Nicaragua - Economic Recovery Credit Project

;>OCXtan ; 4I14: I (;J,' )1-1 ( ThieWorl 'Mc N'T1.-.><, I !.@e ; IVV'3y:. (1'1:. The Worw 'I Vh A,M~' FOR OM1CIM] Report No. P-5598-NI REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED ECONOMIC RECOVERY CREDIT OF SDR 83.5 MILLION (US$110 MILLION EQUIVALENT) TO THE REPUBLIC OF NICARAGUA September 3, 1991 This document has a restricted distribution and may be used by recipients only in the performance of their official duties Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOU IVA;ENTS (as of August 30, 1991) Currency Unit - Cordoba USs1.0 = C$S US$0.20 c C$l FISCAL YEAR January 1 - December 31 ABBREVIATIONS AGROEXCO = Agriculture State Export Company AFA = Rice, Beans and Sugar Food Package APP = People's Property Area BANIC Nicaraguan Industry and Commerce Bank WIN = Nicaraguan Mortgage Bank BND = Nicaraguan Development Bank BP = People's Bank CAFENIC = Nicaraguan Coffee State Trading Company CIT = Corporate Income Tax co = Cordoba Oro CORFIN = Nicaraguan Financial Corporation CORNAP = State-owned Corporations Holding Company CPAR = Country Procurement Assessment Report ENABAS = State Agricultural Marketing Company ERC = Economic Recovery Credit FASO = Fund for Assistance to the Oppressed FISE = Social Emergency Investment Fund FNI = Nicaraguan Investment Fund GVT = General Value Tax ICB = International Competitive Bidding IDB = Inter-Amer'.can Development Bank INAA = Nicaraguan Institute for Water and Se0trage HATONIC = Nicaraguan Cattle/Slaughtering Holding Company MDP = UNDP Management Development Program OECD = Organization for Economic Cooperation and Development PMA - Mother-Children Nutrition Program PTI = Personal Income Tax RUTA = UNDP/IBRD Regional Unit for Technical Assistance SCT = Selective Consumption Tax SOE = Statement of Expenses UNDP = United Nations Development Program USAID = United States Agency for International Development  FOR OFFICIAL USE ONLY NICARAGUA ECONO2!C RECOVERB CREDIT PRESIVENT'S REPORT TABLE OF CONTENTS Paae No* Credit and Program Summary .. .4.. Part I. ECONOMIC ISSUES, PKLICIES, AND IDA ASSISTANCE STRATEGY . 1 Background.. . 1 Recent Economic Developments . . . . . . . . . . . . . . 2 Need for Adjustment and Constraints. 4 The Government's Strategy and Program for Stabilization and Adjustment. 6 Strategy for Renewed Growth . . . . . . . . . . . . 6 The Stabilization Program. 6 The Structural Adjustment Program. 7 medium Term Prospects .. IDA Assistance Strategy.. . 11 Part II. THE GOVERNMENT'S STRUCTURAL ADJUSTMENT PROGRAM . . . . . 13 Public Sector Reforms ..... . ....... . 13 Financial Sector Reform ........ 19 Reforms of Systen of Incentives ........... . 21 Social Sector Requirements and Poverty Alleviation . . . 24 Part III. THE PROPOSED ECONOMIC RECOVERY CREDIT . . . 26 Objective and Size of the Credit . . . . . 26 Conditions for Tranche Release . . . . . . . . . . . 26 Procurement, Disbursement and Auditing . . . 28 Co-financing and Aid Coordination . . . . . . . . . 29 Relations with International Financial Organizations . . 30 Technical Assistance .............. 30 Benefits and Risks . . . . . . . . . . . . 31 Part IV. EXTERNAL FINANCING REQUIREMENTS ............ 34 IFl Arrears Clearance ............... . . 34 External Debt Overhang. . . . . . . . . . . . . . . . . 34 External Resource Requirements . . . . . . . . . . . . . 36 Part V. RECOMMENDATION.. ... . . 37 This document has a restricted distribution and may be used by recipients only in the perfo-manc, t rf Au.h MfRmi,.l ,it... lc n..mo nnt nthAvwiqe he disflced without World Bank auth_: 2X!  paSge No. ANNEXES A. Economic Indicators . ....... . . . . . . . . 38 B. Social Indicators . . . . . 50 C. Government Letter of Development Policy . . 52 D. Matrix of Actions ... . . . . . . ...... . . 64 E. Supplement&ry Credit Data Sheet . . . . . . . . . . 73 F. Status of Bank Group Cperations . ......... 75  NICARUAG ECONOMIC RECOVERY CREDIT CREDIT MND PROGRAM SUMMARY Borrower: Republic of Nicaragua Amount: SDR 83.5 million (equivalent to US$110 million) Executing Aoencies: Ministry of Finance and Ministry of Economy and Development Terms: Standard IDA terms with repayment in 40 years. and ton years of grace. E55Degription The proposed loan would support the Government's structural adjustment program, which is designed to (i) downsize and restructure the public sector, including the privatization of state- owned companies; (ii) reform the financial system to improve resource allocation/ mobilization through establishment of a competitive environment with private sector participation; and (iii) reform the incentives systems by eliminating barriers to private sector entry to production and trade, liberalizing trade, domestic price controls and other regulations. Benefits: The implementation of the structural adjustment program would promote growth through increased private sector participation, improved incentives for production and a more efficient allocation of domestic resources. It would also increase employment opportunities and help alleviate poverty. In addition, it would facilitate the flow of external financing and foreign investment. Bisks: The principal risks are weaknesses in institutional capacity to carry out the program, resistance on the part of organized groups to fiscal and financial restructuring, slow private sector respoase due to uncertainty regarding the property rights, and shortfalls in timely donor support.  - ii - Disbursements: The proceeds of the loan would be disbursod in two equal tranches of SPR 41.75 million (US$55 million equivalent) each: the first tranche upon effectiveness (with retroactive financing of up to SDR 41.75 million), the second tranche after a satisfactory performance review expected around March 1992.  REPoRT AND fEClowENDATION OF 58s PRESIDENT OF TEI TWIERATIONIL DOVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED ECONOMIC RECOVERY CREDIT OF SOR 83.5 MILLION TO TEE REPUBLIC OF NICARAGUA 1. I submit this report and recommendation on a proposed credit in the amount of SDR 83.5 million (US$2.10 million) to the Republic of Nic_ragua. The credit would be on standard IDA terms, with repayment in 40 years, including a 10 year grace period. The credit would support an economic recovery program aiming to achieve economic stabilization and renewed sustainable economic growth, as well as an improvement in living standards. The credit proposal follows the recent decision to declare Nicaragua eligible for IDA credits (IDA/Sec. M 91-131, dated April 16, 1991). The proposed operation would be co-financed with concessionary funds from the Inter-American Development Bank (IDS), the Japanese Government, the German Government, and the Swiss Government (para. 103). 2. The IDA credit would be the first to Nicaragua since 1980. Following the past decade of Sandinista rule, the February 1990 elections brought the Chamorro Government to power. The new Administration approached the Bank and IDA to support its stabilization and recovery efforts after a six-year interruption in relations between the two institutions. Since April 1390, Bank staff visited Nicaragua on several occasions, assessed the economic situation, and discussed with the authorities the elements of a program for stabilization and adjustment. The Bank and IDA also coordinated donor support, including Consultative Group meetings in Paris on December 3-4, 1990, and May 16-17, 1991. In the latter meeting, the donors agreed on a financial package to clear the arrears to the World Bank and the IDB. The Government resumed debt service payments and froze the World Bank arrears at the May 1991 level. The International Monetary Fund (IMF) is helping the Government to monitor a Stabilization Program launched on March 3. 1991. A stand-by arrangement, based on a track record of program implementation, is expected to be presented to the IMF Board during the first half of September 1991. The Government is also requesting Paris Club assistance for debt relief. 1. ECONOMIC ISSUES, POLICIES. IDA ASSIS CE aTEGY Background 3. The Chamorro admin'stration inherited from the Sandinistas a devastated econom-y. Production was well below 1980 levels, exports ran at  about half of the pre-1980 leviel, hyperinflation was about 4,700 percent in 1989, international reserves were depleted, and debt had accumulated to around US$9 billion by late 1989. The administration has also inherited an oversized and extremely inefficient public sector which has crowded out private sector participation through a deep involvement in economic activities, and ownership of productive means. Many skilled technicians and managers had left the country. The tasks of achieving stability, economic revival, and the other prerequisites for sustained growth appeared daunting. Moreover, the economic agenda iad to be pursued in the environment of a fragile political peace. 4. During the preceding decade, the Sandinista government tried to establish a centrally controlled economy. Many privately-owned undertakings were confiscated or expropriated. The financial and external trade sectors were nationalized. The small remaining private sector was heavily regulated. Inappropriate macroeconomic policies and price controls distorted resource allocation. Gross inefficiencies in resource use resulted. Public sector expenditures trebled over the decade, reaching an average of 57 percent of GDP in 1983-87. The Government's resort to Central Bank financing fueled an inflation level which reached 14,300 percent in 1988. The contra war and a United States trade embargo compounded problems. Consequently, the GDP grew only moderately at the beginning of the 1980s. and declined every year beginning in 1984. Table 1 illustrates the economic deterioration of the 1980s. TAble 1 VICACU - GEOB MACDBOCONWC I10?d. 1979-1990 179-83 A1 1984 1985 l986 1987 1988 1969 1990 Annu.L teal Crowtlt fate op -2.3 -1.6 .4.1 -1.0 .0.7 -1U.0 -2.8 -4.4 Total CGeuu