NICARAGUA: ECONOMIC IMPACT OF THE US AID FREEZE

Created: 11/17/1992

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TRANSFERRED TO OTHER AGENCY -CIA

Directorate of Intelligence

Intelligence Memorandum

Office of African and Latin American Analysis2

Nicaragua: Economic Impact of the US Aid Freeze

Summary

The suspension4 million in US aid has halted Nicaragua's economic growth this year and reduces expectations for future perfonriancc. The loss of US aid has forced the government to slash spending, boost taxes, and tighten otomestic credits. While these measures have slowed growth, ihey have not headedoreign exchange crisis. If the full amount of US aid remains frozen, in ourevaluation of the cordoba will be required in the next few months, and Managua will find it impossible to meet IMF targets al yearend. In addition, anti-US sentiment may grow in some quarters. Release of half the aid would allow the government to2 without further belt-tightening, although IMF-mandated goals would still be difficult to reach. Full disbursement would boost investor confidence, allow Managua to meet its IMF targets, and permit some economic growth next year.

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Nicaragua began the year with high hopes for economic progress. Private and government economists hadercent real economic growth, which would have2 the first year of economic expansionn addition, the Chamorro administration, in its proudest economic achievement, held inflation to an annual rateercent for the first halfn contrast0 percentlthough structural reforms had lagged, particularly in the state banking sector and in privatizing stale enterprises, Managua's economic stabili;auon program appeared on track.11

The suspension4 million in US aid in May, however, disrupted the government's plans. The US package represents almostercent of Managua'sillionn response, the Chamorro administration has been forced to cut spending sharply, raise taxes, and grapple with growing pressures on the balance of payments.esult, public investment has plummeted, and we judge the Nicaraguan economy will experience no growth this year.

The IIS Aid Freeze In Perspective

The suspension of US aid has further strained an already-weak economy; even without the freeze, the Nicaraguan economy bad poor prospects for long-term growth. Nicaragua has the highest per capita debt in the world and the lowest per capita GDP in Latin America. The Chamorro administration inherited almost no foreign reserves, an infrastructure devastated by years of mismanagement and war,angle of propeny ownership questions. Yel, after two years in power, the administration has made no headway intable property regime or in contending with Sandinista-dominated and statist-oriented labor unions that cloud the business climate. Production of uadeablc gocds has stagnated; export earnings this year of0 million will be nearly identical8 levels, leaving reserve levels totally dependent on outside largesse. Finally, consistency and stability in economic policy could fall victim to problems between Chamorro and the National Assembly in the next few months.

Managua Tightens Its Belt

ln light of the loss of US aid, the Nicaraguan government hasumber of steps designed to avoid missing critical IMF targets, which would jeopardize next year's IMF

aid programdebt ITtluClinn It ha* ehil wa/ling in hmh ih#

private sectors;

wn ui tne retrocuun is rrom me midgets ot state enterprises, which

account loi more tFanercent nf GDP. In addition. ihc- j'.ovcmmom has DWMOd credit to the private secior-particularly to agriculture, which has received only half the funding it received last year.'

i

Seeor selected economiceeor compliance with IMF targets.

Managua also has acted to increase revenues. President Chamorro announced in late September that the value-added tax, which had been cut toercent in February, would be restored to its previous level ofercent. Moreover, Finance Minister Pereira has satd publicly that water and electricity hikes are being considered. The government

calculates that these measures will bring in anillion this year

Finally, the administration, despite labor opposition, is moving ahead with its privatization programeans ol trimming expenses and boosting revenue. Press reports indicate state rail and bus companies probably will be offered for sale shortly.

Even after taking these actions, Managua was able to meet IMF targets inbecause the lMFshowed leniency in measuring compliance with itsthe targets allowed Managua accessmall amount of IMF fundsthe government's eligibility for other bilateral and multilateral

Balance of Payments Crunch Looming

Despite the measures already taken, pressure on the balance of payments is worsening.

Managuaonors into balance <

the official and black-market exchange rates jumped toercent by mid-October. The government is spreading stories of US counterfeit currency appearing in the country in an effort to discourage Nicaraguans from buying dollars.

Both exports and imports are falling this year. We calculate that exports will dropmillion to0 million, mostly due to the credit crunch and shortagesagricultural inputs (hat have squeezed agricultural production.has been hit particularly hard, and next year's coffee harvest will suffer ifshortage continues. We estimate that imports this year will dropearlier projections to0

The following table provides our projections of what Nicaragua's balance of payments would have been if the US aid had been disbursed on schedule and what it will be without US aid:

Balance of Payments2 (in millions)

Currentmillion

million

million

Netillion

Capitalaid)

Change inmillion

No Aid

illion

illion

illion

million

additional aid for this year-some of it merely br Substantial additional contributions this year are

Efforts to find alternative sources of foreign funding have been only partially successful. President Chamorros trio to northern Europe in Ottuber rettedillinn in

it forward from nex: year's account

What Next For Managua?

The Chamorro administration's policy options and economic prospects are evaluated below under three scenarios:

ontinued withholding of all US aid.

The releaseillion.

The release of the0 million.

ln each case, we assume that Nicaragua will continue to place high priority on meeting IMF-mandated targets.4

US aid remains frozen. To staveoreign exchange crisis Managua iv-rudd to tighten monetary and fiscal policies further and almost certainly would be forced.to

While these measures would slow the crop in foreign exchange icseives, utey run uierisk of fueling inflation and undermining agricultural production and exports next year. Despite these measures, the Chamorro administration would have to hope for more leniency from the IMF, since meeting some December targets would be all but impossible without substantial, unexpected aid from other sources. I

with must IMF lafgfils. in rYrrmhrr wniildould probably be unable to amass adequate

Half of the US package isevaluation wouldrinnnrviry but probably could hevrir, Although additional fiscal belt-Ughtening would be required, there would be less impact on workers in stale enterprise,', Restrictions on credit could be cased, and financial constraints cm agricultural production

The entire US aid package isevaluation could be postponed through next year unless other factors continued to limit export growth. Managua would be able to resume public investment to stimulate the economy. Credit io the agricultural sector would be liberalized, and exports would probably rebound. The likely lifting of import restrictions would boost private investment slightly, with some positive effect on economic growth. The government probably would have little trouble meeting IMF guidelines but might keep recent tax increases in effect anyway.

IMP targets wook! providend reiiodle anaJOQ. Attbontb ptai -callingis consideringadical

No matter what the decision on aid, Managua will continue to face seriousPrivate sector confidence is soil shaky because of slow movementreform, and investment is likely to remain inadequate even if all US aidUnder anv of the three scenarios, economic growth2 will mmaininflation will jump perhaps tn nt mnrh ifrrrf.ni--for ihf^yeja, due to theand import restneoons already in place.

Implications for the United States

Although the suspension of US aid has had some beneficial results-such as encouraging more rapid progress on the privatization of sateti impart nr. ihr rmnamv

has been overwhr.lminp ly nrf ariw. By undermining investment and export produce on. it has contributed to delaying economic recovery, and its effects will be felt for years.

Managua is unlikely to get sustained economic growth started in the near term without substantial financial assistance from the United States or other foreign donors.

Continued economic stagnation is likely to fuel public restiveness andundercut the. fffcctivcrrtssof theChamorro administration.over the recent tax hikes suggest political pressures will mushroom iftakes additional austerity measuresevaluation nf theraise import prices, erode real wages, and providetor cnucs oihinmmi adm|rjstration Hie opposition, led bvPresident Cesar, is certain to exploit the government's difficultiesopportunity.

A prolonged suspension of aid could fan anti-US sentiment within the government, the Army, and the public at large. Many agricultural producers, for example, almost certainly will grumble about Washington's policies if they are unable to obtain credit for spring planting, and workers may blame the aid freeze for job layoffs at state enterprises. For his part, Sandinista Party chief Daniel Ortega will continue his accusations of US indifference to the suffering of the Nicaraguan people, j

s

MF TARGETS *

tadact

September

DFrFWRFrl

Colmg on total oovommont expenditure Sfffl

proutom.

Lvnl on not domosbc credits to nonfInanclal public sector

comnee probtem.

CeSng oa net domestic entral bank assets

target in September;o miss in December

USncased.

Nel Intamafonel reserves

large! in September; likely lo mlsa In December unless US aid Is released.

Limits co oortracOng external credits by Pubic Sector and Central Bank

pis nc* problem '

ii

table ia classified

MiCorvs of cordobas. $indicates rniifcro ot doiien

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