Idb - Country Strategy With Nicaragua

8/22/2019 Idb - Country Strategy With Nicaragua

1/48

DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANK

NICARAGUA

IDB COUNTRY STRATEGY

This document was prepared by: Manuel Agosn (RE2/RE2), Eduardo Balcrcel (COF/CNI),

Hugo Betancor (RE2/SC2), Nancy Jesurun-Clements (RE2/EN2), Carlos Miranda (RE2/SO2),Stefan Queck (RE2/FI2), Charles Richter (RE2/OD3), BCS Team Leader, and Luis Zavaleta(RE2/OD3). Inputs were provided by: Ladislao Brachowicz (RE2/OD3), Sobeida Castillo(COF/CNI), Caroline Clarke (RE2/EN2), Luis Echebarra (SDS/SGC), Juan Manuel Fernndez(RE2/SO2), Lorena Mejicanos (MIF), Jorge Requena (RE2/OD3), Nadia Scharen-Guivel (PRI),Ennio Rodrguez (INT/ITD), Alejandra Vallejo (IIC) and Mariana Wettstein (RE2/OD3). SaraBojorge-Sanz assisted in producing the document.


2/48

TABLE OF CONTENTSIntroduction................................................................................................................................ iExecutive Summary................................................................................................................. iiiBank Country Strategy Matrix ................................................................................................v

I. MAIN CHALLENGES FOR DEVELOPMENT ............................................................................1

A. EVOLUTION OF THE ECONOMY............................................................................ 1B. THE THREE CHALLENGES .................................................................................... 2

1. Economic growth ..................................................................................... 22. Governance............................................................................................... 53. Productivity of the very poor..................................................................... 6

C. POVERTY REDUCTION AND SUSTAINABLE DEVELOPMENT................................... 61. Poverty reduction ..................................................................................... 62. Sustainable development............................................................................ 8

D. MACROECONOMIC PROSPECTS............................................................................ 9

E. RESPONSE TO THE CHALLENGES ....................................................................... 10II. EVALUATION OF THE STRATEGY AND THE PORTFOLIO....................................................11

A. GENERAL CONSIDERATIONS ............................................................................. 11B. DEVELOPMENT OF THE STRATEGY 1996-2001.................................................. 12C. DEVELOPMENT OF THE BANKS PORTFOLIO, 1996-2001 ..................................13D. LESSONS LEARNED FOR FUTURE STRATEGY FORMULATION .............................. 14

III. STRATEGY, OBJECTIVES AND THE AGENDA FOR THE BANKS DIALOGUE WITH THECOUNTRY ..........................................................................................................................16

A. THE LENDING PROGRAM ................................................................................... 171. Strategic approach 1: Economic growth ................................................... 18

2. Strategic approach 2: Governance.......................................................... 223. Strategic approach 3: Productivity of the very poor............................... 25

B. THE BANKS INSTITUTIONAL STRATEGY........................................................... 26C. RISKS IN IMPLEMENTING THE STRATEGY .......................................................... 26D. PROGRAM PERFORMANCE INDICATORS............................................................. 27

ANNEXES

Annex I Summary of the Banks lending programAnnex II Work program for the country and the sectorsAnnex III Debt sustainability indicatorsAnnex IV Actions under way financed by the government, other agencies and

the IDBAnnex V References


3/48

-ii-

LIST OF ABBREVIATIONS

BCN Banco Central de Nicaragua [Central Bank of Nicaragua]BCS Bank country strategy

BPI Bono de pago por indemnizacin [compensation payment bond]CABEI Central American Bank for Economic IntegrationCACM Central American Common MarketCAFTA Central America Free Trade AgreementCENIS Certificados Negociables de Inversiones [negotiable investment

certificates]CFAA Country Financial Accountability AnalysisCGR Contralora General de la Repblica [Office of the Comptroller

General]CIDA Canadian International Development AgencyCONPES Consejo Nacional de Planificacin Econmica y Social [National

Economic and Social Planning Council]CPE Country Program EvaluationDANIDA Danish International Development AgencyDFID Department for International Development, United KingdomEC European CommissionEU European UnionFINDE Fondo del Instituto Nicaragense de Desarrollo [Nicaraguan

Development Administration Fund]FISE Fondo de Inversin Social de Emergencia [Social Emergency

Investment Fund]FTAA Free Trade Area of the American

GTZ Deutsche Gesellschaft fr Technische Zusammenarbeit (Germantechnical-cooperation agency)HIPC Heavily Indebted Poor CountriesIMF International Monetary FundINIFOM Instituto Nicaragense de Fomento Municipal [Nicaraguan

Municipal Development Administration]INSS Instituto Nicaragense de Seguridad Social [Nicaraguan Social

Security Administration]KFW Kredinstalt fr Wiederaufbau (German reconstruction bank)MARENA Ministerio del Ambiente y Recursos Naturales [Ministry of the

Environment and Natural Resources]MDG Millennium Development GoalMIFIC Ministerio de Fomento, Industria y Comercio [Ministry of

Development, Industry and Trade]NDF Nordic Development FundOPEC Organization of Petroleum Exporting CountriesPAHO Pan American Health OrganizationPAIS Project Alert Identification SystemPBL Policy-based loanPES Programa de Empresariado Social [social entrepreneurial program]


4/48

-iii-

PLC Partido Liberal Constitucionalista [Constitutional Liberal Party]POSAF Programa Socioambiental y de Desarrollo Forestal

[Socioenvironmental and Forest Development Program]PPP Puebla-Panama PlanPRGF Poverty Reduction and Growth Facility

PRI Private Sector Department (IDB)PSAC Programmatic Structural Adjustment CreditRAAN Regin Autnoma del Atlntico Norte [Autonomous North Atlantic

Region]RAAS Regin Autnoma del Atlntico Sur [Autonomous South Atlantic

Region]SDC Swiss Development CorporationSETEC Secretara Tcnica de la Presidencia [Technical Secretariat of the

Office of the President]SGPRS Strengthened Growth and Poverty Reduction StrategySIDA Swedish International Development Cooperation Agency

SIEPAC Sistema de Interconexin Elctrica de los Pases de Amrica Central[Central American Electric Interconnection System]

SILAIS Sistema Local de Asistencia Integral de Salud [Local ComprehensiveHealth Care System]

SIN Sistema de Interconexin Nacional [national interconnected system]SMP Staff Monitored ProgramTC Technical-cooperation programUNICEF United Nations Childrens FundUNPF United Nations Population FundURACCAN Universidad de las Regiones Autonomas de la Costa del Caribe de

Nicaragua [University of the Autonomous Regions of the Caribbean

Coast of Nicaragua]USAID United States Agency for International DevelopmentWB World BankWTO World Trade Organization


5/48

-i-

INTRODUCTION

Based on different economic, social andinstitutional studies and on the IDBsexperience in Nicaragua, this BankCountry Strategy (BCS) identifies the main

challenges that need to be tackled to reducepoverty and achieve socioeconomicdevelopment in the country. It alsoanalyzes the previous Bank strategy forNicaragua and, to draw on the lessonslearned and respond effectively to thechallenges, it proposes a new strategy andlending program.

This introduction summarizes some of themost important political, social andeconomic events for developing the BCS.

With respect to the political context, inJanuary 2002 the new government ofPresident Enrique Bolaos of theConstitutionalist Liberal Party (PLC) tookoffice.

One of the new administrations toppriorities is to comply with theMillennium Development Goals includedin the strengthened growth and povertyreduction strategy (SGPRS) which wascompleted in July 2001 and prepared bythe country itself and which, in turn, formsthe framework for the Banks strategicguidelines described in this BCS.

As a complement to the SGPRS, the newadministration has pointed out theimportance of prioritizing the allocation ofscarce resources for productive and socialactivities to geographic clusters with highpotential for contributing sustainably to joband income creation. As the clusters areidentified, the geographic areas where theyare located could be given priority forinvestments financed by the Bank.

The Heavily Indebted Poor Countries(HIPC) Initiative is also an importantprocess for the Banks relations with thecountry, since it reduces external debt to asustainable level and involves a substantialcontribution by the IDB. The Bank

approved internal debt alleviation forNicaragua in November 2001 andproceeded to retroactively return the debtservice paid since January 2001.

Other events and processes that have beenfundamental for preparing the BCSinclude: the consultative groups, theportfolio review in May 2002, the PolicyDialogue Paper and the consultationmeeting organized to discuss the paper on25 January 2002, which opened thedialogue with the new authorities. Themeeting consisted of presentations by thegovernment and the Bank on the mainchallenges faced by the new

administration. The government stressedthe need to strengthen the SGPRS pillar foreconomic growth and underlined theurgency of boosting the countryscompetitiveness.

Consultations were held on the content ofthe BCS with the Governor for Nicaraguain Washington on 13 June 2002; theMinister and Technical Secretary of theOffice of the President on 18 June 2002 inManagua; and with the Economic Cabinetin Managua on 24 September 2002.Perhaps the main message from thoseconsultations is the high priority attachedby the government to economic growth andthe sustainability of social spendingthrough the development of clusters ofsustainable activities with high economicimpact. The authorities suggested that theBank hold consultations on the BCS withcivil society through the NationalEconomic and Social Planning Council(CONPES), which took place on 23

September 2002.

This BCS has been enriched bycomments and suggestions made atmeetings with the World Bank and theIMF in Washington (10 May 2002), theinternational community in Managua(19 June 2002 and 25 September 2002)


6/48

-ii-

and at a meeting on the World Banksstrategy (9 July 2002).

Last, there are a significant number ofbilateral and multilateral institutions inNicaragua that support the country in itsefforts to spur development and reducepoverty. Accordingly, it is very importantfor the BCS to consider these interests,seeking to generate synergies, whileavoiding unnecessary duplications in

programs and ensuring coordination intheir execution. To that end, when theBCS was being prepared, the IDBmaintained a series of formal andinformal exchanges with the IMF, theWorld Bank, DFID, the European

Community, USAID and otherinstitutions. The Bank intends tomaintain these exchanges.


7/48

-iii-

EXECUTIVE SUMMARY

This Bank country strategy (BCS) identifies three main challenges for poverty reduction inNicaragua: (i) economic growth; (ii) governance; and (iii) the productivity of the verypoor. In addition to these challenges, the previous strategy exercise revealed that: (i) it isimportant for the Bank to continually monitor transparency and corruption; and (ii) the

limitations on FSO funds make it necessary for Bank interventions to be focused and tohave indicators so that the results can be evaluated. Last, the design of the strategy uses asits frame of reference the objectives established in Nicaraguas strengthened growth andpoverty reduction strategy (SGPRS), which represents the commitments made by thecountry to the international community and forms an integral part of the HIPC process.

The objective of the BCS, which will guide Bank actions for approximately four years, isto support the Nicaraguan government in establishing and carrying out actions to attain thegoals of the SGPRS. The actions included in this Bank lending program are targetedand chiefly consist of investments and short- and medium-term technical cooperation totackle the three challenges identified above.

Strategic approach 1: Economic growth. This is the necessary condition for povertyreduction in Nicaragua. Based on experience and considering the actions of otherinternational lending agencies, this BCS has identified two key areas for IDB support:strengthening fiscal policy (in the area of macroeconomic policies) and boostingcompetitiveness and production. The proposed goal for this strategic approach is to helpthe country achieve growth in GDP of 5 percent in 2005, with the increases in GDP in2002-2004 that were planned in the SGPRS.

a. Strengthening fiscal policy. The chief purpose is to offer support inreducing the fiscal deficit, achieve a reduction in domestic debt andmitigate the risk of a crisis caused by excessive internal debt.

b. Promoting competitiveness and production. To boost exports andeconomic growth, it is important to continue and step up economic reformsthat will spur the investments and increases in capital necessary to financethem, through direct foreign investment or local capital.

Strategic approach 2: Governance. The objective is to have efficient, effective andethical government with the capacity to attain the goals of the SGPRS, which enjoys theconfidence of the citizenry. The success indicator in this strategic approach is to improveNicaraguas ranking for governmental and bureaucratic efficiency in the World BanksGovernance Index. To that end, sweeping actions will be undertaken to modernize and

reform the three branches of government. Although the Bank will support strengtheningfor the three powers, it will assign the highest priority to reform of the executive branchand to following up on a program that has already been approved to support the judicialbranch. Headway will also be made in some areas linked to strengthening of the legislativebranch.

Strategic approach 3: Productivity of the poorest groups. Top priority has beenassigned to social and productive investments to benefit the very poor, particularlyprograms with highly positive short-term impacts. This strategic approach is particularlyimportant for the government and the Bank on account of its tie-in with compliance withthe goals of the SGPRS. The fundamental indicator for achievement of this strategic


8/48

-iv-

objective is a reduction in the percentage of people living in extreme poverty from 17.3percent (1998) to 14.3 percent (2005).

The IDB, the international community and coordination of activities. Last, there are asignificant number of bilateral and multilateral institutions in Nicaragua that support thecountry in its efforts to spur development and reduce poverty. The proposed strategy takes

account of this confluence of interests and will: (i) generate synergies, (ii) avoidunnecessary duplications in programs, and (iii) favor their coordinated execution.Accordingly, when the BCS was being prepared, the IDB maintained a series of formaland informal exchanges with the IMF, the World Bank, DFID, the European Community,USAID and other institutions. It also held an additional consultation with the internationalcommunity and with representative of civil society organizations in Managua inSeptember 2002 and plans to continue these exchanges.

Indicators. Nicaragua is committed to meeting the goals expressed in the SGPRS. Thegoals are ambitious and meeting them will require concerted efforts on the part of theGovernment with ample support from the international community. The majority of the

indicators of this BCS reflect this commitment. Nevertheless, the Bank, through theactions undertaken in the framework of this BCS, cannot assume the sole responsibility formeeting these goals. This is principally the responsibility of the Government, but it isshared with the international community. Besides, external factors, such as naturaldisasters and unforeseen political, economic and financial events, will necessarilycontribute to the degree of attainment of the goals established in the SGPRS. As a result,an evaluation of the role of the Bank in reaching the indicators would have to consider theissues of attribution and the counterfactual, which have been reviewed by the Board ofExecutive Directors.

Strategy of the Bank Group. This BCS was prepared by the Bank Group. From itsinitiation, the preparatory process involved the active participation of the IIC, PRI andMIF. The contribution of the Bank Group is reflected in the overall program of this BCS,especially in the sections addressing competitiveness.


9/48


10/48

-vi-

(WB).

Reform of thefinancial and

pension systems(WB).

Reform oftelecommunicati

ons (WB). Competitive-ness (WB).

tradable goodswith higheconomic returnsin the short term,focusing onsmall andmedium-scale

producers.

1997)

Support for conflict resolution (MIF,1998)

Development of FINDE (PES, 2000)

Systemization of the network of savingsand credit unions (PES, 2000)

Sheep farming on mini and small farms in

the tropics (PES, 2000)

Multisector regulatory agency (

Airport security (MIF, 2002)

Identification of clusters (200

Public and private sector partne(2003-5)

Clean production centers (MIF

Single window (MIF, 2003)

In-shore fishery, Laguna de Per2003)

Sheep raising RAAN (PES, 200Other

Study on infrastructure to incre

Study on impact of CAFTA


11/48


12/48

-viii-

BANK COUNTRY STRATEGY MATRIX

IDB actions

Area Government

strategy

Strategy/actions of other international

lending agencies

IDB strategy

Current Proposed

Strategic Approach 3: Productivity of the very poor

Social

investments To increaseinvestments inhuman capital.

Theseinvestments willfocus on basicand vocationaleducation and

primary healthcare in ruralareas.

SILAIS for better medical care (Sweden,EU, USAID, Nordic Fund, Italy, Japan, WB).

Primary network and hospitals (RAAN andRAAS). Health services in remote areas(USAID, Sweden).

Reproductive health model (Norway, GTZand UNPF).

Vaccinations and immunizations(Luxembourg and Japan).

Other health programs (Sweden, PAHO,UNICEF, WB, USAID, Spain, KfW, SDC,OPEC).

Malnutrition prevention (WB, USAID,UNICEF).

Water and sanitation (Germany).

Participation in education, design of anational education plan, a training plan,increase in school autonomy (WB, USAID,Finland, UNICEF).

FISE (WB, KfW).

Primary education (WB).

Loan to support poverty reduction (WB).

To promotesocial and

productiveinvestmentsfocused on the

poorest groups.

Loans

Comprehensive childcare (2001)

Social safety net(2000)

Development of theAtlantic region (1999)

Education reform(1999)

Modernization of thehospital system (1998)

TCs

Support for reform ofsecondary education(1998)

Support for privatehealth service

providers (MIF, 2001)

Loans

Social safety net II (200

Social sector (2002)

Urban poverty (2003)

Education II (2004-5)

Social sector II (2004)

Education with job train(2004-5)

Modernization of techneducation (2004-5)

TCs

Support for disabled gro(2002)

Evaluation of social pro

Preschool education (20

Other

Study to provide social by ethnic groups.


13/48

I. MAIN CHALLENGES FOR DEVELOPMENT

A. Evolution of the economy

1.1 In the aftermath of the economic collapse caused by the civil war, Nicaraguaemerged in the 1980s with an economy in acute crisis. At the start of the last

decade, the authorities simultaneously undertook the tasks of putting an end tohyperinflation and implementing an intensive program of structural reformsintended to transform the economy into a market-based system, with the privatesector called upon to play the leading role.

1.2 Nicaragua has made significant progress since the start of the 1990s on four frontsin particular. In the first place, it was able to rein in the hyperinflation that began in1988, bringing it down to 10 percent by the end of the 1990s and to 5 percent in2001. Second, it cut back military spending from 28.3 percent of GDP in 1989 to1.5 percent in 1996. Third, the authorities made significant progress in opening upthe economy, starting from a position of excessive protectionism. In addition to

participating in a regional liberalization strategy through the Central AmericanCommon Market (CACM), the country has signed several free trade agreements,participates in the negotiations on the Free Trade Area of the Americas (FTAA)and is currently part of the Puebla-Panama Plan. Fourth and last comes the impulseit has given to the free zones to develop and diversify exports. As a complement tothis effort, the treatment of direct foreign investment has been liberalized.

1.3 Despite this undeniable progress, serious problems must still be addressed withregard to economic performance and the social situation. Nicaragua is one of thepoorest countries in Latin America, with per capita GDP (in dollars at purchasingpower parity) that is a mere 7.2 percent of per capita GDP in the United States

(Graph 1.1). Furthermore, it has lost ground, even in Central America. The fourneighboring countries included in Graph 1.1 have a history of poor performance,with growth rates lower that in the United States. Even in this context, Nicaraguaseconomic performance is unfavorable, since after having been the regional leader(after Costa Rica) in 1975, it has become the country with the lowest per capitaincome today. In the second half of the 1990s, the speed up in Nicaraguas growthmeant that its relative situation did not continue to deteriorate, but it has still notbegun to make up for the ground lost in the previous 20 years.


14/48

-2-

Graph 1.1. Per capita GDP in current US dollars at purchasing power

parity

(percentage of United States GDP)

0%

5%

10%

15%

20%

25%

30%

35%

1975 1985 1995 1999

Nic ara gua

Costa Rica

El Salvador

Guatemala

Honduras

B. The three challenges

1.4 This chapter identifies three key challenges for poverty reduction. They form partof the reference framework for this Bank country strategy (BCS) 1 and are: (i)economic growth; (ii) governance; and (iii) the productivity of the very poor.Attention to these three challenges during the period this BCS remains in effect iscrucial for poverty reduction and the countrys socioeconomic development. Thischapter also examines the countrys situation with respect to two major areas of theBanks institutional strategy poverty reduction and sustainable development and ends with a brief evaluation of two key areas for the countrys development:macroeconomic prospects and vulnerability to natural disasters.

1. Economic growth

1.5 The main pillar of the strengthened growth and poverty reduction strategy(SGPRS) and a necessary condition for poverty reduction is broad-based economicgrowth coupled with high employment. To achieve that growth, sustainedmacroeconomic stabilization and the implementation of policies that boost thecountrys competitiveness and production are necessary.

1.6 The fiscal deficit. In the area of macroeconomic stabilization, the Banks analysispoints to the importance of reducing the fiscal deficit. In 2001, the deficit of theCentral Government was 17 percent of GDP and preliminary estimates place it at

about 10 percent in 2002. One-third of the deficit in 2001 (6.1 percent of GDP) wasfinanced by donations and the rest by external and internal borrowing.

1.7 Despite substantial growth in domestic debt, the inflationary impact of thisfinancing has largely been cushioned by the open market operations of the CentralBank of Nicaragua (BCN). This debt is composed of long-term instruments,

1 It should be noted that some important challenges have not been included in this BCS. Most will be

addressed by the Nicaraguan government, in many cases with support from bilateral andmultilateral institutions. See Annex 5 of the SGPRS: Matrix of policy actions.


15/48

-3-

compensation payment bonds (BPIs) issued to cover land confiscations andexpropriations, and short-term instruments in the form of negotiable investmentcertificates (CENIS) issued by the BCN for open market operations and to supportdepositors in banks in receivership. The CENIS have grown significantly in recentyears, rising from 8.2 percent of GDP in 1999 to 22.6 percent in 2001.

1.8 While long-term instruments pay moderate nominal interest rates, they are boughtand sold in secondary markets at deep discounts. Short-term instruments paybetween 10 and 15 percent both indexed to the dollar.

1.9 Although inflation has been contained so far, there is another problem in themedium term. The internal debt represents about 70 percent of GDP and almosthalf of it will fall due prior to the end of 2004. In that year, the country will have tobegin repaying the BPIs, whose service (principal plus interest) will rise fromUS$16.9 million in 2001 (0.7 percent of GDP) to US$60 million in 2005 (1.9percent of GDP).

1.10 It is a priority to reduce the fiscal deficit. Its financing through donations andCENIS is not sustainable in the long term.2 On the one hand, a reduction inexternal donations is expected and, on the other, internal financing through theaccumulation of short-term instruments issued by the BCN has the potential fordestabilization by making government finances more fragile and vulnerable toshocks in the financial system if private agents do not continue to roll over theirCENIS.

1.11 It is also important for the country to lessen its dependence on external donations,while implementing a series of macroeconomic policies to promote significant andsustainable growth that stems from the dynamism of the Nicaraguan economyitself. Rapid accumulation of internal debt raises the cost that the private sector

must pay for credit and discourages investment, affecting the countryscompetitiveness.

1.12 Competitiveness and increases in production. To achieve high and sustainablegrowth that would permit a permanent reduction in poverty, production will haveto be boosted through measures to improve the competitiveness of Nicaraguangoods and services on international markets.

1.13 Increases in production, particularly in tradable goods, are also fundamental forreducing the deficit in the balance of payments current account, which climbed to37.8 percent of GDP in 2000 and was about 38.8 percent of GDP in 2001. This

deficit is not sustainable, given the scant possibilities of continuing to finance itover the next four to five years.

1.14 The size the this gap is explained by the negative trade balance, which rose to theequivalent of over 42 percent of GDP in 2000 and was approximately 40 percent in

2 Even working on the assumption that the international community would be willing to increase itsconcessional resources in real terms, estimates indicate that the average primary deficit ofNicaraguas consolidated nonfinancial public sector will not be sustainable in 1999-2001. SeeSebastin Edwards, Debt Relief and Fiscal Sustainability, National Bureau of EconomicResearch, Working Paper 8939, May 2002.


16/48

-4-

Box 1.1. Integration. A key element for development

Integration is a key element for development in Nicaragua. In addition to having the potential for opening up newmarkets for the countrys exports, regional integration offers broad potential for developing common, cost-efficient

policies for addressing regional challenges. For the small economies of Central America, subregional integration isustified as part of the process of opening up to the outside and making the most of its strategic location. The potential

benefits of proximity and cultural affinity with neighbors are under-used in terms of trade and investment flows,given the institutional obstacles (nontariff barriers, customs and border formalities, etc.) and inadequate infrastructure(bad roads).

The countrys commitment to move toward greater openness has been clearly demonstrated. It is in the process ofnegotiating or approving free trade agreements with Chile, the Dominican Republic and Canada and has taken thefirst steps toward an agreement with the United States. Nicaragua also participates in the process of the Free TradeArea of the Americas (FTAA) and in World Trade Organization (WTO) negotiations. Nicaraguas strategy ofopenness and integration includes different levels of association. The most direct are the Central American CommonMarket (CACM) and, in meso-America, the Puebla-Panama Plan (PPP). In these contexts, integration goes beyondstrictly trade objectives, to include infrastructure and cooperation in a number of fields, ranging from health andeducation to disaster prevention.

Nicaraguas participation in trade negotiations makes it necessary to strengthen all the institutions in the publicforeign trade system and their capacity to build consensus on national positions with civil society and with the privatesector, in particular. The need to build up public and private institutions can also be seen when it comes time toimplement trade agreements. Openness is also linked to macroeconomic imbalances, owing to the anticipatedreduction in fiscal revenues as a result of tariff reduction. Alternative sources of revenue will have to be found tocompensate for tariff reduction.

Progress in subregional integration could provide better conditions for economies of scale, investment allocation andsolutions for competitiveness on third markets in key areas of infrastructure, particularly in transport (a regionalconcept of multimodal solutions) and energy (regional investments in power generation under SIEPAC and growingliberalization of trade in oil and gas).

The strategy presented in Chapter III of this BCS deals with these issues.

2001. Half of the current account deficit was financed with public capital, mainlytransfers (12.8 percent of GDP). The net government debt also contributed to thisfinancing (loans less amortization), which accounted for 4.2 percent of GDP.Private capital financed 35 percent of the current account deficit, particularly directforeign investment and net external borrowing, which amounted to 6.3 percent and7 percent of GDP, respectively.

1.15 Like the fiscal deficit, the external deficit is also unsustainable on account of theprobable reduction in donations in the coming years. Sustainable growth requiresthe country to find means of financing its imports through exports, which havestagnated, direct foreign investment, or direct private borrowing on internationalfinancial markets. Whatever the case, borrowing at concessional rates willgradually diminish over the coming decades.

1.16 The analysis of the investment climate performed by the Banks Private SectorGroupthe Inter-American Investment Corporation (IIC), the MultilateralInvestment Fund (MIF) and the Private Sector Department (PRI) Identified twogroups of key actions to promote private sector investment: (i) actions to decreasethe perception of economic, financial, legal and regulatory risks; and (ii) policiesaimed at increasing the supply of local private capital and local technical expertise.

1.17 To attract foreign investment and, in particular, to obtain greater private sectorinvolvement in the energy, transportation, water and telecommunications sectors,Nicaragua has its own development opportunities and challenges that can besummarized in three key points:


17/48

-5-

a. Creation by the government of a new vision and commitment that is favorableto international investors interested in financing projects in the country.Consolidation of democracy and the reduction and prevention of corruptionare key elements in this vision and commitment.

b. Improvement and diversification of the Nicaraguan economy. It is important toboost productivity, enhance the efficiency of key economic sectors, provide

better maintenance of basic infrastructure, improve core services and ensurestable macroeconomic policies that promote private investment.

c. Strengthening of the legal and regulatory framework. The regulation of tariffscharged to users must be improved, the discrepancies between the lawsregulating each sector must be eliminated and the justice system needs to bereformed, since at present it is slow, opaque and perceived to be corrupt.

1.18 Another key aspect linked to competitiveness and, in general, to the countryssocioeconomic development is its openness to the rest of the world. Box 1.1analyzes the main aspects of economic and regional integration. It should benoted that Nicaragua has worked very hard in this area.

2. Governance

1.19 In the second half of the 1990s, Nicaragua experienced a major loss of confidencein its public administration.3 Although the evaluation made by citizens of thepublic sector is closely linked to macroeconomic issues, certain indicators confirma decline that needs to be reversed. The democracy index (a combination ofsatisfaction with and support for democracy) fell from 41 percent in 1996 to 34percent in 2001.4 The situation is no better with regard government effectiveness(27.5 percent for Nicaragua compared to 49.2 percent for the region), justice (21.2percent compared to 46.1 percent) and corruption control (24.2 percent compared

to 50.6 percent).5 Nevertheless, these indicators may improve in 2002 due to thestrong anti-corruption measures taken by the new government.

1.20 In the 1990s, Nicaragua undertook major reforms to begin the process ofconsolidating democracy and modernizing the public administration. However, inrecent years the pace and depth of these reforms has stagnated, largely due todeterioration in political institutions and the lack of transparency in the use ofpublic resources (the indicators mentioned in the preceding paragraph confirmthese views).

1.21 It is important for Nicaragua to take up the process of institutional reforms once

again, with the central objectives of consolidating democracy and the rule of law,ensuring transparency in public spending and instilling credibility and confidencein citizens and private investors for decision making and the exercise of theirrights. Execution of the SGPRS will require good governance for economic growthand for poverty eradication. However, the strategy itself takes note of majorchallenges in governance and institutional development.

3 Latinobarmetro, 1996 and 2001.4 Ibid.5 World Bank Institute on Governance and Anti-corruption.


18/48

-6-

1.22 Therefore, a second challenge for the country is to revisit the process ofinstitutional reform to consolidate democracy and the rule of law, ensuringefficient and effective government and transparency in public spending.

3. Productivity of the very poor

1.23 The SGPRS estimates that 47.9 percent of the population lives in poverty and 17.3

percent in extreme poverty. Poverty is linked to very unequal income distribution.6Apart from being multi-dimensional in nature, poverty goes beyond low income toinclude discrimination and exclusion expressed in terms of the privation of basicsocial services.

7For example, Nicaragua has high levels of child malnutrition,

disease and lack of education (see Table 1.1). The highest incidence of poverty ison the Atlantic coast, where Afro-Nicaraguans and indigenous groups live, andefforts must be directed to that area to boost productivity.

1.24 This is why the second pillar of the SGPRS highlights the importance of makinglarger investments in the human capital of the poor for the purpose of helping tobreak the inter-generational cycle of poverty. As a response, this BCS proposes to

bring about permanent increases in the productivity of the poor by improving theireducation, health, nutrition and training to enable them to obtain sufficient incometo surmount their poverty and exclusion.

C. Poverty reduction and sustainable development

1.25 The Banks institutional strategy attaches particular importance to two crosscuttingissues: poverty reduction and sustainable development. The country has progressedunevenly in these areas, as is explained below.

1. Poverty reduction

1.26 After extensive consultations with civil society and international financial

institutions, Nicaragua prepared a strengthened growth and poverty reductionstrategy (SGPRS) in July 2001. Preparation of the strategy was supported by theinternational community (See Box 1.2). The SGPRS uses the results of studiesconducted over a number of years and reflects the governments and moreimportantly, the countrys commitment to increase and improve spending onpoverty reduction. This commitment has already transcended one political cycle,when it was handed down from the previous administration to the currentgovernment in 2002.

1.27 The strategy establishes the guidelines for poverty reduction as well as the goal ofreducing extreme poverty by 50 percent by 2015 as compared to 1995. Attainmentof that goal necessarily requires that the country achieve substantial and sustainableeconomic growth. It also requires expansion of the supply of essential services toboost the productivity of low-income groups. Thus, the main challenges discussedin this chapter of the BCS complement the analysis and priorities established in theSGPRS.

6 According to the UNDP, Human Development Report 2002, Nicaraguas Gini coefficient forincome is the fifth highest in the world. A high Gini coefficient indicates greater inequality inincome distribution.

7 Jean Drze and Amartya Sen, La India: Desarrollo Econmico y oportunidad social, IDB,Regional Policy Dialogue, June 2001.


19/48

-7-

Box 1.2. The Strengthened Growth and Poverty Reduction Strategy.

Content and role of the international community and the IDB

The SGPRS. Backed by the Bank and other international entities, the SGPRS was prepared under thegovernments leadership and establishes poverty reduction as the mainstay of the strategy. It incorporates theresults of extensive consultations with civil society and international lending agencies. It contains short-, medium-and long-term indicators for poverty reduction and millennium development goals. For example, it plans for a50 percent reduction in extreme poverty by 2015, as compared to 1995.

The SGPRS is built on four pillars: broad-based economic growth and structural reform; larger and betterinvestments in human capital; better protection for vulnerable groups; and governance and institutionaldevelopment. It also has three crosscutting themes: environmental vulnerability, social equity and decentralization.

Role of the international community. Although the SGPRS is a Nicaraguan document prepared exclusively forNicaraguans, virtually the entire international community has contributed to different aspects of its preparation: tothe study and analysis of poverty; to the sector analyses; to the design and implementation of the consultations; tothe preparation of the system of indicators, monitoring and consultation; and to the implementation plan. Theinternational community has also participated in several coordination and consultation meetings in Managua. Likethe IDB, the other international lending agencies are determining their future support for the country under theframe of reference established by the SGPRS.

Role of the IDB. During the preparation process, the Bank supported the government through technical cooperationprojects and loans to support the Technical Secretariat of the Office of the President (SETEC), sector analyses,consulting services, design of the system of indicators, monitoring and evaluation, and design of the

implementation strategy. The Bank also worked closely with SETEC on revising the drafts of the SGPRS.

This Bank country strategy is intended to program the IDBs future actions under the framework established by theSGPRS. In addition to an innovation loan in execution (implementation of the reinforced poverty reduction strategyapproved in 2000), the Bank expects to approve two sector loans offering direct support for achieving the goals ofthe SGPRS. All the investment loans and technical-cooperation projects are also geared directly and indirectly to

the same goals.

1.28 Table 1.1 presents the main social and poverty indicators in Nicaragua. Asexpected, there is a strong correlation between poverty and low educationalachievement, disease and malnutrition. Although the country made significantprogress in poverty reduction during the 1990s, poverty and privation levels remain

high. The maternal mortality index deteriorated during the 1990s and little progresswas made in the net primary school enrolment rate.

TABLE 1.1. MAIN SOCIAL AND POVERTY INDICATORS

Indicator 1990-94 1995 1996 1997 1998 1999 2000

Poverty index 50.3 % - - - 47.9 % - -

Extreme poverty index 19.4 % - - - 17.3 % - -

Chronic malnutrition in

children under five

23.7 % - - - 19.9 % - -

Infant mortality per 1,000 live

births

58.0 - - 43.0 40.0 - -

Maternal mortality per

100,000 live births

98.3 111.8 154.4 142.7 138.2 148.3

Net rate of primary schoolenrolment

77.9% 75.2 % 73.2 % 73.6 % 73.1 % 75.0 % 77.0 %

Children who complete

primary school in six years

17.9 % 18.6 % 22.4 % 27.8 % 38.8 % 32.0 % 29.5 %

Illiteracy rate 23.0 % - - - 18.8 % - -

National potable water

coverage

50.0 % 56.1 % 59.1 % 61.6 % 62.8 % 66.5 % 67.9 %

National access to sanitation 82.6 % - - - 84.1 % - -Source: SGPRS, July 2001.


20/48

-8-

1.29 Although not included in the Table, the high population growth rate bears a closelink to poverty.

8The poorest households tend to have larger family sizes and

higher dependency ratios than wealthy ones. High unemployment, estimated at10.5% in 2001, and low incomes have contributed to a large flow of Nicaraguanimmigrants to other countries. Even though this indicates a shortage of jobs,remittances from Nicaraguans living abroad, which are the equivalent of about 15

per cent of GDP, help substantially in financing the countrys balance of payments.2. Sustainable development

1.30 Nicaragua has made progress in the environmental area. It has an institutional andlegal framework and government policies, including the second version of theenvironmental action plan launched in 2000 (the first dated from 1993), whichprovide a foundation for suitable environmental management. The Ministry of theEnvironment and Natural Resources (MARENA) is the lead agency, but its limitedresources hamper effective environmental monitoring and control on the nationallevel. With support from projects financed by the Bank, the environmental capacityof public institutions has improved and environmental rules and procedures have

been designed and included in each sectors project cycle. Environmentalmanagement units have been established in 12 public institutions.

1.31 Agriculture has expanded in recent decades at the expense of natural resources,through unsustainable farming practices and expansion of the agricultural frontierthat have led to rapid deforestation and general degradation of water and soil.Productivity is low. Recent programs (POSAF, rural production reactivation) havebeen including actions to address this concern and solve these problems, stressingthe need to introduce technologies that make for the sustainable management ofnatural resources and significant increases in productivity.

8 Nicaraguas population growth rate of 2.8 percent from 1975-2000 is almost 50 percent higher theaverage of Latin America and the Caribbean which is 1.9 per cent (UN, Human DevelopmentReport, 2002).

Box 1.3. Nicaragua: One of the countries hardest hit by natural disasters

Nicaragua is located in one of the parts of the world that is most vulnerable to natural disasters of different kinds,

including hurricanes, storms, tidal waves, earthquakes, eruptions, drought and flooding. The magnitude is reflectedin large losses, which have exceeded US$4 billion (more than 150 percent of GDP in 2001). Those same disastershave affected more than 3 million Nicaraguans.

On the regional level, Nicaragua has made important commitments to reduce the risk of disasters. Thecommitments recognize the common challenges and set out lines of action to address them jointly.

Also, the country has taken some major steps with a view to mitigating the risk of disasters: (i) it passed a law in2000 establishing the National Disaster Fund (which must still be regulated); (ii) it has obtained financing toidentify risks in selected municipalities and carry out community works to mitigate them; and (iii) it isstrengthening the environmental management system through the Ministry of Environment and Natural Resources(MARENA).

Additional steps that could be taken include: (i) promoting a private disaster insurance market as envisaged in thePuebla-Panama Plan; (ii) making more use of hydrometeorological information to reduce disaster risk; and (iii)

preparing a financial strategy to respond to disasters quickly, effectively and efficiently.

These actions form part of the policy dialogue between the Bank and the government. The IDB has played aleadership role in disaster prevention. The World Bank and the international community also have importantprograms in this area.

Bank Group programs contribute to disaster prevention and mitigation through financing municipal public worksfor disaster protection through the Municipal Strengthening and Development Program (1086/SF-NI), land riskmaps as a criteria for housing vouchers through the Low Income Housing Program (1111/SF-NI), droughtmanagement in the Rural Production Reactivation Program (1110/SF-NI), and a regional MIF program in

preparation which will include support for a private disaster insurance market.


21/48

-9-

D. Macroeconomic prospects

1.32 Excessive public spending in 2001 was the main reason why the targets establishedfor year two of the Poverty Reduction and Growth Facility (PRGF) agreed uponwith IMF were not met. The difficulty in meeting the targets and in presenting acoherent program for year three of the program led the authorities in mid-2001 tonegotiate an interim program (SMP Staff Monitored Program) for the second half

of that year, in order to assist the new authorities in laying the groundwork for athree-year PRGF starting in 2002. The country fell far short in meeting the targetsof the SMP and the IMF has begun a review of the situation with the newgovernment with the objective of negotiating a new PRGF in mid-2002. Afterseveral months of satisfactory implementation, the program will be presented to theIMFs Executive Board, possibly in the second half of 2002.

1.33 In 2001, growth in GDP was positive (3 percent) but the decline observed in theprevious year continued (see Table 1.2). The biggest slowdown was in theagricultural sector, owing to a severe drought and the collapse of internationalcoffee prices. The immediate prospects for Nicaragua are not bright. For 2002, the

serious macroeconomic imbalances and an external situation that continues to beadverse, despite the recovery in the United States, will continue to be reflected invery low growth. However, the figure could rise to 5 percent in 2004-2005 if theauthorities are able to create a context that promotes economic growth and if theworld economy continues to recover. The Nicaraguan economy is expected torecover by the middle of this decade, as a result of exports and private investmentin response to policies to promote the countrys competitiveness on internationalmarkets.

1.34 It should be noted that the macroeconomic indicators in Table 1.2 presentedas percentages of GDP are seriously skewed by a substantial under-estimation ofGDP. The IDB and other international institutions are cooperating with the

government to correct this problem.

TABLE 1. 2. MAIN MACROECONOMIC INDICATORS AND PROJECTIONS

1997 1998 1999 2000 2001 2002 2003 2004 2005GDP (change) 5.1 % 4.1 % 7.4 % 5.5 % 3.0 % 1.5 % 3.5 % 4.5 % 5 %

Inflation (Dec./Dec.) 7.3 % 18.5 % 7.2 % 9.9 % 4.7 % 6 % 5 % 4 % 4 %

Gross fixedinvestment/GDP

21.5 % 23.1 % 30.1 % 26.1 % 24.8 % 24.3 % 24.3 % 25.2 % 25.5 %

External debt (withHIPC debtrelief)/GDP

305 % 304 % 296 % 275 % 251 % 77 % 80 % 81 % 81 %

Total Internal debt/GDP

92 % 79 % 72 % 66 % 69 % 70 % 67 % 63 % 60 %

Total debt/GDP 397 % 383 % 368 % 341 % 320 % 147 % 147 % 144 % 141 %

Fiscal deficit nonfin.pub. sect. beforedonations (% ofGDP)

7.3 % 3.0 % 12.5 % 14.6 % 16.1 % 13.0 % 10.6 % 10.3 % 10 %

Donations (% ofGDP)

5.4 % 3.8 % 8.7 % 7.3 % 6.1 % 6.1 % 5.0 % 4.5 % 4 %

BOP current acct.deficit (% of GDP)

47.1% 39.6 % 49.3 % 37.8 % 38.8 % 32.8% 30 % 28 % 26 %

Source: Banco Central de Nicaragua, projections based on a consistency model.

1.35 The Heavily Indebted Poor Countries Initiative contributes to Nicaraguasmacroeconomic stability by reducing the external debt. The total reduction of the


22/48

-10-

countrys debt could be as high as US$3,267 million in net present value or 72percent of the net present value of the external debt in 2001. The present value ofthe IDBs contribution is US$386 million, which is the second highest.9 The figurefor the Central American Bank for Economic Integration (CABEI) is US$435million (the highest) and for the World Bank it is US$189 million.

1.36 Nicaragua reached the Decision Point in the HIPC process in December 2000,when it became eligible for interim debt service alleviation. This alleviation couldreach a maximum of one third of the total alleviation described in the precedingparagraph. The two main conditions for obtaining an irreversible reduction of thedebt under the HIPC Initiative are concluding a PRGF arrangement with the IMFand executing the SGPRS for a period of one year. The Culmination Point could bereached in 2003. The effects of the HIPC process on the countrys debt situationand on its debt with the IDB and service on that debt are presented in Annex III.

E. Response to the challenges

1.37 This BCS outlines the Banks response to the challenges that have been presented

in this chapter.

9 The face value is US$726 million.


23/48

II. EVALUATION OF THE STRATEGY AND THE PORTFOLIO

A. General considerations

2.1 This chapter includes a brief overviewof the Banks experience in implementingthe strategy established for the period 1996-2001. It summarizes the main

achievements and problems in portfolio execution and the lessons learned. Thenew BCS is generally in agreement with the themes for the future proposed by adraft version of the Country Program Evaluation (CPE) as noted in Box 2.1.10

2.2 The strategy established for the period was approved by the Board of ExecutiveDirectors in the Country Paper of October 1996. The strategy was implementeduntil 1998, when it was revised to address the destruction caused by HurricaneMitch. Although the strategy continued to be valid, it needed to be adjusted tobring it into line with the plan for the reconstruction and development ofNicaragua.

2.3 The country asked to have loans reformulated to cope with the situation at thattime, and US$55 million were identified from programs in execution. Theimmediate purpose of the reprogramming was to repair infrastructure that had beendamaged or lost and to assist the population with its most pressing needs. Fundswere programmed to reactivate agricultural production, protect the health ofvulnerable groups that had been affected, and repair schools and economicinfrastructure (roads and electricity).

2.4 The consultative groups for Nicaragua played a crucial role in this situation,particularly the 1999 consultative group for the reconstruction and development ofCentral America after Hurricane Mitch and the Central American consultativegroup that met in February 2001. In addition to promoting reconstruction, the

10 Office of Evaluation and Oversight, Country Program Evaluation: Nicaragua: 1991-2000,November 20, 2002, Draft submitted to the Programming Committee of the Board. RE-272. At thetime the BCS was completed, the final version of the CPE was not available.

Box 2.1. Nicaragua: Recommendations of the Country Program Evaluation (CPE) and the BCSThe CPE suggested consideration of the following four themes for the future:

(i) Prioritization of growth.(ii) Bank leadership aimed at improved coordination between the country and theinternational

community.(iii) Enhancement of accountability mechanisms.(iv) Work toward the reduction of the volatility, unpredictability and pro-cyclicality of aid

disbursements.

The BCS is consistent with the first three themes. Consonant with the emphasis on economic growthexpressed by the first pillar of the SGPRS, the first strategic approach of this BCS also prioritizes growth asa necessary condition for poverty reduction in Nicaragua. As leader of the Consultative Group forNicaragua, the Bank will encourage country leadership in the definition of effective coordination ofinternational agencies oriented toward meeting the countrys development goals. The enhancement of

accountability mechanisms is a central thrust of the BCSs second strategic approach.The fourth point concerning volatility, unpredictability and pro-cyclicality of aid is still a workinghypothesis, and will be given further consideration.


24/48

-12-

consultative groups supported the Banks efforts by committing funds for thecountrys socioeconomic development.

B. Development of the strategy 1996-2001

2.5 The main objective was to support the country in achieving sustained and equitable

development. Four strategic areas were selected for Bank intervention: (i) externaldebt reduction; (ii) poverty alleviation and human capital development; (iii)promotion of the private sector and reactivation of production; and (iv)optimization of the use of natural resources. The strategy also identified twonecessary conditions: maintaining the stability of the economic system andconsolidating structural reforms.

2.6 The strategy was developed in an international economic climate that favoredgrowth. However, the natural disaster caused by hurricane Mitch drastically alteredthe conditions and needs envisaged when the strategy was designed, particularly inthe social assistance area.

2.7 Stability of the economic system and consolidation of structural reforms.During the time the strategy was in effect, GDP grew by a respectable average of 5percent a year. Although it is difficult to measure the Banks contribution to thecountrys economic growth, the presence of major economic policy reforms thatthe government introduced with support from the Bank and other internationallending agencies contributed to that growth. The reforms included tariff reduction,negotiation of free trade agreements, privatization of public companies,strengthening of bank supervision, reform of the pension system, a start onstrengthening the justice system and a law that facilitated the settlement of propertydisputes.

2.8 The results of the strategy have not been uniform in all areas, but two merit specialattention. The strategic area ofexternal debt reduction is in the process of beingsuccessfully implemented. Under the HIPC process led by World Bank and theIMF, and with extensive IDB participation (see Chapter I), Nicaragua has alreadyobtained temporary debt service alleviation and is in the process of obtaining a 72percent reduction in its present value. One third of the reduction will be financedby multilateral institutions, and the Paris Club and bilateral donors will contributethe other two thirds.

2.9 The strategic area ofpoverty reduction and human capital development is anexcellent example of the Banks capacity to respond to changes in a dynamic

atmosphere. Initially, the tools or programs were not sufficient to achieve theobjectives outlined in the strategy. The Bank responded rapidly to the gaps found.To address the lack of technical and institutional capacity, it financed the designand implementation of the Technical Secretariat of the Office of the President(SETEC), the lead agency responsible for making social needs compatible witheconomic policy which, subsequently, became the institutional anchor andinterlocutor in the formulation of future programs.


25/48

-13-

2.10 Immediately afterwards, the social safety net program was prepared, which had ahigh impact on the development of groups living in extreme poverty and served tobridge gaps in basic health and education services.11 For example, the programbrought about a net rise of 30 percent in the number of children covered by growthmonitoring and promotion programs and of 17 percent in the number of childrenreceiving immunization at appropriate ages, in comparison with nonbeneficiary

poor families. The program also led to a net increase of over 28 percent inenrolment of children living in extreme poverty in the first four grades of primaryschool, in comparison with nonbeneficiary families.

2.11 In response to the devastation caused by hurricane Mitch, the Bank reallocatedfunds to assist in the emergency and in reconstruction of the country. At least 2,500schools, 350 health care units and 50 social welfare units were reconstructed and atleast 45 water projects were built. The quality of the projects was high and the vastmajority will almost certainly be sustainable.

2.12 To respond to the new opportunities created by the birth of the HIPC Initiative, theBank supported the country in designing two innovative instruments: (i) theSupplementary Social Fund, a plan for channeling resources from the internationalcommunity and protecting social spending; and (ii) a program to facilitateimplementation of the SGPRS.

2.13 These examples permit the Bank to infer that although work remains to be doneto achieve the countrys poverty-reduction goals the efforts made thus far havecontributed significantly to improving the indicators reported in Table 1.1.

C. Development of the Banks portfolio, 1996-2001

2.14 At 15 May 2002, the Banks portfolio in Nicaragua was composed of 82 operations

for a value of US$705.7 million, as shown in Table 2.1.

TABLE 2.1. COMPOSITION OF THE PORTFOLIOType of operation Number of operations Amount (US$ million)

Projects 31 629.6

Technical cooperation 21 6.2

MIF 20 13.0

Small projects 3 1.4

PPF line of credit 1 5.0

IIC 5 20.5

PRI 1 30.0

TOTAL 82 705.7

2.15 Of the 31 projects in the current portfolio, 27 were approved during the time thatthe 1996-2001 strategy was in effect. Execution of this portfolio has generally beensatisfactory, with an average of 20 percent of available funds disbursed annually,for a five-year execution period per project. These results have been possibledespite the difficulties mentioned in the following paragraphs.

11 The preliminary evaluation performed by IFPRI concluded that looking at the impact of the socialsafety net the pilot stage of the project can be judged a success.


26/48

-14-

2.16 Of the 31 projects, 7 were identified by the Banks Project Alert IdentificationSystem (PAIS) and placed under alert status and were being subjected to a closemonitoring by COF/CNI.12

2.17 The portfolio was affected by the weak institutional capacity of the executingagencies and the difficulties presented by projects that were being carried out by

several executing agencies concurrently. High staff turnover in the institutions,chiefly on account of political appointments, increased the difficulties of projectexecution.

2.18 Two cases in the portfolio merit special recognition. In the first, after receivinginformation that some funds from a program had been used to contribute to thegoverning partys political campaign financing, the Bank immediately suspendeddisbursements and conducted a special audit. As a result, the institution in chargeof the program repaid the funds, adopted a code of ethics and improved its internalaudit systems to prevent similar situations from recurring.

2.19 In the second case, the Bank did not disburse funds for a sector operation since oneof the conditions stipulated in the loan contract had not been complied with. Thenew government has been able to correct that situation.

2.20 Both cases and the visibility they had with the government and the internationalcommunity have helped to affirm the Banks role as a leader in promotingtransparency in government spending and in the fight to combat corruption.

D. Lessons learned for future strategy formulation

2.21 Transparency and the fight to combat corruption. These are highly importantareas that the Bank must monitor continually, particularly on account of the publicperception that there is a systemic problem of corruption in the countrys

governments. Periodic supervision by the Bank, supplemented by external auditsand timely presentation of audited financial statements, can provide some degree ofcertainty that the Banks funds are used for the purposes for which they wereintended and are not being illicitly diverted or appropriated. Future Bank action isrequired to support efforts to improve the management of public funds, which isincluded as part of the new BCS (see Chapter III).

2.22 Flexibility and innovation. Although the strategy seeks to create a coherent set ofinstruments to achieve the objectives, it is impossible to anticipate every possibleevent or circumstance. Strategy is designed in a set of circumstances that canchange rapidly and drastically, which means that it should be flexible enough toadapt to the new situation. The case of the social component is an excellentexample. The Bank not only reacted quickly and effectively to the new situation inthe country, but it did so with innovative programs.

2.23 Focus. Nicaragua is a country facing large challenges in different areas. Therefore,the limited FSO resources demand that the Banks intervention be focused andinclude indicators of results. Having indicators makes it possible to superviseexecution of the Banks country strategy and to directly and indirectly evaluate itscontribution to the countrys development objectives.

12 As of December, 2002, only four of these seven programs remained on alert status.


27/48

-15-

2.24 Suitable scaling of the strategy. The strategy should be targeted. This will help toincrease the impact of Bank operations on achieving the objectives. However, itshould be kept in mind that, given the limited funds available, even fullimplementation of the strategy could be a necessary but insufficient condition.Only in very special cases, such as debt reduction where the convergence offinancial resources is high in comparison with the total problem, would it be

realistic to expect that an ambitious goal can be attained.

2.25 Institutional capacity. One of the main systemic problems in the Banks portfolioin Nicaragua is the difficulty that institutions encounter in executing projects.Although this limitation is present in most government agencies, it is particularlyserious in the social sectors, which is a priority area in the proposed strategy.Therefore, the interventions proposed in the strategy should be based on a simplydesigned institutional framework in order to reduce the risk that operations cannotbe executed efficiently.

2.26 Project coverage. Coverage should be carefully determined. Projects that arerelatively new should be carefully scaled and, preferably, involve moderateamounts. This would permit the institutions to fine-tune their processes foradequate project execution and avoid the high opportunity costs that are incurredwhen resources are paralyzed.

2.27 Convergence of donors. The Banks sphere of influence in comparison with needsis quite limited, even in small countries like Nicaragua. Accordingly, it needs toseek convergence with the resources provided by bilateral donors and multilateralinstitutions to achieve greater impact (see Chapter III). In turn, this strategicconvergence would be a great help in minimizing local counterpart requirements,which is particularly important in a climate of fiscal restriction, such as the climatethat could prevail during execution of the proposed strategy.


28/48

III. STRATEGY, OBJECTIVES AND THE AGENDA FOR THE BANKS DIALOGUE WITH THECOUNTRY

3.1 The vision that guided preparation of the Banks country strategy (BCS) isNicaraguas strengthened growth and poverty reduction strategy (SGPRS). Thevision is consistent with the priorities of the Banks institutional strategy and with

the Banks new poverty reduction and social equity strategy currently inpreparation.

3.2 The objective of the BCS, which will guide Bank actions for a period of about fouryears, is to support the Nicaraguan government in determining and carrying outactions to achieve the targets of the SGPRS. The actions included in the Bankslending program are focused and consist mainly of short- and medium-terminvestments and technical cooperation projects to address the three challengesidentified in Chapter I of this BCS. Box 3.1 summarizes the proposed structure forthe BCS.

3.3 The BCS matrix given at the beginning of this document summarizes the portfolioin execution and new operations to support the proposed strategy. It also presents asummary of the governments priorities and the main actions of other internationallending agencies.

Box 3.1. Structure of the IDBs country strategy

Vision guiding the preparation of the BCSPoverty reduction and achievement of the targets establishedin the Strengthened Growth and Poverty Reduction Strategy

(SGPRS)

Objective of the BCS

To lay the groundwork for achieving the goals of the SGPRS

Strategic approach 2

GovernanceStrategic approach 3

Productivity of the very poorStragegic approach 1

Economic growth

Macroeconomic

policyCompetitivenessand production


29/48

-17-

A. The lending program

3.4 The maximum financing for the lending program for Nicaragua will depend on theresources available in the Fund for Special Operations and on Nicaraguas progressin economic and social reforms, compared to other countries that are also eligiblefor FSO financing. If Nicaragua makes faster progress that other eligible countries,its allocation will increase under the country institutional and policy evaluation(CIPE). Thus the triggers determining Nicaraguas share of FSO resources will be

measured by its relative progress in the four areas included in the CIPE: economicmanagement, structural policies, policies for social inclusion and equity, and publicsector management and institutions.

3.5 Table I.1 in Annex I lists the projects that would form part of the annual programfor 2002-2005. The final determination of the lending program will also depend apart from the availability of the FSO on the results of the programmingnegotiations between the government and the Bank.

3.6 Scenarios. The FSO allocation for Nicaragua for the period 2002-2003 isUS$211.2 million, which constitutes the base scenario (Table 1.1, Annex I). A high

Box 3.2. The IDB, the international community and coordination of activities

The IDB and the international community. The IDB is the largest lending agency in Nicaragua with averageannual disbursements of US$88 million in 1997-2001, followed by the World Bank with US$85 million. Thelargest bilateral institution is Taiwan, with an average loan portfolio of US$26 million over the same period.

The two largest donors are Japan and the United States, with average annual disbursements of about US$50million in 1997-2001, followed by Sweden and Denmark (US$21 million). Other countries with annual

disbursements of more than US$5 million are Germany, the Netherlands, Spain, Norway, Switzerland, Finlandand Taiwan. The support provided by United Nations agencies has averaged US$30 million a year.

The IDB was the institution that offered the largest sum at the consultative Group meeting in May 2000 (34percent of the total of US$2,593 million). The country making the largest contribution was Spain (9 percent of thetotal). The sum of the contributions by the other multilateral entities was 31 percent and other countriescontributed the remainder (26 percent).

Coordination. Given the countrys dependence on donations and concessional loans, actions by the internationalcommunity are highly visible in Nicaragua. Over the years, effective methods have been developed forexchanging information among international entities but there is still a need for better coordination of theiractivities.

The current government has taken important steps to: (i) improve coordination among donors; (ii) improve theidentification of areas where assistance is needed most; and (iii) improve systems for accountability andmonitoring of donor activities.

In its capacity as chair of the consultative groups and in the process of formulating its strategies and programs, theIDB takes great pains to ensure good coordination with the international community. Based on its closecooperation with the World Bank in preparing their respective strategies and excellent exchanges of ideas with

bilateral entities, the IDB will improve its coordination with other international entities during implementation ofthis BCS. This BCS takes account of programs being implemented by other agencies (see Annex IV) that arerelated to the strategy (see the BCS matrix at the beginning of this document).

This BCS has been enriched by different comments and suggestions made at meetings with the World Bank andthe IMF in Washington (10 May), the international community in Managua (19 June) and a meeting on strategywith the World Bank (9 July 2002). It is highly important for the BCS to take this confluence of interests intoaccount, seeking to generate synergies, avoid unnecessary duplications in programs and achieve their coordinatedexecution.

In the forthcoming CG for Nicaragua, expected to take place in 2003, the IDB will take advantage of its leadershiprole to encourage and support the government work with international agencies to develop sector strategies withclearly defined goals.


30/48

-18-

scenario is also considered, which assumes the allocation to Nicaragua of anadditional US$34.2 million in 2003. The increase would finance the PPPintegration program in 2003 instead of in 2004-5. For 2004 and 2005 the BCSproposes an investment pipeline in which the base scenario assumes that FSOfunds will remain at US$211 million for two years. If major progress is made in thereforms, the high scenario increases the funds available for Nicaragua in that

period by US$40 million. However, if there are problems in implementing thereforms, the low scenario assumes a US$40 million reduction in the fundsavailable.

3.7 Over the four-year period, the estimate for the funds available in the base scenariois US$422.2 million. The figure is US$382.2 million in the low scenario (US$40million less than in the base scenario) and US$496.4 million in the high scenario(US$74.2 million more than in the base scenario).

3.8 To maximize the probability of achieving the objective of the BCS and its threestrategic approaches, the technical-cooperation projects will focus on those sameobjectives and approaches.

3.9 The three strategic approaches. This section presents the Banks three strategicapproaches and the main lending and technical-cooperation activities that respondto the challenges identified in Chapter I. Within the strategy framework presentedin this section, the Bank will explore the possibility of undertaking productive andsocial investments in clusters of activities with high potential for making asustainable contribution to income and job creation (see the reference to thispriority in the introduction to this BCS). The synergies among the three approachesshould be underlined. For example, strategies to boost competitiveness could havea large impact on boosting the productivity of the poor. Improvements ingovernance would improve the economic climate and, therefore, competitiveness.

1. Strategic approach 1: Economic growth

3.10 As mentioned in Chapter I, economic growth is a necessary condition for povertyreduction in Nicaragua. Based on experience and considering the actions of otherinternational lending agencies, this BCS has determined two key areas for IDBsupport: strengthening fiscal policy (within the macroeconomic policy area) andpromoting competitiveness and production. The proposed goal for this strategicapproach is to help the country achieve growth in GDP of 5 percent in 2005, withthe increases in GDP in 2002-2004 proposed in the SGPRS.

3.11 Strengthening fiscal policy. The IMF is the lead institution in the support offeredby international financial institutions for macroeconomic stabilization inNicaragua. The IDB and the World Bank have also participated in IMF missions,with the IDB backing actions to strengthen the financial and pension systems.

3.12 Under the first challenge described in Chapter I, the main purpose of strengtheningfiscal policy is to reduce the fiscal deficit. This is a key to reducing the need fordeficit financing by the Central Bank. It is also an important condition for reducingthe size of the internal debt under a PRGF arrangement with the IMF and forallaying the risk of a crisis caused by excessive domestic borrowing by thegovernment. Further, reduction of the deficit will ease the pressure on interest rates


31/48

-19-

thanks to lower demand for credit by the government and will increase the creditavailable to the private sector to finance productive activities.

3.13 The main actions proposed by the BCS in the field of fiscal policy include: (i)technical support for the process of transparency in government operations and forthe tax reform launched by the country, which seeks to increase revenues by

broadening the tax base; (ii) technical assistance to rationalize public spending,particularly current spending; and (iii) technical and financial support to bringabout the conditions necessary to reach the Culmination Point of the HIPCInitiative, as soon as possible.

3.14 In the short term, it is hoped that successful negotiation of the PRGF by thegovernment and the IMF will help to improve the countrys fiscal situation. Banksupport will be coordinated with the targets established by the government and theIMF under the PRGF.

3.15 Promoting competitiveness and production. To boost exports and economicgrowth, it is important to continue and step up economic reforms that will spur theinvestments and increases in capital necessary to finance them, through directforeign investment or local capital.

3.16 Owing to the need to rationalize public spending, thereby reducing the fiscaldeficit, direct foreign investment should be maximized, particularly in theinfrastructure needed to increase exports, which mainly involves transportationinfrastructure, ports and electric power. Public investments will have to be limitedto the most urgent priorities which are absolute necessities for stepping up theproduction of tradable goods and services, hence exports. Sustainable programsthat increase investment and the production of tradable goods with high economicreturns in the short term will be supported. Programs of this kind could promote

production and the productivity of the rural economy, the workforce, and small andmedium-scale producers through the effective use of technology, job training,implementation of effective management systems and promotion of sustainablecredit programs.

3.17 An aggressive program is envisaged, in which the public sector forges partnershipswith the private sector to make the necessary investments. Specifically, apartnership with the private sector to find alternatives outlets for exports to Atlanticmarkets, particularly the United States and Europe, as quickly as possible.

3.18 Bank program. Bank actions to strengthen fiscal policy will be framed in the

context of the IMFs PRGF and will draw on the experience of the taxadministration program approved in 1999. The tax modernization study alreadyconducted by the Bank will also be used.13

3.19 The Banks program will cooperate with the government in promoting increasedcompetitiveness and production, while setting the stage for the private sector torespond favorably to the brighter investment climate. The Bank will support the

13 Juan Carlos Gmez Sabiani, Nicaragua: Desafos para la modernizacin del sistema tributario,April 2002, study contracted by the IDB.


32/48

-20-

integration process and will finance the investments in infrastructure defined in thePPP. It will also promote actions to boost production by small producers. The mainactions are described below.

a. Actions to strengthen fiscal policy14

3.20 Loans. Two loans will lay the foundation for strengthening fiscal policy. The firstwill be a sector loan for modernization of the state and fiscal reform (2003). It willback government actions to improve the regulatory framework for investments andthe transparency of procedures, based on the guidelines established in the study onmodernizing the tax system. The second sector loan for fiscal modernization(2004-5) will strengthen fiscal policy. The goals of these two loans will becoordinated with those of the PRGF.

3.21 Other actions. To bring countrys external debt down to sustainable levels, theBank will continue to participate in the HIPC process, which involves cooperationwith the government and other international lending agencies for compliance withthe HIPC conditions. Regarding the internal debt, the Bank will finance a TC tohelp the country explore and propose alternatives to bring this debt down to moresustainable levels. The TC will complement Bank loans and the PRGF, that aim tolowering the fiscal debt through improved fiscal policy.

3.22 One particularly important area for the IDB is implementation of the SGPRS. Onecondition for reaching the Culmination Point in the HIPC process and making thedebt alleviation irreversible, is implementation of the SGPRS for at least one year(see Box 1.2).

3.23 The Bank will continue to cooperate with IMF missions, taking the lead in actionstargeted to the financial and pension systems. In addition to contributing to the

dialogue on financial policies with the authorities and other international financialinstitutions, IDB participation in these missions serves to frame the general contextof Bank support for financing small and medium-scale producers. The Bank willmaintain its leadership in the financial area, which is a key for boostingcompetitiveness and production.

3.24 To strengthen the tax system, the IDB will participate with the World Bank in 2002in a country financial accountability analysis (CFAA).

b. Actions to boost competitiveness and production

3.25 The Bank has programmed six new loans and several technical-cooperationprojects to support competitiveness and higher production. All these operationssupport the countrys attempts to increase growth through expanding trade, tariffreduction and integration, especially in the frameworks of the Central AmericaFree Trade Agreement (CAFTA) and the Plan Puebla Panam (PPP). Box 3.3summarizes this support.

14 See Annex I for a description of the objectives of each operation. The Banks country strategymatrix at the beginning of this document also mentions the main loans and technical-cooperationprojects under way, which support competitiveness and other areas included in the strategicapproaches.


33/48

-21-

Box 3.3. Bank Group support to economic integration and trade liberalization

The IDB will provide ample support to economic integration and trade liberalization over the periodspanned by the BCS. A summary of key actions include:

A loan to strengthen the countrys negotiating capacity.

An innovation loan to improve competitiveness through stronger cooperation between the public

and private sectors. Two loans to support increased competitiveness and production of small producers.

PRI support to the private sector in four strategic areas: energy, transportation, water and sanitation,and telecommunications.

IIC financing of small and medium enterprises through financial intermediaries and directinvestment.

Seven MIF TCs to increase the countrys competitiveness.

Plan Puebla-Panam Integration Loan.

Feeder roads loan in support of increased production

Study on the benefits and challenges of the TLC.

Policy dialogue to facilitate the transition toward regional integration and freer trade of Central

America with its principal trade partners.

3.26 Loans. Two loans will directly support Nicaraguan competitiveness. The loan tostrengthen negotiating capacity (2002) will help the authorities to open up marketsunder new programs for economic integration and trade liberalization. Thecompetitiveness innovation loan (2003) will strengthen cooperation between thepublic and private sectors. This is particularly important for forging keypartnerships between the two sectors, which will permit the private sector toincrease its financing for basic investments that the public sector is unable toundertake owing to the restrictions on public spending that will prevail during theperiod that the BCS will remain in effect.

3.27 Two operations will contribute to higher production by small producers. A global

multisector loan (2003) will support development of the private entrepreneurialsector by expanding the financial supply, and the loan to reactivate rural production(2002) seeks to provide more opportunities to boost rural family income, mainlythrough the provision of small infrastructure works. These resources will permitthe private sector, particularly small producers, to respond to the improvement inthe investment climate and to new international markets that open up.

3.28 PRI will explore operations with the government in four strategic areas: energy,transportation, water and sanitation, and communications (see Table I.4, Annex I).

3.29 For its part, the IIC will support the private sector through medium- and long-termfinancing for small and medium-sized enterprises through financial intermediariesand direct investment. Sectors identified as having good investment potential areagriculture, agri-business, power generation and textiles (in-bond industries).

3.30 It should be noted that the IDBs rural development program has been designed inclose communication with the World Bank, which is making large investments,particularly in agricultural technology, and with other international financialinstitutions. The Bank has also made contact with the European Commissionregarding major investments that the EC has programmed for the same sector in2003. The IDB has offered to exchange information and to cooperate with the ECin preparing the investments.


34/48

-22-

3.31 The Bank has also programmed a Puebla-Panama Plan (PPP) integration loan(2003) and a loan for feeder roads (2004-5) that will back key investments forincreased production. It is expected that a large part of these investments will belinked to rural development (roads and rural electrification), physical integration toreduce production costs in the Puebla-Panama corridor and other integrationprojects identified in the PPP. They include disaster prevention and border

integration of the Gulf of Fonseca and the San Juan Basin.

3.32 Technical-cooperation projects. Three technical-cooperation projects that havebeen planned for financing through the Multilateral Investment Fund in 2002 willplay an important role in regulatory strengthening and in boosting the countryscompetitiveness. They include operations to improve airport security and tosupport the Office of the Superintendent of Banks and the entity responsible formultisector regulation.

3.33 The MIF has also identified the following potential areas for action: (i) support forthe Ministry of Development, Industry and Trade (MIFIC) in establishing a singlewindow for the registration of new businesses; (ii) management of eco-efficientsystems; (iii) improvement in the operation of the financial market, particularly aprimary mortgage and underwriting system; and (iv) the productive linkage ofSMEs in the tourism industry. Annex I, Table I.3, summarizes these and otheroperations proposed by the MIF to promote competitiveness and production.

3.34 To help small producers make the most of opportunities to expand their production,the Bank has planned two technical-cooperation projects for 2002, to supportunconventional financing for farming and the transfer of agricultural technology.

3.35 Additional technical-cooperation projects will be required for 2003-2005 to lay thegroundwork for partnerships between the public and private sectors. Over the same

period, a Bank-financed TC will help the government identify clusters that offergood potential for job and income creation. In response to the interest expressed bythe government in this area and the potential it offers to assure the sustainability ofinvestments, it has been made a priority

Idb - Country Strategy With Nicaragua

Documents

Transcript of Idb - Country Strategy With Nicaragua