New Government, New Economy?

What are the first economic steps the new government is expected to take and what obstacles must be surmounted?

Arturo Grigsby

The most defined feature of the new government’s economic design is that the motor force of economic growth during its five-year term will be large-scale foreign investment, followed by national private business investment. This growth strategy is based on the very traditional idea that the benefits of the big investments will trickle down to the others. It thus fits perfectly with the overall economic plans being promoted by the United States: the free trade agreements, the Free Trade Area of the Americas and the Puebla Panama Plan.

As part of President Bolaños’ inaugural events, a major forum was held to promote the country as an attractive area for foreign investment. The 600 attending investors from some 30 countries heard promises, plans and discussions. Two new major investments have been announced so far: Grand Pacific, a US corporation, will build a tourist complex near the existing one in Montelimar, and Grupo Promérica will build an industrial park in León where Payless, one of the largest US shoe manufacturers and retailers, will set up two factories. Payless will later open over a dozen shoe stores around the country. It is no accident that the forum was followed by President Bush’s announcement of a free trade agreement with Central America; they are two integral components of the same design.

Yes to the maquila,
no to agriculture

These two investments reflect the new government’s priority areas: tourism and the assembly plants known as maquiladoras, which process imported materials for re-export and are exempt from import and export taxes. The latter will be given particular priority because this type of operation seems to be of greatest interest to the investors currently sniffing around.

With all polls showing unemployment as the social problem most affecting the population over the past decade, Bolaños’ campaign promise to create new jobs sparked particularly high expectations. Like its predecessor, the current government is counting on the maquila industrial parks—commonly referred to as free zones—as the quickest way to mass-create the longed-for jobs. Indeed, when Alemán took office, around eight thousand people were employed in the maquiladoras; today, according to the Central Bank, that figure has climbed to nearly forty thousand. Nonetheless, his seemingly exclusive reliance on big investors is questionable considering that small urban and rural businesses still provide the bulk of Nicaragua’s jobs and the government has no clear plan for this sector.

Bolaños is offering investors two advantages. The first is competitive prices—"starting with the cost of our labor force," to use his words. The second is security, at least compared to most of the other Central American countries vying for tourists and maquila investors. In his opening speech at the investment forum, Bolaños told the audience that "Nicaragua is a safe country, its people very warm and welcoming. We have one of the lowest crime rates in Latin America, and the public safety we can offer today is the envy of our neighbors north and south. There are no kidnappings or violent crimes against tourists or investors here, and the tourists who come don’t have to listen to special instructions about security beyond the dictates of common sense." This security is largely a legacy of the revolution. Nicaragua was the only Central American country to create, from scratch, a new police force and new army, while the police in the other countries—excluding Costa Rica—have been an arm of corrupt and repressive armies until very recent, still incomplete and long overdue changes.
The most noteworthy aspect of this government’s economic strategy is that agriculture, for nearly two hundred years the kingpin of the national economy and the source of the new President’s own wealth, has been left in the dust. It seems to be viewed as a problem rather than a solution, a sector that drags on the economy rather than driving it forward.

At least at the starting gate, this vision establishes a substantial difference between the Bolaños and Alemán governments. Five years ago, Alemán centered his promises on making Nicaragua the "granary of Central America" once again; he pledged to reactivate agricultural exports and announced that the economic growth would come from the rural sector. After an initial dynamism, a few projects along those lines and a discourse that lasted longer than the practice, Alemán started veering toward his real strategy: the maquilas and public investment in infrastructure construction. The devastation wreaked by Hurricane Mitch provided the external financing opportunities if not perhaps the impetus for the latter. Bolaños, in contrast, is wasting neither words nor time. His compass was pointed straight toward large foreign and national urban investment even before the gate went up.

The agricultural sector:
Let it eat cake

This leaves agricultural production with the greatest lack of definition. Although the public is still largely unaware of it, there is a contradiction between the thinking of Agriculture and Forestry Minister Augusto Navarro and that of the presidential economic team headed by Mario de Franco, who also chairs the Cabinet and is the new government’s key minister. Navarro’s approach is very similar to that of both the National Union of Farmers and Ranchers (UNAG) and the Union of Nicaraguan National Agricultural Producers. Seeing himself as a minister of the associations of agricultural stakeholders, whether they represent small, medium or large production, Navarro floated the idea of creating a development bank to expand the state’s financial and technical services in rural areas. But this proposal is anathema to the multilateral financial institutions and the rest of the economic Cabinet because it presupposes an increase in state spending. Neither Bolaños nor any of Navarro’s Cabinet colleagues have backed the idea. Their approach seems rather to be one of strengthening "second tier" institutions, those that work through other financial institutions rather than directly with individual clients, creating arrangements to stimulate private banks and micro-financing institutions to provide direct loans in rural areas.

Rejection of the state development bank idea is largely based on fears about how deeply rooted the culture of subsidy and the expectation of debt pardons for political reasons is among the peasantry. The fear is merited: such a culture really does have roots, and not only among small producers. During the revolution, bank credit was used to subsidize production with little concern about recovering the loans, while afterward, many NGO-promoted credit projects with revolving funds also acted as subsidies rather than real credits. Huge uncollected loans of questionable creditworthiness provided to large producers both during and after the revolution also led to the collapse of both state and private banks in recent years.

Another pending decision is the future of the Rural Development Institute (IDR). President Alemán pulled this institution out of the Ministry of Agriculture and put it directly under presidential control. He appointed Eduardo Mena, who also administered Alemán’s personal haciendas and is today a National Assembly representative, to head the IDR. His motive in all this was to use the external resources earmarked for rural development to finance his own party’s political patronage. Perhaps the most controversial and scandalous case in point was a Taiwanese-funded IDR program to repopulate the cattle herd with 25,000 breed cows. In the end, Alemán’s rural development program proved not to be a program at all, but just party-biased, non-transparent administration of a collection of projects. Furthermore, rural development policy had been fragmented, with the IDR hogging the resources, the Ministry of Agriculture in charge of technical assistance and the Treasury dealing with land tenure issues.

In Nicaragua, private commercial banks do not work with the rural productive sectors. The bulk of their credit portfolios is dedicated to financing consumption. An individual can easily get a loan to buy one of the plethora of luxury 4-wheel-drive vehicles clogging Managua streets today, but faces often insurmountable obstacles when applying for a loan to plant papayas for export. Around five years ago, the World Bank set up a program to extend private banking services to the countryside, providing a US$30,000 subsidy to the banks for each branch they opened in rural areas. The banks jumped at the offer, but did precisely the opposite of what the World Bank intended: they used these branches to attract the savings of the rural population and thus increase their capacity to finance consumer loans in the cities, providing no credits for any rural productive activities.

Nor do private banks in Nicaragua offer housing loans, since these are long-term credits. The Inter-American Development Bank, however, has earmarked substantial financing for housing, and the government is now negotiating with both micro-financing institutions and banks to see how best to advance with its promise of new housing.

Not only is the agenda less clear in the rural sector, the challenge is also more acute. How is the government going to increase agricultural production? How are the much-needed long-term investments for agriculture to be financed if there is no state development bank at all and no private bank that is willing to offer them? In the areas affected by the coffee crisis and/or the continuing drought, time is of the essence and the situation is dramatic: the unemployment, hunger, decapitalizing of the population and tensions of last year have not disappeared; they have in fact festered. So far, the only response has been food-for-work programs, but new conflicts will surely break out when they come to an end.

Cattle ranching represents one of today’s few bright lights for the rural sector. Much of Nicaragua’s agricultural land is now dedicated to pasture and the herd has been recovering in recent years due to significant and growing demand for Nicaraguan cheeses in neighboring El Salvador. The transnational company Parmalat and its national intermediaries have taken the market for dairy products by storm, particularly energizing the small and medium cattle ranchers, which offer the best prices today for milk, cheese and meat. The light is even brighter because this is a long-term opportunity. El Salvador has a large population living in a country too small to feed them all. In addition, it receives US$2 billion a year in family remittances. Nicaragua’s small and medium-sized agricultural producers and cattle raisers are therefore finding not just an answer but also a strategic solution to their marketing needs in this nearby market. Thinking up similar solutions that combine large-scale foreign investment and small-scale national production would provide a basic way of moving toward a more harmonious and more authentic development than the free-zone plants could ever offer.

Assets and deficits in
negotiating with the big guns

What does the government’s strategy still need in order to function and bear fruit? The indispensable point of departure is to negotiate a new three-year structural adjustment agreement with the international financing institutions—the International Monetary Fund, World Bank and Inter-American Development Bank. The government is forecasting that this agreement will be ready for signing in June, but it is more likely to be July 2002 at the earliest.

Another of Bolaños’ campaign promises that created major expectations was the creation of a new housing plan. Since the team that drew up his government program knew which social projects were already signed and which others are being negotiated with the multilateral agencies, promises such as the housing plan were based on the likelihood of abundant external financing for projects that were already guaranteed. Nonetheless, the money will not start moving through the pipeline until the government-IMF agreement is signed, so few such projects can be expected to get underway until next year. The government will have to handle the tension between the rhetoric of its promises and crude economic reality very ably and intelligently since both Arnoldo Alemán and Daniel Ortega are waiting in the wings to benefit from and even manipulate any social tension.

The government team will bring to these negotiations its growth strategy, the latest evidence of the country’s extreme poverty and worrying macroeconomic indicators. While it will stress Bolaños’ overwhelming electoral victory, resulting domestic backing and promise of stability, transparency and clear rules, which Alemán did ever so little to ensure, the lending institutions’ team will not lose sight of Nicaragua’s enormous and unsustainable fiscal and trade deficits.

Despite all of the support Bolaños enjoys, the IMF no longer has much confidence in Nicaragua: both agreements it signed in the previous decade were broken. The first one, with the Chamorro government, went on the rocks in 1994, only six months after being signed. The second one, with the Alemán government, survived a little longer, but still no more than half of its three-year period.

In addition to macroeconomic concerns, other essential aspects that will determine whether the IMF signs a new agreement with Nicaragua include political issues and new laws that guarantee good governance, a concept that includes transparency. The bills that President Bolaños presented to the National Assembly on January 31 for urgent approval (see "The Month," this issue, for details) respond to conditions imposed by the multilateral financing institutions to firm up any new agreement that will give the government new resources to administer.

The macroeconomic challenges

The country must tackle four major macroeconomic challenges if it is to become viable and have a sustainable economy: two debts (the domestic debt and the foreign debt) and two deficits (the fiscal deficit and the trade deficit).

The Domestic Debt. Until 1993-94, Nicaragua only had a foreign debt burden, but in those years the Chamorro government began to issue compensation bonds to those who had lost properties in what were deemed unjust confiscations by the revolution. In the conflictive negotiations of the property problems, the least problematic solution that was hit upon was to compensate any unredeemable properties with these government IOUs at a fixed interest rate and fixed maturity date.

At the outset, the overall amount of the bonds was not very significant. As the years passed and the crisis grew, however, this began to change. Next came the CENI bonds, issued to stop the drain on the country’s international foreign exchange reserves. At the end of its term, the Chamorro government issued US$46 million worth of CENIs for this purpose, which by the end of Alemán’s administration had grown to US$200 million. Then came the CENIs to bail out the fraudulent bankruptcies of several banks in 2000 and 2001. While most of those responsible for these closures went free, all Nicaraguans are still paying for the bonds issued to cover them at a round cost of US$350 million. In 2001, a good part of these bonds were renewed in a very tense negotiation between the Central Bank and the private banks.

By the end of 2001, then, the domestic debt—bonds, certificates and titles issued by the government in different crises—was asphyxiating public finances with a US$645 million burden. This debt, as unpayable as the foreign one, is aggravated by the fact that all creditors are private; unlike the foreign debt, there are no international actors with whom to negotiate the crisis and no way to negotiate, reduce or pardon the debt to free the economy of this burden.

It is calculated that Nicaraguan banks are the creditors of three-fourths of this domestic debt, a good part of which was contracted at very high interest and very short maturation. President Bolaños’ first meeting with any national sector was with the Association of Private Banks. The new treasury minister, banker Eduardo Montealegre, declared that he has a team dedicated to seeing how to convert this short-term, high-interest debt into a long-term one with low interest rates.

The Foreign Debt. Nicaragua today has a US$6.7 billion foreign debt. While that is US$5 billion less than it was a decade ago thanks to a Chamorro government campaign to get a significant portion of pre-1991 loans written off, it is still the highest per capita debt in Latin America, and surely in the world.
In 1990, Nicaragua paid barely US$53 million to service its overwhelming debt. In 1991, after the change of government, it "paid" over US$600 million, but the donor community actually financed the payments as a "favor" to put Nicaragua’s credit back in good standing with the international financing institutions. In 1997, when the incoming Alemán government failed to reach an agreement with the IMF, largely due to a conflict about whether to close the National Development Bank, Nicaragua had to pay over US$350 million, a full quarter of its budget.

After finally signing the second Enhanced Structural Adjustment Facility (ESAF) agreement with the IMF, payment on the debt began to drop significantly and Nicaragua went into 2000 at the "decision point" for acceptance into the Initiative for Highly Indebted Poor Countries (HIPC). That reduced its interest payments to US$140-160 million, but contrary to expectations and Alemán’s initial ballyhoo, Nicaragua was not admitted into the initiative during his term of office. The Bolaños government expects to gain full entrance ("completion point") in 2003, which will mean the pardoning of 80% of the debt and thus a significant further reduction of Nicaragua’s debt service payments.

The Fiscal Deficit. Moving now from debt challenges to deficit challenges, Nicaragua must reduce its fiscal deficit and close its trade deficit. Reducing the fiscal deficit involves both cutting public spending and collecting more taxes. Closing the trade gap means consuming less imports, perhaps raising taxes on them, and exporting more, reactivating production and/or lowering taxes on exports as has been done to stimulate tourism. None of these solutions is either easy or fast. Reactivating the export sector will reduce both the fiscal and trade deficits, but the Bolaños government has so far failed to come up with either responses or clear proposals to achieve this goal. It is one of the shadowy areas of his strategy.

The degree to which the new government can reduce Nicaragua’s fiscal deficit will be a key point in its negotiations with the IMF. The deficit has been constantly high since 1980, exceeding 20% of the Gross Domestic Product (GDP) during the most intense war years during the 1980s, when half of the national budget went to military spending. A brutal first effort to shrink it was made in 1988 when the Sandinista government "compacted" the state and made the first reductions in the army rolls. In 1990 the deficit shot up again due to spending on the 1990 elections, the outgoing government’s plundering of state goods, known popularly as the "piñata," and a general relaxing of all controls on state spending.

It was significantly reduced again in 1991, coinciding with the IMF-impulsed stabilization plan implemented by the Chamorro government, which managed to put an end to the five-digit hyperinflation. But it started growing again in 1994 when the government failed to comply with the first ESAF agreement signed with the IMF the previous year. Nicaragua was put under what was called a "Shadow Plan," which took some of the pressure off the government’s fiscal discipline. In 1998, the first year of the new agreement signed by the Alemán government, the fiscal deficit was under 5%, the lowest in 22 years. Nonetheless, the emergency provoked by Hurricane Mitch in late 1998 and the subsequent relaxation of fiscal discipline that the international financing institutions granted the government so it could deal with such extraordinary expenditures bloated he deficit yet again.

In 2000, Nicaragua permitted the fiscal deficit to go even beyond the new limits set out. With the deficit nearly as high last year, the agreement with the IMF became a dead letter. The IMF now wants Nicaragua to bring the deficit back down below 5%, which would mean reducing it by over half. While this implies a draconian reduction of public spending, the government does not disagree with the need or the figures. It only differs with the rhythm, aspiring to a more gradual reduction than the IMF is espousing.

In negotiating an acceptable fiscal deficit level, the IMF never requires that it be reduced in absolute amounts, but rather in proportion to the size of the economy. The government is basing its negotiations on two hopes: one is to reactivate the economy relatively quickly with foreign investment and the other is to convince the IMF to give Nicaragua a chance to grow so that the reduction need not be either drastic or immediate.

The Trade Deficit. Another major economic concern is Nicaragua’s trade deficit, that huge gap between export earnings and import spending. It is the largest trade deficit in Latin America in percentage terms, and is now widening even more due to the crisis dragging down the nation’s productive sector.
In the early revolutionary years, the trade deficit was 10%; in other words, Nicaragua only bought abroad 10% more than it sold. With the war, the deficit began to expand, so that by 1988 the country was buying 30% more than it was selling. Today, 11 years after the end of that war, the deficit has skyrocketed, hitting more than 50% in 1999.
The country has been experiencing a collapse in exports, which means it must increase both productivity and export production and diversify exports. The export crisis of recent years has been caused partly by the plunging international prices for coffee, the country’s main export since the late 1800s. The crisis in coffee prices affected all forecasts by the technical experts of both the outgoing government and the IMF and World Bank, which were the basis for the agreement signed in 1998. It was projected at that time that Nicaragua would be exporting goods worth over US$1 billion by 2000, but we exported only US$620 million in 2001.

The export collapse, however, is not due only to the coffee crisis, which has been just the largest and latest bolt from the blue. The problem is older, in that very few of the abundant resources pumped into the country for its reconstruction have been invested in the productive sector.

The imbalances in Nicaragua’s economy are much more acute than those affecting Argentina. Argentina’s foreign debt, although a staggering US$140 billion, represents half of that country’s GDP whereas Nicaragua’s seemingly insignificant US$6.7 billion is twice the size of its GDP. According to data from the Economic Commission on Latin America and the Caribbean (ECLAC), Argentina has a fiscal deficit of 3.5%, counting only central government income and expenditures, while Nicaragua’s is 8.5%. In addition, Argentina has a foreign trade surplus while Nicaragua sells US$600 million worth of exports and buys US$1.6 billion worth of imports. In proportional terms, then, Argentina’s problems pale in comparison to Nicaragua’s, but the good news is that keeping Nicaragua afloat is a whole lot cheaper than shoring up Argentina, which has a per capita income of over US$7,000 compared to under US$500 here.

Nicaragua has not erupted into a crisis similar to Argentina’s because we are plugged into a dual lifeline from abroad: foreign cooperation and family remittances. Nicaragua could not survive without the international loans and donations and the remittances that its emigrants in Costa Rica, the United States and elsewhere send home to family members. And more oxygen comes in from the sum of remittances than from all the soft loans and donations provided the governments of Europe, the United States and elsewhere. Only a decade ago, despite the numbers of Nicaraguans who had emigrated to escape the war, the figures on family remittances barely made a dent in the national accounting books. They began to appear in 1993, when around US$50 million was sent. Now both official and unofficial figures place the amount at $600-800 million annually, while average international cooperation totals some US$500 million a year.

The Poverty Reduction Strategy:
Safety nets or productive inclusion?

If very few resources have been invested in the productive sector in the past decade, the Poverty Reduction Strategy, now an official World Bank-approved document that the new government is committed to implement, does not appear particularly concerned with production either, mentioning it only in very general terms. The strategy’s main objective is to create a social safety net that will use subsidies to alleviate (not reduce) the poverty of the most vulnerable population. The strategy does not propose incorporating the poor into the national economic project. Based on a very traditional mentality, it assumes that the poor will automatically be pulled in as the large, modern sector of the economy grows.

In the framework of this strategy, for example, a school bond subsidy is already being provided to poor rural families that send their children to school. Although this plan seeks to expand school coverage, it is far from enough. The challenge will be to provide comprehensive technical, financial and human support to help these families break out of their poverty, getting to the heart of problem rather than just treating the symptoms.

The new government is expected to continue the education and health design implemented during the Alemán government, largely centered on significant infrastructure investments. The difference will be in how they are administered. Lucía Salvo and Silvio de Franco, respectively appointed to head the health and education ministries, are recognized for their efficiency and honesty and signs of this essential shift should begin to show up in the near future.

In fact, it has already been demonstrated in the first steps taken by Health Minister Salvo, which are geared to investigating and punishing the corruption surrounding the supply of medications in hospitals and health centers and to organizing available resources rationally, transparently and with social sensitivity. Meanwhile, two themes have dominated the education debate: the meager school coverage—hence the school bond to poor families—and a proposal by pro-Alemán legislators that the 6% of the state budget now granted to universities through the FSLN-dominated National University Council should go directly to students as scholarship grants. Education Minister de Franco, who insists on free basic education, has expressed a strong interest in expanding school coverage to include the over 700,000 children and youths who do not attend, and to reach a consensual decision on the long-standing controversy over the 6% issue. All these positions also demonstrate a change of course.

The poor have gotten poorer

The graph below expresses one aspect of Nicaragua’s worsening poverty. The behavior of per-capita income shows an initial growth after the triumph of the revolution in 1979, followed by a sustained drop between 1984 and 1993, during the intensification of the war and the first years of the transition to peace. In those 10 years the population’s income fell year after year, with a spectacular drop in 1988, the year of the so-called "Sandinista adjustment" when the government began to implement devaluation policies and try to reduce the fiscal deficit. The recovery and economic reactivation finally got underway in 1994, with per capita income growing every year between then and 2000, but it fell again between 2000 and 2001, a crude expression of the costs of the Alemán government’s controversial finale and the tense electoral year.

Increasing per-capita income is a central aspect of any development strategy and depends on two bottom-line factors: how much the economy grows and how much the population grows. During the past two decades or more, economic growth in Nicaragua has been slow to negative, encountering major obstacles that resulted in the still high rates of open employment and underemployment. But Nicaragua is also grappling with another serious structural obstacle to increasing the population’s income: one of the highest demographic growth rates in Latin America.
From 1990 to 1995, the population grew at an annual rate of 3%. In 1996, after processing the 1995 census, the figure was adjusted to 2.8%. According to the latest study by the United Nations Fund for Population Affairs, Nicaraguan women have an average of four children. Meanwhile, the GDP had negative growth until 1994, when it showed real growth in absolute terms for the first time in a decade. But a 3.3% economic growth rate and a 3% population growth rate means that per capita income only grew 0.3%.

Any program that aspires to reduce poverty in the near future is thus obliged to reduce the demographic growth rate, a challenge that has many cultural and religious-moral implications in Nicaragua. The Catholic hierarchy has obvious power and the new government is not likely to want conflicts from that flank. There are rumors that Nicaragua’s bishops are drafting a declaration against the international financial institutions, which are said to be including birth control campaigns among their conditions for Nicaragua. Could this be all another maneuver by pro-Alemán forces to trip up the new government?

Some socioeconomic indicators

In 1990, the annual per capita GDP was equivalent to US$454. Today it is US$484. In other words, eleven years after the war, during which Nicaragua has been receiving an annual average of US$500 million in foreign cooperation, the income of each Nicaraguan has only grown US$30! If that is not shocking enough, it must be remembered that this figure only expresses a mathematic or artificial reality, homogenizing the head count of not only both babies and the retired, but also the very rich and the very poor. It in no way reflects real income distribution, which is profoundly inequitable in Nicaragua and becoming more skewed with every passing day.

International analysts calculate that a country’s economy must grow at least 7% a year to effectively reduce that country’s poverty. During the reactivation period of the past seven years, Nicaragua’s economy grew an average of 4.5% annually. Mario Arana, the new government’s presidential technical secretary and coordinator of its Poverty Reduction Strategy, declared that this strategy is based precisely on increasing economic growth. The Bolaños government first calculated that the economy would grow between 5.5% and 6% annually in the first years of its administration, but has now revised that downward to 4.5%. It remains to be seen where even that growth will come from. After that, of course, must come an income distribution policy, which attempts to influence the degree to which the whole population actually benefits from any positive per capita growth in income.

Arturo Grigsby is an economist and director of the Nitlapán-UCA institute.

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