Nicaragua's economic development problem and credit worthiness

 RETURN TO No. E 155a REPORTS OESK RESTRICTED \'VITHli\! ONE VvEEK 67080 This report is restricted to use within the Bank. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT NICARAGUA'S ECONOMIC DEVELOPMENT PROBLEM AND CREDITWORTHINESS ... May 25, 1951 ~"'l''''ll -0 R tl HI" I Economic Department Prepared by: Albert Waterston pnr~i~?t, ;~~~··~n;~~ri("~,~r~ lI...:,\j'.....H "';;H)I..I>V ... : f ~ _ _ _ _ .... IC".""'.IZ"tz:<T7t''''''':,~ t • TABLE OF CONTENTS Page Basic Statistics Charts 1. Conclusions i I. Major Characteristics of Nicaragua's Economy ••• 1 IIo Impediments to Economic Development •••••••••••• 3 III. Possibilities for Economic Development ••••••••• , IV. Internal & External Finances ••••••••••••••••••• 9 v. Needed Fiscal & Financial Reforms ............... 13 VI. Capacity to Service Additional Foreign Debt •••• 14  NICAR~GUA BASIC STATIS~ICS , . Area 50,000 sq. mi. Population (1950) , 1,05.3,189 currency (selling Rates) 7.05 cordobas US~l = 1 cordoba US$0.14 = = 1 million cordobas uS~plhl, 844 International Reserves Gross Net . Dec. 31, 1949 ~3.7l million $0 0 96 miD.ion Dec. 31, 1950 $.3.43 million $1.05 million Eoney sunply (end of year) 1940 19u9 1950 (Millions of cordobas) 23 .. 6 113.1 122.7 Balance of Payments (Current I\~ount) 1949 ~)1.3 million 1950 -$4.0 million (estimated) Government Fin~nce (millions of cordo~) 1949-50 1950-51 (est.) Receipts 65 66 Expenditures 60 64 ----r3al ance 5 - 2 External Debt JanuarYI95! ~4 million Internel Debt pecember 1950 27 million cordobas era million) . Exports (195'0) Excluciing gold ( 26.6 million Gold $ 7.5 million ~orts (1949) ,;2503 million Prices (Retail Food) December 31, 1940 :: 100 December 31, 19W -=-.31>  NICARAGUA DISTRIBUTION OF POPULATION NUMBER OF INHABITANTS PER PER SQUARE KILOMETER, 1950 SQUARE KILOMETER, 1950 o 20 40 EL SALVADOR GUATEMALA 7· I COSTA RICA ::.:-:. CENTRAL EAST ·;W%;. . HONDURAS ~!1 tl'tiI0iI'1i ~C~ ;/%{;c'·;/i/";"'............ NICARAGUA TOTAL EXTERNAL TRADE, 1949 VALUE fN MILLIONS OF U.S. DOLLARS VALUE PER CAPITA IN U.S. DOLLARS 150 100 50 0 o 50 100 COSTA RICA xx .xx HONDURAS PARAGUAY x GUATEMALA EL SALVADOR ~:iEilll NICARAGUA J REVENUES AND EXPENDITURES l MILLIONS OF CORDOBAS) 100~----------------------------------------------------~10( YEAR ENDING JUNE 30 50~-4--~------ ~~Wr----------~50 O!....-~ --'----IO L.....t.o~............L.-.l.-.I......I......... 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 {Prelim.) {Prelim.l No.550 I.B.R.D. - Economic Dept.  NICARAGUA MONEY SUPPLY AND FOOD PRICES: INDEXES (INDEX, DEC.31, 1940 = 100) 600~~~-r~~~~~~-. 600 END OF PERIOD MONTHLY 400 ' - FOOD PRICES 400 200 t11fI' ... ......... ~ ,---... -----.".. •••••• ~ "'-. ....................... 200 ·-~···"······U.S.RETAIL FOOD PRICES 0~~~~~~~~(I~94~O~=~IO~O~)~ '40 '42 '44 '46 '48 '50 ' 52 D J D J D J DO 1950 1951 1952 TOTAL EXTERNAL TRADE (MILLIONS OF U.S. DOLLARS) 40~~~~~~~~~~~~~~ ~-­ YEARLY TOTALS QUARTERLY TOTALS Scale is 1/4 of annual scale c- - - - - \ -5 TRADE BALANCE (MILLIONS OF U. S. DOLLARS) +20~~~~~~~~~~~~~~ YEARLY QUARTERLY Scale is 1/4 of annual scale 1 O~~----~~------------~--~ ~----~--~--------~--------~O -20~~~~~~~~~~~~~~ II III IV I II III IV , 1/ III IV - 5 '37 '39 '41 '43 '45 '47 '49 '51 1950 1951 1952 COFFEE: AVERAGE. PRICE PER COFFEE EXPORTS POUND (UNIT VALUE f.o.b PORT) 600~~~~~~~~~~~~30 ~~~-r~~~~~~~-.60 u.c.n VOLUME 0 a:: (CENTS) YEARLY ~ 400 (LEFT SCALE) 20 ~:s 40 ~ -+- I 25 ~ 200 VALUE~... I 10 j~ 20 o (RIGH~~~!=l.~ ....... ' ... / i~ o - o ~~~~~~~~~~~~~O '39 '41 '43 '45 '47 '49 '51 '39 '41 '43 '45 '47 '49 '51 SESAME EXPORTS:VALUE (MILLIONS OF U. S. DOLLARS) '-'--'-'--'-'-~~--'-'-~-'5.0 YEARLY ~~~~~~~~~O '41 '43 '45 '47 '49 '51 No.551R I.B.R.D. - Economic Dept.  NICARAGUA BALANCE OF PAYMENTS (MILLIONS OF U.S. DOLLARS) o 10 20 30 40 1938 TOTAL RECEIPTS PAYMENTS TRANSACTIONS OF 1947 FOREIGN MINI G COMPANIES TOTAL RECEIPTS PAYMENTS 1948 TOTAL RECEIPTS PAYMENTS 1949 TOTAL RECEIPTS PAYMENTS 1950 TOTAL RECEIPTS PAYMENTS GOLD AND FOREIGN EXCHANGE ASSETS (MILLIONS OF U. S. DOLLARS) 8 . .-.-..-~,,-..-.-. ., , - . . END OF PERIOD TOTAL 6 6 4 4 2~m=U GO L 0 >OO<J<X o '37 '39 '41 '43 '45 '47 '49 '51 0 J o J o J o o 1950 1951 1952 No. 552 I.B.R.D. - Economic Dept.  NICl\R~HUA IS ECON01rrC DEVELOP1\;}ENT PROBLEi''r. .t1!-ID CREDIr;;ORTHI1:IESS 1. Conclusions The key to higher standards of living in Nic!iragua lies, not in any considerable expansion of industry, but in the development of more efficient agricultural methods and the opening up of new productive areas. Increased mechanization to lower costs, reduced losses of grain through the building of proper storage facilities, and the construction of a highv.ray system to permit easy mobility between zones of production and consumption are of the highest priority in promoting economic development in Nicaragua. Under existing conditions in Nicaragua, hov',ever, even a relatively small development program is likely to aggravate inflationary tende:::lcies unless compensatory measures are taken. Consistent budget deficits over several years and almost exclusive use of bark credit as a basis for capital formation, have inflated money circulation and prices, reduced foreign exchange r9serves to the vanislling point and introduced disequilibri~~ in the balance of payments. Althou.gh results from a nevi exchange control law appear to be proL;ising, the inflation continues with little abatement. TJnc.erlying the fiscal 2nd monetary maladjustments impeding development, and responsible for them in considerl)'Jle measure, is the vndespread ineffectiveness of the Nicaraguan fiscal, financial and administrative machinery, an ineffectiveness which can be rectified only by fundalllental reforms. The outlook for obtaining these reforms j.s good. t~icaraguan officials from the President dO';VI1 are aware of the need as indicated in the request to the Bank for 8.ssistance in this enterprise. Poli tica1ly, the si tuaticn is also promising, there appearing to be a good chance that a ;?rogram of reform could continue without interru9tion for years to come. -1.... < • In spite of a favorable outlook for exports" the extent of !!icaragua's capacity to absorb and service additional external debt depends in the short-run an the i'lillingness and ability of the Government to adopt the internal reforms Which would relieve pressure on the balance of payments.· Nicaragua1s foreign debt is small and is scheduled to be liquidated by 195'7. Total service payments in 195'1 amount to 4.4"1, of 195'0 exports 8.nd decline progressively each year hereafter. If then, as now appears reasonable to expect, the Govern'1ent takes the neoessary steps to maintain balanced budgets and to curb the expansion of money in circulation, Nicaragua should not find it burdensome to assume additional foreign debt of about ~6 million to finance the construction of roads, nechanize a part of its agriculture, build grain storage facilities and for worthwhile projects. It is expected that disbursements for the projects to be covered by IBRD financing y.lill be made over a two- year period. hith the contemplated periods of grace, the service on these loans will raise only slightly the service above present levels and r,ro'Jld not represent an appreciably higher burden. Over a longer period of time, Nicaragua TS credi tWort:1iness for 8ddi tion- al lpans will depend on the formulation of a program of eco!'omic develo?ment which "would open up new lcmds to cultivation and increase out~Jut on existing farms and plantations through the application of improved a.gricul tural techniques"  NICARI\GUA. 'S ECONOl;!IC DEVE10PKENT PROBLEM ftND CREDITfJORTriINESS I~ Major Characteristics of Nica+~gU:'lj~ Economy • Nicaragua, like most Latin American countries, presents characteristics common to non-industrialized countries" It is predominantly an agricultural and pastoral land, with most of the population engaged in producing coffee, field crops and livestock, principally cattle and hogs. Coffee is the principal crop and the most valuable export, averaging between 50 and 60 per cent of total expo"'ts.. Unlike most of its coffee.,..,prod'l.',cing neighbors, how- ever, Nicaragua exports substantial quantities of other crnps (cotton, sesame seed, rice) and an appre'.!iable number of cattle.. Gold production has been important since colonial days, but only a fraction of the exchange value of gold exports is realized by the Goverrnnent under existing contracts with foreign mining comp:mies. .A some"what similar 8i tuation e:dsts in the case of lumber, which is also exported in the main by foreign concessionaires. Although agricultural processing (sugar mills, cotton ginning, vegetable oil extraction) and consumer goods industries (cigarettes, soap, cotton goods, shoes, furniture, matches, beer, soft drinks) have expanded considerably in recent years, production is largely flcottage industryll in homes or small shops employing a few artisans and usually require tariff protection to survive. There is also a small high cost cenlent pla.nt in operption. "With the largest area and next to the sln?llest population of any Central American country, Nicaragua has only 7 inhabitants to the square kiloueter, Qompared. with 10 for Honduras, 12 for Costa Rica, 31 for Guatemala and 38 for El Salvador. However, the two mountain ranges 'which traverse the country from northwest to southeast and the absence of roads over these natural barriers, have caused most of the population to concentrate on the western side of the country. Consequently, with 41 persons to the square kilometer,  -2- western Nicaragua is more populous than El Salvadoro By contrast, the Atlantic Coast region averages only 0n6 person per square kilometer. Most Nicaraguan farmers produce f0r their own use and are almost com- pletely removed from the money economy. Nonetheless, the production of crops for export plays an important role in Nicaragua's economic well-being and is the most important cash-producing activity in the country. The loW' degrees of industrialization and economic diversification make Nicaragua dependent on a long list of manufactured goods imports, Nicaraguats external trade, however, is lower on an absolute or per capita basis than that of any other I.atin .I\merican country. There are a sufficient n~~rof reasons for the depressed standard of living in tacaragua, but vrith over 80% of the arable soil still unused be- cause of the lack of access roads, scarcity of land cannot be considered one of them. The high rate of mortality from malaria, dysentery and other insect- borne dise2.ses has limited population growth, devitalized large n1U:1bers of people, and caused a chronic shortage of agricultural labor which has been aggravated recently by the movement of workers to tile citieso 'Hith an illiteracy rate of 70%, it has been difficult to train specialized workers and there are not enough technicians in the country" Primi ti ve far'ning !:lethods with obsolete implements account for low yields, high losses, and poor quality of produce. Between one-third and one-helf of the grains frown in Nicaragua are destroyed by fer:nentation and insects because of t11e lack of grain-drying equipment and suitable storage facilities. Even in the growing of crops for exports, 1:yhere somewhat better techniques may be found, there could be considerable improvement in production methods. The use of fertilizers is practically non-existent. Irrigation, Which couln increase output in areas with insufficient rainfall, is employed rarely and  -3- and on a diminutive scale. Since the depression of the 30's, uhen coffee was bringing 7 cents per pound to growers, coffee plantations have been subject to widespread neglect. Consequently, Nicaraguan coffee trees yield less than one-half pound of coffee annually on the average compared to about three pounds per tree in neighboring El Salvador. II. Impediments to Economic Development Economic development in Nicaragua has been hindered by a nlli~ber of factors besides the shortage of skilled and unskilled labor, and inefficient methods of cultivation. Nicaragua's transportation system is poor, even by Central American standards. There are only about 1000 miles of highway in the entire country, all of.it concentrated on the Pacific coastal area, and half of this mileage is unusable in the rainy season. Almost all of the eXisting paved highway is the Inter-American Highway, 'which has !:teen con- structed more with international objectives th8.n with internel needs in mind. The complete lack of any road linking the Atlantic and Pacific sides of the country leaves large sections of the c0untry ~~thout connections with the populous western part of the country. A road joining east and west is now under construction and requires another 100 kilometers to complete, but progress has been slow because of the failure of the U.S.A. to provide funds promised for its construction in accordance vdth commitments made by Presidents Roosevelt and Truman. Nicaragua's 400 miles of Govern~ent-ovmed railway trackage is also located on the Pacific coast.. The railwayfs equipment is antique.ted, its roadbed in poor condition t operating costs and rate structure high, and its ad~nistration less than efficient. Nicaragua's two large lakes, surrqunded by productive agricultural communities, are ideal natural highw~ys for the transport of'  -4- freight and passengers. An archaic system of taxation, however, has penalized lake shipping and throttled the movement of shipping. As in most neighboring countries prevailing rates of interest are high and represent a burden on production. Although a Government-ormed Mortgage Bank exists, its long-term operations have been unable to cope v:ith the demand, Continued dependence on high-rate short-term credit to f:l,nance long-ter:l1 agricultural operations has been a feature of Nicar<3.guen finance. Tne three private co~~ercial b~~s in the country make relatively minor contributions toward promoting agricultural production, the me.jor credit:J.edium being the Centfal Bank, operating through a commercial department which extends about 75 per cent of all banking loans. Such local capital as exists is either held abroad or invested in speculative ventures. Lack of confidence in the countT'lJ and in government policies has stifled enterprise and depressed the level of economic activ~ty. The sea.rch for iIlll!lediate returns has dominated investment and prevented the building of a permanent and progressive agriculture. Few ovmers of coffee plantations live on their properties, most preferring the life of a trader in the to'ims. For many years Nicaraguans have been diverted from agricult'Jl'al pursuits by the possibility that an inter-oceanic canal might be built across their country~ Preoccupation with this intriguing potentiality has resulted in the settlement of less productive areas of the COl,lntT'lJ (which largely accounts for the marked concentration of ~pulation in and around M~nagua) and the isolation of much of the country 1 s productive areas. In spite of existing legislation which gives many advantages to foreign investors and the almost complete lack of anti-foreign feeling, Nicaragl,la has not been able to attract a large amount of investment from abroad. The United Fruit Company formerly produced and exported SUbstantial quantities of  -5- bananas until the progress of banana diseases forced it out of production. Foreign investment is presently limited almost er.tirely to extractive industries (gold mining and lumbering) under concessions which hl'lve had little effect on the country's balance of payments in spite of the fact that substantial amounts of gold and lumber are exported each year.. Although gold exports have increased, the sale of foreign exchange by mining compp.nies to the National Bank has been diminishing stead,ily, so that in 1950 they sold. only 40 per cent of the exchange delivered in 1948. As in other central American cowitries, the development of Nicaraguan industry is limited by the small size of the domestic market and the absence of primary materials. llore immediately, however, industrial expansion is virtually precluded by an acute shortage of electric power and the high cost of such energy as is available. In the entire f"'ountry, the installed capacity for generating electricity does not exceed 6000 kwts. Umost 60% of l'Iicaraguals electric power is produced by diesel plants using imported fuel oil. Nicaraguans contend that the rivers and volcanoes of the country could becorae the source of ample supplies of hydroelectric and geAthermal power, but possibilities cannot be gauged intelli;::entJ.y until a detailed study of reSf)urces has been made. F'ortunatf~ly for Nicaragua, an eight-men team from the U. S. Dept. of Interior is undertakinr, such a survey as a part of the U.S. Technical Aid Program. If the investigation should reveBl that the development of a source of cheap power is feasible, progress for sorn8 industries may become possible. It is unlikely, however, thClt Nicaragua will require large am0unts of power in the foreseeable future. III. Possibilities for Economic Developmen! There is undoubtedly room for further grQwth 0£ industry, but to be ecnnnmic it would have to be limited almost entirely to industries producing  -6- c~nsumer goods or to those engaged in processing domestically-grovrn agricultural products. Prospects would appear to be g~od for a modern oil extraction. plant for sesame seed (extraction factories already operate in the country but they seem to be unable to compete ~~th foreign plants).' Increased local manufacture of cotton textiles, greater utilization of cotton- seed for oil, and the feeding of residual cake to cattle would greatly improve the long-term outlook of cotton gro'Ning in Nicaragua, and reduce the drain on foreign exchan~e resources. Most of the cotton produced in Nicaragua is s~ld abroad, the amount in19~ totalling 01.9 million. On the other hand~ c.tton textile imports amount to over ~~4.5 million per year, about 20% of Nicaraguafs imports. Nor does there seem to be any reason why Nicaragua CQuld not eliminate the import of coffee and sugar bags, rope, cord and twine by manufa.cturing its own products from native henequen. ' Some henequen is already grown in Nicaragua and it would not be difficult to increase production. Possibilities also appear good for the use of Nicaragua's abundant supplies of mahogany and other tropical woods in the fabricativ~ of furniture, plJ~ood and veneers. Cattle raising for export has always been important in Nicaragua, and it would appear reasonable to expect that ,pp.rtunities exist for the production of meat and milk products" Nevertheless, the key to htgher standards of living in Nicaragua lies not in any considerable expansion .f industry, but in developing a more scientific approach to agriculture and animal husbandry. An FAO f;iission recently estimated that Nicaragua pOssesses enough good soil to support at least three times the existing population if agricultural methods were improved! The scattered distribution of the people in the central and eastern parts of the country, taken in conjunction vdth the FAa anal~rsis of agricultural potent1alities~ clearly suggests unusual opportUnities for immigration. Paradoxically, Nicaraguans now emigrate to surrounning countries" particularly Costa Rica, because of the lack of economic opportunity in their orm countryolt In order to improve agricultural methods, ways must be found fer cutting costs of production which have risen steadily because of iaefficint methods of cultivation and the shortage of nanpower. In many parts of the country) a considerablt:1 improvement of technique could be obtained simply by repla.cing the stick or machete by an ox-dra\\'Il plow or modern hand tools. There are, however, room and need for greater utilization of tractors and other mechanized equipment to counterar.t the scarei ty of labor.. Gre~ter mech;:mizaticn, particularly on the nat, fertile Plain of Leon in western Nicaragua., could pro:note higher production, better quality and lower costs to improve the com- petitive position of Nicaraguan agricultural commodities in internCltional markets. Tractors and attachments :'ire being used successfully at the present time, but there is a shortage of drivers and mechanic::;, as there is of other specialized v:orkers. However, the major obstacle to incri]8sed mechanization periods long enough to oermit has been the lack of agricultural credit for - '" ::;:) .~, farr.:ers to amortize payments for equipment over the working life of the Although Nicaragua needs to produco :nore, it is ;nore lOsical to arrest, and if possible eliminate, the wastage of food alreCldy produced before trying to grow more. The FAD has concluded th8t annual destruction of grains valued at a minimum of \,500,000 makes the establishment of faoili ties f0r grain storage an urgent need of the coun:'ry. Proper measures ta]<:en in this field would give quick returns by inereasin;;; the amcunt of food available for domestic consQ'TIption and export. The construction of an adeqUAte highwCl.y system to permit easy mobility between zones of production and consumption is a necessary preliminClr"J to the economic and social unification of Nicaragua., Because of poor cQmmunic~tions between the western and eastern parts of the country~ English rClther than S}anish is spoken on the Atlantic side, and coffee in cans import:~d from the United States is consumed there instead of the product gro,m in western Nicaragua. In the more populous west, roads are needed to increase food supplies for intern(ll consumption and export and to reduce costs of prodllc- ticr. and distribution. nhile corn rots on inaocessible farms,. th~ pril";G of grain rises in the tovms. Since product"i.on areas are not connected vrith processinf, centers, sizeable quantities of coffee either never reach processing plants or deteriorate on the dow muleback journey to the plant. Nicararua possesses the largest unused coffeeland reserves in Central America. They are not utilized because of the lack of roads.l'he F~D }lis~ion estimated that the existing 67 million coffee trees could bei..ncreased to almost 100 million if transportation facilities could be extended to new lands. If, 1:18 the F ~O aL'o reports, wheot production could so be oxp;>nded on such ll'lnds, "'he2t imports (now exceeding :.1 million per annu.vn or 5;; of total c;ollar imports) could be reduced with corresponding savings in foreign exchA.nge.. The unused 12L1ds also appear suitable for mixed farming and the gro'\l\'ing of citrns 2r..d other tropical fruits. A road construction program which would open Pl0St of Nicaragua I s proJuc ... ti ve areas and connect them with consumption centers a.nd ports will ne:::cssarily take a long time to complete. The projects submitted to the Bunk for finaneing are a modest beginning toward realizing these objectives. Nevertheless., the economic effect to be expected from their completion likely to be profound. The need for developing tlle country' sa.gricul tural resources is wcll- recognized in Nic.:lr8gua, al thou~h annual government ex)encli tures on agricul~ure between 1946 and 1948 amounted to only 1..5?S of the 'total budget. At the present  -9- time agencies in the ;~inistry of Agriculture, the Ministry of ;"conomy, the National Bank, the "Iortgage Bank and other bodies, are engased, al thO'lg;1 50mevrhat haphazardly and without coordinAtion, in attempting to promote agricultural production. It is encouraging that, plans are being made in Nicaragua to unify these activities in a nm'[ development institute whj,ch wouldb~ empo'wered to prepare an integrated development pro,";ram for the country. IV. Internal and External Finances If Nicaragua obtains funds for road construction, the major factor limiting the speed vlith which the projects can be completed ",ill be the availability of labor. Under present conditions of full employment of labor which exist in Nicaragua, even a minor increase in highway construction is likely, by bidding up workers I incomes, to be inflationa~J unless com- pensatory action is taken by the authorities. By itself, additional annual expendi tures of about ~)4oo,ooo for local currency requirements for highway construction should not create any difficult problem. Nicaragua can hardly afford any further aggravation of the powerful inflationary forces which threaten its economy and retard development. t;onsistent budgetary deficits over a half dozen years and almost exclusive use of bank credit as a basis for capiteJ. forDation have inflated money circulatioI and prices, reduced foreign exchange reserves to the vanishing point and introduced diseq'lilibrium in the balance of pa;)'111ents. 11s a consequence, Nicaragua has found it necessary to establish import quotas and licensing, exchange regulations and other systems of control. Between 1942 and 1949, budgeta.ry cefici ts totalled 48 million cordobas ($9 million). These deficits were covered in large part by borrovJings from the Central Bank, to which the Government is still indebted for oVer  -10- 27 million cordobas (1:;3.9 million). The budget for the year ending June 1950 showed a surplus (of 5 million cordobas or Sl million) for the first time in many years, largely because increased imports raised customs receipts above expectations. The official budget for the 1950-51 fiscal year indicates a deficit of 2.3 million cordobas CO.3 million), but increased revenues will probably result in balancing the budget~ Deficits in recent years have to some extent been due to an expansion of public services and the construction of roads. However, visible alloca- tions for Hicaragu8' s military, police and av;.ation forces (tl-.e largest and best equipped in Central America) exceed 2r)~~ of the current bud-:;et and the tot2l amount spent in this category may actUally exceed 301, of government disbursements. Pu.blic debt payments account for 9.5% of the budget. The supply of money in circulation has been rising steadi],.y, mostly in the form of deposits, and at the end of February 1951 was over 17'0 above the year before and almost 70<; higher than at the end of 1945. ?fost of the in- crease in the quantity of money in circulation since 1945 has originated from budgetary deficits and credit expansion. 1.1ore recently, the rise in export prices, has contributed to the expansion of money ,,,nd deposits, )artic'clla.rly since no real attempt has been made to sterilize, even te~:lporarily, hiv,her incomes arising from the increase of export prices. In the absence of dependahle statistical data it is not possible to be certain, but competent ob.'3ervers agree th2.t internal prices appeAr to have risen to a greater extent in ncaragQa than in other Centralilmerican countries and that tlJ.ey are con- tinuing to increase steadily.  -ll- B<acauae of its social and economic structure .. Nicaragua (like other Latin American countries) has a high tendency to import. The steady rise in the money supply after the war stimulated this tendency and placed the cordoba under increasing pressure. In order to reduce imports, stringent exchange and ~mport controls were applied in April 1949. These controls proved ineffective partly because of ineffective administration, but largely because of the failure to reduce the amount of money in circulation. The exchange law of April 1949 sought to obtain an over-all 2r;';; reduc." tion in the amount of credit outstanding by setting ceilings on commercial bank lending for imports and miscellaneous purposes at half the levels of Harch 31, 1941. VJhile loans for these purposes have been kept within legal limits, other lending has more than made up for the decline in import and miscellaneous loans. As a consequence .. total outstanding loans to business and individua:s increased from 65 million cordobas (~~13 million) at the end t)f Harch to 88 million (~~18 million) at the end of February 1951, and Central Ban.l{ discounts from 35 million cordobas (~67 million) to 65 million (813 million), It would have been no easy matter to reduce or even '1lainta,in bank credits at March 1949 levels in a period of rising export and domestic prices. ~!Iore­ over, it is difficult to differentiate among transactions for the purpose of ap;:>lying selective credit controls in Nicaragua, where a trader may be importer, exporter, local merchant and real estate s~eculator. Nevertheless, a share of the responsibility for the failure to curtail lending must be attributed to the fact that credit faoili ties are larg~lY concentrated in the National BalLI{ of Nicaragua, where the commercial department and export-import department (which finances foreign trade operations) dominate the issue department. In November 1950, Nicaragua established new foreign exchange controls. These measures Provide for an effective rate of 7 cordobas to the dollar (in- stead of 5 to the dollar), imposesul'charges of up to 3 cordobas to the dollar in addition on all imports except essentials, and require prior local cur- rency deposits by importers equal to 100% of the vall18 of merchandise for w~lich a license is requested. TlI'fenty per cent of the receipts from the sur"; charges are to go to amortize the government debt to the National Bank; the remaining 80% are to be held for at least six months, after which they may be used for development purposes if the inflationary situation has subsided and the foreign reserve position has improved. It is too early to determine the full effect of the new regulations but results so far appear tl) be promising" The free rate for the cordoba, which had fallen to over 8 to the dollar, now appears to have stabilized at approxi- "!lately 7 to the dollar. Reserves, which had sun!\: to a low of ~~3.314 million in OctobeJ;' 1950, amounted to $6.66 million at the end of February 1951. Although a con.::;iderab1e portion of this rise is ottributable to seasonCll factors, some of it is undoubtedly due to the effect of the new exchange lcwf. The National Bank reports some repatriation of foreign holdings by importers to meet the stringent import deposit requirements of the law. By the end of January 1951, funds frozen as deposits against authorized imports amounted to 19 million cordobas ($2.7 million), flver 10 1, of total mnney supply. 0 Nevertheless, the inflation continues w'tth little abatement in spite of these improvements. An immediate result of the imposition of surcharges on non- essential imports was a sharp increase in the price of most imported goods, which was expected, but there is no evidence that the volume of such imports has decline. ~ Since the average household budget includes imports dtrect1y or indirectly and domestic food prices he.ve been rising steadily, price inflation continues to be a serious problem in the country. In addition, the money supply continues to expand under the combined effect of higher export prices and expanding cred! t.  -13- V.. Needed Financial and Fisqal Reforms Financial reconstruction in Nicaragua depends on tl','O fundamentals: 1. Maintenance of budget equi.librium by the Governrnent, and 2. Stabilization of the money supply. The rapid increase in the means of payment and attendant price rises present a threat to budgetary equilibrium. Precisely because it is more difficult to stabilize internal prices when world prices are rising, special efforts need to be made to minimize increases in mQnetary circulc:tion. On the other hand, as long as there a danger that public expenditures are to be met by increases in the means of payment, and as long C'.8 creQit ex- pansion continues at the present rate, a stabilized currency becomes impossible, and pressure on the budget, as 1;';e11 as the balance of pey~ents, livil1 continue jl' Underlying the short-run maladjustments impeding development, and responsible for them in considerable measure, is the widespread ineffective- ness of the Nicaragu.an fiscal, financial and administrative machinery, a situation which can be rectified only by certain basic reforms. The Nicaraguan tax structure re~lires a complete overhauling. Heavy dependence on import duties (30% of ordinary governlnent revenues came from custom receipts in the fiscal year ending June 1950) makes it difficult to adopt a policy for reducing i:nports. Increased use needs to be I:J.ade of direct and eA~ort taxes as a source of revenue, particularly at a time when record profits are being made by Nicaraguan exporters, not only from the rise in world prices of coffee, cotton and other raw materials, but AS a result of the grea.ter nu.1ilber of cordobas they obtpin for their eJC:)orts under the new exchange law. It may be desirable to consider whether the Central Bank should not be freed from the responsibility of a commercial bar~ing department which  -14- overshadows the central banking function of the institution to the dis- advantage of the financial and economic welfare of the country. On the other hand, a workable credit system for agriculture needs to be established in Nicaragua to increase the flow of investment into primary production. The Mortgage Bank has never had adequate capital, and as now operated, serves a. limited number of influenti8l landovvners. The outlook for obtaining necessaI"J fiscal and administrative reforms is good. The Nicaraguan letter requesting the Bank's aid in bringing about these reforms reflects awareness on the part of the authorities that corrective meaSUTes must be taken soon to place the country's finances and economy on a sound footing. President Somoza, who has just finished the unexpired term of his deceased predecessor t entered upon a new six-year term on May 1, 1951, to which he Vias elected in the last election.. ~lhile the opposition to the Presi- dent, both a~ong Conservatives and within his ovm Liberal Party, expresses its VievlS freely, there appears to be no real threat to President Somoza's incumbency. The President has manifested a strong interest in correcting the economic maladjustments which plague the country. It would appear1 therefore, that a program of reform would have a good chance of continuing without interruption for yea.rs to come under conditions of political stability.. VI. Capacity to Service Additional Foreign Debt Except in 1949, when the coffee crop was exceptionally poor, Nicaraguan exports have shov1n a steady increase in value terms. In 1945, they a~ounted to only $6.9 million; in 1950" to about ~2S million, and they are expected to reach at least $25 million in 1951. BetWeen 50 and 60 per cent of Nicaraguafs exports go to the United States, but practically all exports are sold for dol- lars or other convertible currency. The recent conclusion of a liberal trade treaty between Nicaragua and El Salvado~ should result in increased exports to  -15- El Salvador. At the present time, Nicaraguats exports to aJ.:l other Central American countries allounts to less than 5% of it!'; total exports. Unlil~e E1 Salvador, where population pressures are making it increasingly necessary to import foodstuffs to supplement domestic production l NicaraGua grows mort of its ovm food supply. [.1oreover, while Nicaragua's prosperity depends, as in the case of other raw material producing countries, on price movements in 'V'!orld markets, its agricultural production is relatively diversified, and for this reason it is less vulnerable than such countries as E1 Salvador to changes in world deMand for a single crop'. Durinz end following vilorld Y-ar II, Nicaragua was able to expand its agriculture and grow sesame', cotton, rice and other comnodities for export. Opportunities for expanding exports appear to be good,. In recent yeArs, the export of ;nmanas, Yilhich had declined because of the spread of brmana disease, has begun to increase again. A further rise in e:xports over the next few years is foreseeable a.S a result of the acquisition by the Standard Fruit Company of a large tract of land for use in gro'V'Ying bananas. rrhe oultivation of Nicaraguan cotton, which has found a ready market in England, has been expanding in the last three years and is likely to continue as long as de'cland for that commodity remains high. Improved coffee production, the construction of effective grain storage facilities, improved mechanization of agriculture, and the opening up of new areas of production through the extension of highways could also do much to increase the quantity of commodities available for export. In spite of the favorable outlook for exports, j-,owever, the extent of Nicaraguats capacity to absorb and service additiO<1a1 external indebtedness depends in the short-run on the willingness and ability of the Gover~~ent to adopt the internal reforms Which would relieve import pressure on the balance of pa~nnents. (In 1950 Nicaragua had an estimated deficit on current account of $4 million despite record exports).  Nicaragua 1 s foreign debt is small, amounting at the end of Janua.ry 1951 to only ~~4,040,000 as follows: Bank of America $2,232,000 Export-Import Baru{ 1,016,000 Total Dollar Del;rt $3,248,000 EtFieIbUrga (sterling) 79 2 ,000 $4,040,St000 The Bank of America loan made in 1947 for $405 willian, is fully secured by Nicaraguan gold and is being serviced according to schedule. Al- though interest payments on the sterling loan have been male regularly, amortization of the loan was suspended in July 1946, but was resUL'1ed, in the latter half of 1950 by regular monthly payments as required under the agree- ment with bondholders. The Government has accumulated funds of US~~300,000 in New York and a minimum of 1,85,000 (~238,ooO) in London, which are being used to purchase bonds offered in those markets. The Government reports that such purchases are being made from time to time at about B2~ The Eximbank loan is being serviced regularly. The Eximbank and Bank of America loans are scheduled to be liquidated in 1955 and the Ethelburga loan by 1951. Total service payments in 1951 amount to :;,,1.2 million, or 4.4% of 1950 exports. Ser\i.ce payments decrease to $700,000 by 1954 and to only ~,280,OOO in 1955. If then, as nay be reasona.ble to expect, the Government takes the necessary steps to maintain balanced budgets to curb the expansion of money in circulation, Nicaragua should not find it burdensome to aSSlLrne an additional foreign debt of about 06 million to finance the construction of roads, mechanize a part of its agriculture, build grain storage facilities and other worthwhile projectso It is expected that disbursements for the projects to be covered by I3R~ financing will be made over a two-year period. With the contemplated peril')ds of grace, the service on these loans "'1'111 raise  -17... ... only slightly the ser~Jice above present levels and would not represent an appreciably higher burden. Over a longer period of time, Nicaraguafs creditworthiness for additional loans vlill depend on the formulation 'Of a program .of economic development which would open up new lands to cultivation and increase output on existing farms and plantations through the application of improved agricultural techniques • • ,