VZCZCXRO0953
RR RUEHLMC
DE RUEHMU #2524/01 3350037
ZNR UUUUU ZZH
R 010037Z DEC 07
FM AMEMBASSY MANAGUA
TO RUEHC/SECSTATE WASHDC 1739
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC

UNCLAS SECTION 01 OF 02 MANAGUA 002524 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR WHA/CEN, WHA/EPSC, AND EEB/IFD 
TREASURY FOR SARA GRAY 
USDA/FAS FOR BRIAN GRUNENFELDER, ONA; YVETTE WEDDERBURN, OCRA 
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN 
3134/ITA/USFCS/OIO/WH/MKESHISHIAN/BARTHUR 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EAGR PGOV NU
SUBJECT: NICARAGUA: 2007 INFLATION RATE MAY REACH 16.5% 
 
REF: A. MANAGUA 2368 
REF: B. MANAGUA 2516 
 
¶1. (U) Summary:  In the last four months, the GON has thrice revised 
its 2007 inflation estimate from the 7% target established in the 
recently approved Poverty Reduction and Growth Facility (PRGF) with 
the International Monetary Fund.  The Nicaraguan Central Bank's 
(BCN) latest estimate is 16.5%, higher than the 13.5% predicted by 
most private economists.  The increase in prices of basic 
commodities has had the greatest impact on poor and working class 
Nicaraguans.  One significant factor contributing to inflation has 
been the continuing rise in the international price of crude oil, 
but the government believes that the most important factor has been 
the weather.  Its solution, therefore, is to supplement the local 
supply of basic foodstuffs by opening the economy to cheaper imports 
of beans, wheat flour, oats, barley, noodles, pastas, and foods with 
a soybean base.  End Summary. 
 
Inflation Surges 
---------------- 
 
¶2. (SBU) In the last four months, the GON has thrice revised its 
2007 inflation estimate from the 7% target established in the 
recently approved Poverty Reduction and Growth Facility (PRGF) with 
the International Monetary Fund.  The first revision was in August, 
when the BCN announced that the rise in world oil prices would drive 
inflation to 9.5%; the second, on November 23, when the BCN 
announced a rate of 14.5%.  On November 28, only five days later, 
the BCN released an inflation estimate of 16.5%.  If this figure 
proves true, 2007 would have the second highest annual inflation 
rate since 1998, when oil prices were low but shortages caused by 
Hurricane Mitch produced 18.5% inflation. 
 
¶3. (SBU) BCN's latest inflation estimate is higher than the 13.5% 
predicted by most private economists.  According to Mario Arana, 
former BCN president and CEO of local economic think tank FUNIDES, 
BCN president Antenor Rosales announced a higher rate to "control 
expectations and cap the upward trend."  Arana feels that this 
strategy is ill-advised because producers and suppliers are likely 
to raise prices on the expectation that inflation will be higher. 
 
¶4. (U) The increase in prices of basic commodities has had the 
greatest impact on poor and working class Nicaraguans.  According to 
the Ministry of Labor, the last two months have shown a marked 
reduction in purchasing power.  The price of the market basket of 53 
basic consumer products, tracked by the BCN to measure consumer 
inflation, currently exceeds the monthly minimum wage.  The costs of 
transportation, communications, housing, education, food, and 
beverages have most contributed to price increases. 
 
Internal and External Factors 
----------------------------- 
 
¶5. (U) Both internal and external factors are responsible for the 
inflation spike.  One significant external factor has been the 
continuing rise in the international price of crude oil, now more 
than $90 a barrel.  More expensive oil not only affects the cost of 
shipping and transportation, but also the cost of power because 
Nicaragua generates 80% of its electricity by burning imported fuel 
oil and diesel.  This dependency means that the negative 
consequences of rising oil prices flow quickly and directly to all 
segments of the Nicaraguan economy. 
 
¶6. (U) The most important external factor has been the weather.  On 
September 4, Category 5 Hurricane Felix slammed into the north-east 
coast of Nicaragua, killing more than 130 persons and destroying 
440,000 hectares of tropical forest.  Felix was followed by low 
pressure weather systems hovering over the country for the next two 
months, producing sustained rainfall that flooded farmlands and 
destroyed homes, roads, and crops, including staples such as rice, 
beans, and corn.  Shortages of these basic grains have led to higher 
prices for bread, tortillas, and processed foods, as well as animal 
feed, thus increasing the cost of beef and poultry. 
 
¶7. (U) A significant internal factor contributing to inflation has 
been persistent and growing electricity shortages caused by rising 
demand, lack of investment in power generation, poor regulation, and 
periodic breakdowns of aging power plants.  Interruptions to the 
supply of power raise the cost of business throughout the country 
and reassign value chain incentives.  In particular, sales of 
refrigerated products have plummeted, as retail stores close out 
inventories of chilled and frozen products to avoid losses caused by 
daily power outages.  Many manufacturers are forced to run diesel or 
gasoline powered generators to avoid shutdowns and meet their 
production targets. 
 
¶8. (U) Another contributing internal factor has been BCN's decision 
in October to reduce the reserve requirement from 19.25% to 16.25%, 
injecting liquidity into the market.  BCN made the move because the 
growth in lending capacity and deposits had returned, signaling a 
recovery in borrower confidence to pre-2006 election levels (Ref A). 
 The increased liquidity, however, coming at a time of rising oil 
prices and commodity shortages, may have had the unintended 
consequence of contributing to inflation. 
 
GON Response 
------------ 
 
¶9. (U) The GON views the crisis as primarily weather related and 
thus temporary.  Its solution has been to supplement the local 
supply of basic foodstuffs by opening the economy to cheaper 
imports.  In the past two months, the Ministry of Trade and Industry 
(MIFIC) has eliminated tariffs for three months on beans and for six 
months on wheat flour, oats, barley, noodles, pastas, and foods with 
a soybean base.  Based on consultations with local producers, MIFIC 
is also considering temporarily removing tariffs on other products, 
such as rice and chicken, and extending the window on zero tariffs. 
The idea is that lower priced imports will keep local food prices 
down and discourage hoarding and speculation. 
 
¶10. (SBU) To date, very small amounts of food commodities have been 
imported under the zero tariff import scheme - only 245 metric tons 
(MT) of beans, 78 MT of which are from the U.S.  A MIFIC source 
relates that the GON has purchased beans from a local FSLN 
cooperative - the third local bean harvest having commenced - with 
the objective of selling them at below-market prices through the 
Citizen Power Councils (CPC), established by President Ortega to 
carry out his social and political agenda (Ref B).  A Taiwanese rice 
donation has reportedly also been sold through the CPCs. 
 
¶11. (U) The disconnect between rising inflation and the lack of 
adjustment to the cordoba's crawling peg is worth noting.  While 
inflation estimates have risen from 7 to 16.5 percentage points, the 
rate of depreciation of the Nicaraguan Cordoba against the U.S. 
dollar (set at a 5.5% annual rate) has not changed.  The increasing 
spread between Nicaraguan and U.S. inflation (16.5% vs. 3.3%) 
suggests that the cordoba may now be overvalued, making Nicaragua a 
more expensive place to do business. 
 
TRIVELLI