors considered the agreement 
essential for releasing more funds to Nicaragua.  Whether 
this program is completed will depend on the GON economic 
team's ability to balance the PRGF terms with Ortega's 
rhetoric of "battling global capitalism, led by the Yankee 
imperialists."  End Summary. 
 
The Agreement 
------------- 

¶2. (SBU) On July 9, after two weeks of intensive 
negotiations, the IMF and GON had almost completed a 
three-year Poverty Reduction Growth Facility (PRGF) 
agreement.  A short meeting in DC the week of July 23 will 
finalize budgetary numbers and the PRGF will go before the 
IMF Board in October.  Characterizing the agreement as "plain 
vanilla," IMF ResRep Humberto Arbulu Neira stated it has no 
special or unusual components.  The PRGF contains specific 
targets for 2007 and projected targets for 2008 and 2009. 
Actual targets will be negotiated at the beginning of each 
year.  The IMF will review Nicaraguan progress every six 
months.  Stemming from this agreement, Nicaragua will receive 
between USD 80-90 million in disbursements over three years 
(an equivalent of 45% of Nicaragua's quota in the IMF.) 
 
The Macroeconomic Indicators 
---------------------------- 

¶3. (SBU) The major macroeconomic targets include: 
 
                               2007   2008   2009 
-- Real GDP Growth             4.2%   4.5%   5% 
-- Inflation                   7.5%   7%     7% 
-- Deficit (as % of GDP)       1%     1.8%   1% 
-- Increase in reserves (USD)  60M    70M    80M 
-- Exchange rate (crawling peg) 5%    5%     5% 
(Note: Nicaraguan GDP for 2007 will be about USD 5 billion. 
End note.) 
 
¶4. (C) Arbulu believes the targets for GDP growth and 
inflation for 2007 will not be met.  He feels the 4.2% growth 
rate is optimistic given the flat growth rate of 3% measured 
by the Major Economic Activity Index (IMAE), the slow GON 
capital spending, and the continuing lack of an economic plan 
by the Sandinista government.  Since the June accumulated 
annual inflation was 6% due to high oil prices, inflation for 
2007 will be closer to 9%.  Arbulu believes the deficit 
target will be easily reached, given that tax revenues are 
already higher than budgeted.  Contrary to local press 
reports, IMF-GON differences over net international reserves 
were easily resolved, according to Arbulu.  The IMF convinced 
the GON to tie reserves to imports and not the M2 monetary 
base.  (Note: Nicaragua has already met its 2007 reserve 
target. End note.)  Both sides agreed that, even with the 
increases, reserve rates are not high enough to support 
Nicaragua abandoning its crawling peg exchange rate for a 
free float. 
 
¶5. (SBU) Differing from past years, the IMF required the GON 
to include the full costs and funding sources for its poverty 
reduction programs.  Given President Ortega's habit of 
announcing large-scale social programs with no clear source 
of financing, the IMF felt it was prudent to commit the GON 
to clear numbers for its eight major poverty reduction 
programs (all based on Millennium Development Goals- MDG). 
Usually, financing sources for such programs are the purview 
of the government, not the IMF. 
 
Social Indicators 
----------------- 

¶6. (SBU) The GON will include social indicators in its 
Memorandum of Intent.  Originally, the GON's wanted these 
indicators to replace the PRGF's macroeconomic indicators as 
targets.  According to Central Bank (BCN) General Manager 
Jose de Jesus Rojas, the GON will publish yearly 
results/advances for their chosen targets.  Matching MDG 
goals, the major indicators will be: 
 
                                 2007   2008   2009 
-- Primary education reg.        85.1%  87.6%  90.1% 
-- Illiteracy rate               18.5%  14%    10% 
-- Maternal mortality            96     94     90 
      (Per 100,000 live births) 
-- Access to potable water       65%    70%    78% 
(% of total population) 
 
The Structural Agenda 
--------------------- 

¶7. (SBU) The main structural issues in the PRGF include 
energy, capital spending control, tax administration, 
pensions, and decentralization.  None of the structural 
targets from the previous PRGF were carried over (pension 
reform, energy regulation reform, etc.)  The primary focus of 
the energy target will be the high loss level in the system 
(almost 30%), caused principally by theft.  Commitments 
include a law penalizing electricity theft and fraud, an 
audit of the electrical system to determine sources of 
technical losses, and a plan to increase coverage in poor and 
rural areas, thereby reducing theft and improving service. 
(Note: This program is modeled on a successful Colombian 
program and will receive IDB technical assistance. End note.) 
 As part of these commitments, the GON will revisit the 
current 100% subsidy for users of less than 150KW per month 
(about 60% of users.)  The GON also agreed to publish the 
formula for calculating the automatic tariff increases, and 
will announce the scheduled increases throughout this year, 
increasing transparency in the system.  (Note: The National 
Assembly has frozen electricity tariffs for one year.  The 
GON has committed to raising tariffs to the scheduled level 
when the freeze ends in the summer of 2008. End note) 
 
¶8. (C) The IMF was particularly concerned over the low levels 
of capital spending by the Sandinista government and 
dedicated a significant portion of the last round of 
negotiations to the issue, according to BCN GM Rojas.  The 
GON requested that the PRGF allow them to take advantage of 
the increased inflows of concessional rate funds for 
infrastructure projects in energy and water.  The PRGF 
objective is to increase capital expenditures from 5.1% of 
GDP to 7.4% (from USD 225 million to 370 million).  The PRGF 
allows the GON to create a state-owned development bank 
(Banco de Fomento) which could become involved in some of 
these capital projects.  Both Rojas and Arbulu expressed 
concern about the GON's ability to meet these markers and the 
economy's capacity to absorb these funds.  They also believe 
that the increased spending may not result in quality 
projects.  Complicating the issue, according to Arbulu, 
Nicaraguan capital accounts are heavy on salaries as a result 
of a transfer from the current account to meet the last 
PRGF's savings target.  The IMF has promised technical 
assistance to help the GON figure out how to reverse this 
action. 
 
¶9. (SBU) The PRGF, endorsing current improvements in tax 
policy and administration, focuses on improving the 
accounting and budgeting process for state revenues.  For the 
last three years, as a result of technical assistance 
programs such as U.S. Treasury's OTA program, the General 
Office of Taxes (DGI) has collected 0.5% of GDP more than 
allotted in the budget (in 2007 it will be 0.6% - USD 30 
million.)  The PRGF requires the GON prioritize projects so 
additional funding will be assigned according to state needs. 
 Clear guidelines for programming and spending are a key 
component of this section of the PRGF. 
 
¶10. (SBU) Decentralization will be on the back burner until 
2009 as the GON refused to contemplate changes to the system 
until after the November 2008 municipal elections. 
Currently, the municipalities receive 6% of the budget 
(increasing 1% a year for the next four years).  In exchange 
the municipalities are expected to administer local schools, 
water, health, and social security services.  So far, the 
municipalities receive the money but have not taken on the 
additional responsibilities, claiming they need new 
infrastructure to do so.  As a result the central government 
provides these social services from its own budget and the 
mayors do not have to account for how they spend their 6%. 
The PRGF contemplates a 2008 law mandating the municipalities 
take on the social services in exchange for their 6%.  In 
2007 and 2008, the GON must cut spending in other parts of 
the budget to offset the mandated 1% increase to 
municipalities. 
 
¶11. (SBU) Due to the large divergence between IMF and GON 
estimates on the viability of Nicaragua's pension system 
(INSS), both sides agreed to step back from pension reform at 
this time.  Instead the PRGF calls for a new actuarial 
analysis of INSS, so that future discussions center on the 
same numbers.  The PRGF also requires a phase out of a law, 
currently on legislative hold, which increases INSS benefits. 
 These additional benefits, both sides agreed, would bankrupt 
INSS in five years. 
 
Where is the Venezuelan Assistance? 
----------------------------------- 

¶12. (C) The major hurdle throughout the negotiation has been 
accounting for Venezuelan assistance.  The IMF was 
particularly concerned with the potential revenues and debt 
accumulated through the Bolivarian Alternative for the 
Americas (ALBA) oil deal (reftels).  Ortega has been 
consistence in his calls to keep the assistance off-budget 
and out of the public spending accounting system.  (Note: In 
response to GON statements during the negotiations that MCC 
assistance is off-budget, the IMF responded that they would 
be pleased to have the Venezuelan assistance contain all of 
the transparency and public spending reporting requirements 
contained in the MCC-GON agreement. End note.) 
 
¶13. (C) According to Arbulu, even though the PRGF now 
requires three operational and financial reports a year from 
Petronic, the oil debt with Venezuela may become a non-issue 
as the deal has been completely revamped, again.  (Note: This 
would be the fourth iteration of the deal since the original 
signing on January 11. End note.)  The GON told the IMF that 
the deal had been converted to a straight commercial credit 
program, with no long-term debt accrual.  According to 
Arbulu, Venezuela will sell petroleum products (not crude) to 
Nicaragua (through state oil company Petronic) at market 
rates, and provide a 90-day market credit.  These new terms 
are to be singed during the upcoming ALBA meeting in Cuba. 
The IMF is requiring a finalized agreement before the PRGF 
can go to the IMF Board. 
 
¶14. (C) The GON also informed the IMF that during the Havana 
meeting they will sign the charter creating the ALBA Fund 
Bank, which will finance projects in all its member 
countries.  Details on the Bank, how it will be funded (from 
some of the money from the oil payments?) and how this money 
will be distributed to the different ALBA countries, are not 
clear at this time.  According to Arbulu, the GON confirmed 
that funds from the ALBA Bank will follow all of the standard 
transparency regulations and any loans will be approved by 
the National Assembly, per Nicaraguan budgetary 
administration laws.  The amount of funds involved, and the 
ability of the Nicaraguan economy to absorb then, is an issue 
the IMF will continue to explore as the PRGF progresses. 
Currently, the PRGF allows for Venezuelan assistance amounts 
equivalent to around 2% of GDP (about USD 100 million) to be 
used for infrastructure projects.  (Note: Some sources 
indicate that this may actually be an allowance for the 
deficit to go up to 2% of GDP in order to finance the 
Nicaraguan portion of the new Venezuelan refinery.  End note.) 
 
¶15. (C) BCN President and lead GON negotiator Antenor Rosales 
has evaded press questions on accounting for Venezuelan 
assistance by saying that the issue was clarified in past 
negotiation sessions; adding that "the IMF did not succeed in 
getting Petronic to be part of the National Budget."  He has 
not publicly revealed the changes in the terms of the oil 
deal, claiming instead that the assistance is a non-issue 
because existing laws provide for transparency on the funds. 
 
 
Comment 
------- 

¶16. (C) While it is true that this is a bare-bones PRGF, it 
provides much needed assurances for macroeconomic stability. 
Given the lack of any other coherent economic program from 
the Sandinistas, donors have long considered the agreement 
essential for providing the assurances necessary to release 
additional funds to Nicaragua.  This release of funds is 
important for the GON economic team, according to Arbulu, 
because they have realized that Venezuela is not the cash cow 
Chavez had painted it to be.  Whether this program is 
completed will depend on the GON economic team's ability to 
balance the PRGF terms with Ortega's rhetoric of "battling 
global capitalism, led by the Yankee imperialists."  End 
Comment. 
TRIVELLI