Envío Digital
Central American University - UCA  
  Number 101 | Diciembre 1989



The Fight Against Inflation: A Challenge for the Months Ahead

Envío team

After three months of holding under 10%, inflation crept slightly over the government's one-digit goal in October, at 10.2%. The combination of economic measures undertaken by the government has so far achieved this year's objectives of stopping hyperinflation and bringing monthly inflation under control. Annual cumulative inflation to date has been held at 959%, a great improvement over last year's 36,000%. Updated official figures have set monthly rates at 8.9% for July, 8.6% for August and 8.9% for September.

Controlling inflation is part of a three-phase process begun in February 1988. The first phase was to eliminate relative price distortions by doing away with subsidies and giving imported products and the dollar their real value on the domestic market. This goal has virtually been met. The second phase, currently in process, was to eliminate hyperinflation and bring inflation to a livable level. One of the principle aspects of the anti-inflationary program's success is the reduction of the fiscal deficit, which, at the cost of some 25,000 state jobs, dropped 50% in real terms relative to 1988. This drastic decrease is considered spectacular by international standards.

The third phase, expected to get underway after the elections, is to reactivate the economy, a step Nicaragua will be ready to take once inflation remains in the single digits. Single-digit inflation is also needed to attract foreign loans and investment, a central part of the FSLN's reactivation program.

Inflation and production

Though overall inflation has been brought under relative control, prices for the basic "market basket" of some 50 products have risen more than the overall inflation rate would suggest. Arturo Grigsby, economist and planning director at the Ministry of Agricultural Development and Agrarian Reform (MIDINRA), explains that as public buying power decreases, people spend money only on their basic needs, driving up prices on those products they can afford. For example, no one can make a profit on shoes, he says, because no one can afford to buy them, so shoe prices increase more slowly. The production cycle of basic grains also drives up prices in the market basket. The fall harvest hasn't come in yet, and the summer stores of corn, beans and rice are coming to an end.

The October increase in inflation is partly due to the annual production cycle. Every year, the period from October to December is marked by a chronic shortage of available hard currency. Little money comes in from exports, because the country's major crops (sugar and coffee) have not yet been harvested, while, at the same time, the harvest of those crops demands cash.

In addition, Christmas brings with it increased demand for commercial products and hard currency. Since the government doesn't have the foreign exchange, speculation for dollars increases, and inflation rises. The government also just approved the payment of the "thirteenth month," a full month's pay traditionally given to state employees as a December bonus. In anticipation of greater quantities of money in circulation, prices rise.

Recession. The recessive impact of the government's anti-inflationary measures, a normal and expected result of such policies, has been high. The gross national product is continuing to fall with its greatest impact on industry, which shrank this year alone by 15%, according to current government estimates. As the public's purchasing power drops, production for the domestic market of all but basic necessities suffers most. Real salaries have fallen substantially even since June. The industries least affected are those that could turn to foreign markets, such as the chemical industry. Agricultural production for the domestic market has also dropped compared to last year, partly due to this contraction in demand.

Donations. International food donations are a mixed blessing and are partly responsible for the drop in agricultural production. While on the one hand they increase supply and thus hold prices down, donations can also provide a disincentive to domestic production. When supplies are high and public buying power is low, demand drops substantially. Due to large donations of powdered milk, for example, national milk production has fallen to about 1/3 of 1986 levels. To avoid undercutting the domestic market and domestic production, some donor agencies require that their donations be sold at national prices. But in a severe recession, the public can't afford to purchase some products even at national market prices.

There are two powerful incentives to continue receiving donations, however. One is that it makes products more available. In addition, the sale of these donated products, a common practice fully accepted by the donor agencies, helps finance the fiscal deficit. Both factors fight inflation.

Exports. Exports increased substantially in some products this year, a trend expected to be even more significant in 1990. However, this is due not so much to increases in production as to the contraction of the domestic market. Beef exports, for example, more than doubled from last year's 22 million pounds to approximately 50 million this year, while total beef production rose only slightly.

Production in many export crops has increased, though most of the effects will be seen in next year's harvests. Coffee, tobacco, banana, sugar, mining and lumber production have all increased total output. Coffee prices, however, have dropped substantially since last year, from approximately $125 to $85 per 100 pounds. In spite of a small increase in production, Nicaragua expects to lose $28 million.

The fishing industry also increased production relative to last fall, but largely because hurricane Joan devastated the industry last year. Processing plants, currently operating at low levels, are still being rebuilt. The greatest increase is in sesame production, where the area in cultivation almost doubled compared to 1988, from about 45,000 to 85,000 acres.

The coming months

In addition to the tensions of the agricultural production cycle and Christmas, the elections will strain the anti-inflationary programs. Foreign financing has only covered a small part of the costs, putting tough demands on the national budget. A campaign period is a difficult time to maintain harsh anti-inflationary policies. State workers' demands for salary increases and producers' demands for credit will prove a challenge to resist without printing money.

Long lines at the bank to buy dollars are also an indication of possible problems to come. Nicaraguans are aware that prices rise this time every year, and low interest rates on córdobas make dollars a better investment. But as long as the bank's supply can't meet the demand, black market speculation on dollars will increase. So far, the black market seems to be operating minimally and sporadically, responding to daily circumstances. Some economists feel it will continue this way; others see a possible inflationary chain resulting from a rise in the price of the dollar on the black market. Many salespeople set their prices by the exchange rate in the black market, not at the bank. Higher prices mean greater demands for salary increases, and so on.

To address this concern, the government recently reported that the exchange rate for córdobas would be tied directly to the market value of dollars and will rise and fall daily, based on supply and demand. With newly arrived foreign financing for the economic stabilization plan, the banks now have a greater supply of dollars and have removed ceilings on the amount of dollars any one person can buy. These new measures should serve to control, if not defeat, the black market.

What options does the government have to confront other inflationary tensions over the next few months? Ample foreign funds to finance the stabilization measures, were they available, would be the ideal solution. And though President Ortega's recent visit to several Arab nations is rumored to have resulted in promises of some $20 to $30 million, this money will probably not come in immediately and only offsets the loss of coffee’s international market value.

Other options pose serious risks. Reducing the fiscal deficit would mean layoffs right before Christmas and the elections or else cutting military spending at a time when contra attacks are again increasing, while hiking interest rates on credit would break some basic grains producers, whose income wouldn't even cover their costs, and would provide a major disincentive to exporters by slashing their profits. Another alternative is to raise the sales tax, already 10%, at the Diplomatic Store, where all sales are in dollars. The government's most likely action, says Grigsby, will be a combination of all the possibilities in order to spread out the effects.

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