Nicaragua - Public sector expenditure review (Vol. 2 of 3) : Main report

Report No. 10785-NI Nicaragua Public Sector Expenditure Review (In Three Volumes) Volume 11: Main Report September 11, 1992 Country Operatiois Division 2 Country Department II Latin America and the Caribbean Region FOR OFFICIAL USE ONLY Document of the World Bank 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 One Cordoba (CO) = One Hundred Centesimos () 5 CO = US$1.00 (1992) FISCAL YEAR JANUARY 1 TO DECEMBER 3 FOR OFFICIAL USE ONLY Table of Aronyms AS Autonomous Entitites AFA Rice, Beans and Sugar Food Package BAU iBudget and Accountant Unit BCIE Central American Bank for Economic Integration BCN Central Bank of Nicaragua CIDA Canadian International Development Agency CORNAP State-Owned Corporations Holding ENABUS Nicaraguan Urban Bus Company ERC ftonomic fWteoery Credit DAB Directorate of Autonomous Entities (GODB-MIFIN) DAR Directorate of Rural Water (INAA) DD Director Delegates DFI Direct Foreign Investment DGIP General Directorate for Public Investment (MEDE) DP Directorate of Planning (GDB-MIFIN) ENIGAS Nicaraguan Gas Company ENIMPORT Nicaraguan Trade Company FD Financial Director FDT Technology Development Fund (MAC) FISE Emergency Social Investment Fund PSLN Fronts Sandinista de Liberacion Nacional GODA General Directorate of Accounting (MIFIN) GDB General Directorate of the Budget (MIFIN) GDI General Directorate of Information (MIFIN) GDR General Directorate of Revenues (MIFIN) GDT General Directorate of the Treasury (MIFIN) GDP Gross Domestic Product GON Government of Nicaragua GTZ German Agency for Technical Cooperation IBRD International Bank for Reconstruction and Development (World Bank) IDA International Development Agency IDB Inter-American Development Bank IMF Internationa Monetary Fund INAA Nicaraguan Institute for Water and Sewag. INATEC National Institute for Technology INE Nicaraguan Energy Institute INRA Nicaraguan Institute for Land Reform INSSSI Nicaraguan Institute of Social Security INTURISMO Nicaraguan Institute for Tourism IRENA Nicaraguan Institute for Nataral Resources LAC Latin America and the Caribbean LUBNICA Nicaraguan Lubricant Company MAG Ministry of Agriculture and Livestock MCE Ministry of External Cooperation McT Ministry of Construction and Transport MED Ministry of Education MEDE Ministry of the Economy and Development MIFIN Ministry of Finance mIGOB Ministry of Police and Internal Affairs MINSA Ministry of Health 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. NM Ministry of Foreign Affairs NTP Wediua Tem Xxpedniture Plan NTYP Medium Term Financi& Plan PPS %on-financial Public Services MeCs NOA-Governamental Organisations MORAD Norvegian Agency for Development ODA Overseas Development Aid PSTROMIC icaraguan Oil Company P00 mployownt Reduction Program PiP Public Envestment Program SILIS Local Systems of Integrated Health Services SINACAP Training National System SPP Planning and Budgeting Secretariat TNLCOR Nicaraguan Telephone Company TISA Nicaraguan Oil 2ransport Company USAID United States Agency for International Development NICARAGUA - PUBLIC SECTOR EXPENDITURE REVIEW TABLE OF CONTENTS CHAPTER I - OVERVIEW OF THE ECONOMY AND GOVERNMENT FINANCES... . . . . 1 A. INTRODUCTION................. ... . . . . 1 B. BACKGROUND................... . . . . . 2 C. OVERVIEW OF GOVERNMENT FINANCES..... ..... . . . . . 6 Overall Trends.............. .... . . . . 6 The 1989 Expenditure Adjustment. ........ . . . . . 7 The 1990 Expenditure Impulse..... ..... . . . . . 7 The 1991 Fiscal Program........ .... . . . . . 8 The 1952 Budget.............. ... . . . 10 D. COVERAGE OF THE REPORT.......... .... . . . . 10 CHAPTER II - THE STRUCTURE OF GOVERNMENT EXPENDITURES: ANALYSIS AND RECOMMENDATIONS........ .... . . . 12 A. THE STRUCTURE OF CENTRAL GOVERNMENT EXPENDITURES . . . . . 12 Overall Position of the Central Government... . . . . 12 The Economic Composition of Current Expenditures . . . . 13 Personnel Services.......... .... . . . 13 Goods and Services........ .... . . . . . 15 Current Transfers........ ..... . . . . . 16 Block Allocations........ ..... . . . . . 17 B. COMPARATIVE ANALYSIS OF THE STRUCTURE OF EXPENDITURES 18 Introduction... . . . . **..................... .18 Current Expenditures: Economic Classification . . . . 18 Trends and Composition......... .... . . 16 Cross-Country Comparison *.................... . . .21* Current Expenditures: Functional Classification . . . . 23 Trends and Composition........ .... . . . 23 Cross-Country Comparison...... .... . . . . 26 Capital Expenditures......... .... . . . 29 This report was drafted by Claudio Sapelli (LA2C2), based on the findings of two PSER missions which visited Nicaragua during June 24 - July 6, 1991 and September 29 - October 16, 1991. The first mission was comprised of Messrs. Claudio Sapelli (LA2C2, mission leader); Norman Hicks (LACCE, public investment program); Gustavo Arteta (consultant, statistics); Jerri Romm (consultant, health); Stephen Klees (consultant, education); Pablo Ihnen (consultant, public expenditure analysis; and Ercis Kurtulus (consultant, management ^f public expenditure). The second mission was headed by Claudio Sapelli (LA2C2) and included Messrs. Ivan Rivera (LA2C2, macroeconomic framework); Gustavo Arteta (consultant, statistics); Gaston Labadie (consultant, education); Robin Carruthers (consultant, transportation); Enrique Crousillat (IENED, energy); Jerri Romm (consultant, water and sanitation); Martin Raine (RUTA, agriculture); Pablo BIaea (consultant, public expenditure analysis); and Ercis Kurtulus (consultant, management of public expenditure). C. SUMMARY AND CONCLUSIONS. . .......... . . . . . . . 31 CHAPTER III - SECTORAL ISSUES. . ........... . . . . . . . . 34 A. INTRODUCTION............ ...... . . . . . 34 B. AGRICULTURE . . . . . . . . . . . . . . . . . . . . . . . . 34 Institutional Framework . . . . . . . . . . . . . . . . 34 Recent Trends in Current and Capital Expenditure . . . . 35 Main Sector Issues . . . . . . . . . . . . . . . . . . . 37 Sectoral Strategy, Action Plans and Coordination 37 Type and Composition of Expenditure . . . . . . . . . 38 Conclusions and Recommendations . . . . . ... . . . . . 39 C. rALTH ........... ......................... 40 overview . . . . . . . . . . . . . . . . . . . . . . . 40 Institutional Framework . . . . . . . . . . . . . . . . 41 Recent Trends in Current and Capital Expenditures . . . 41 Main Sector Issues . . . . . . . . . . . . . . . . . . . 42 The Budget and Investment Program . . . . . . . . . . . 43 Conclusions and Recommendations . . . . . . . . . . . . 44 D. EDUCATION . . . . . . . . . . . . . . . . . . . . . . . . . 46 Institutional Framework . . . . . . . . . . . . . . . . 46 Recent Trends in Current and Capital Expenditures . . . 47 Main Sector Issues. . ........... . . . . . . . 48 Intrasectoral Resource Allocation....... . . . . 48 1992 Budget Structure......... . . . . . . . . 49 Higher Education. . ......... . . . . . . 50 MED's Administration and Management . . . . . . . . . 50 The Ley de Carrera Docente. ....... . . . . . ..51 Instituto Nacional de Tecnologia..... . . . . . . 52 Conclusions and Recommendations. ....... . . . . ..52 B. TRANSPORTATION ....................................... 54 Institutional Framework . . . . . . . . . . . . . . . . 54 Recent Trends in Current and Capital Expenditures . . . 55 Current Expenditure . . . . . . . . . . . . . . . . . 55 Operations and Maintenance (O&M) .... . . . . . ..57 Conclusions and Recommendations. ....... . . . . ..57 F. ENERGY SECTOR . . . . . . . . . . . . . . . . . . . . . . . 58 overview . . . . . . . . . . . . . . . . . . . . . . . . 58 Institutional Framework . . . . . . . . . . . . . . . . 59 Main Sector Issues . . . . . . . . . . . . . . . . . . . 59 Rule of the State . . . . . . . . . . . . . . . . . . 59 Operational Efficiency . . . . . . . . . . . . . . . 60 Conclusions and Recommendations . . . . . . . . . . . . 60 - iii - G. WATER AND SANITATION . . . . . . . . . . . . . . . . . . . 62 Overview . . . . . . . . . . . . . . . . . . . . . . . . 62 Main Sector Issues . . . . . . . . . . . . . . . . . . . 62 Project Sustainability: Income Generation and Subsidies . . . . . . . . . . . . . . . . . . . . 62 Water Supply and Health . . . . . . . . . . . . . . . 63 Conclusions and Recomnendations . . . . . . . . . . . . 63 H. SOCIAL SECURITY . . . . . . . . . . . . . . . . . . . . . . 64 CHAPTER IV - THE PUBLIC INVESTMENT PROGRAM..... ..... . . . . . 67 A. INSTITUTIONAL FRAMEWORK FOR PUBLIC INVESTMENT... . . . . 67 Background............... .... . . . . 67 Actual Processing of 1992-94 Public Investment Program . 67 Major Issues to Be Addressed......... . . . . . . 68 B. THE PUBLIC "NVESTMENT PROGRAM (PIP). . .... . . . ..69 The Evolution of the Size and Structure of the PIP . . . 72 C. THE AGRICULTURE INVESTMENT PLAN. . ........ . . ... 7 Ministry of Agriculture and Livestock.... . . . . . . 75 Land Distribution and Tenure . . . . . . . . . . . . . . 76 Natural Resources . . . . . . . . . . . . . . . . . . . 76 Control of Implementation and Expenditure.... . . . . 77 D. THE TRANSPORT INVESTMENT PLAN..... ... . . . . . . 77 Sectoral Strategy............. ... . . . 77 Level and Composition of Proposed Expenditures . . . . . 77 Project Assessments............ ... . . . 78 Rural Road Rehabilitation. ........ . . . . . 78 Reconstruction of Nejapa-Izapa.... .... . . . 78 Improvement of San Francisco-Camoapa.... . . . . 78 Financing the Investment Plan...... .... . . . 79 Institutional Changes....... .... . . . . . ..19 E. THE ENERGY INVESTMENT PLAN...... .... . . . . . . 79 F. THE WATER AND SANITATION INVESTMENT PLAN..... . . . . . 81 Analysis of Planned Capical Expenditures and Financing: 1991-1994..... .... . . . . . . . 82 Relationship of Investment Plan to Strategy a Policy Objectives....... ... . . . . . . . 82 Composition of Investment...... .... . . . . . 82 Proposed Cost-Effective Priorities for Nicaragua . . . . 83 G. THE SOCIAL SECTORS INVESTMENT PLAN...... . . . . . . . 83 - iv - CHAPTER V - STRENGTHENING AND RESTRUCTURING THE PUBLIC EXPENDITURE MANAGEMENT SYSTEM............. .... . . . 85 A. INTRODUCTION ............... ..... . . .. eS B. THE BUDGETARY PROCESS....... . . . . *...............85 Organizationrl Issues and Functional Borderlines . . . . 85 The Budgetr Process......... .... . . . . 86 Selected Budgetary Issues...... .... . . . . . 88 C. GOVERNMENT ACCOUNTING AND ACCOUNTABILITY OF THE SPENDING INSTITUTIONS . . . . . . . . . . . . . . . . . . . . . . 89 Lack of a Comprehensive Government Accounting System . . 89 Accountability of Spending Institutions.... . . . . . 90 D. EX-POST EXPENDITURE CONTROL..... ..... . . . . . . 90 Monitor the Macro-level Revenue/Expenditure Balance on a Cash Basis............. .... . . . . 90 onitor the Use of Credits Given to Institutions by the Budget Law . . . . . . . . . . . . . . . . . . 91 Controls on the Legality of Expenditures . . . . . . . . 91 Control of Personnel Emoluments. ........ . . . . 91 E. COORV:NATION AND CONTROL OF EXTERNAL AID . . . . . . . . . 92 Legal Scatus . . . . . . . . . . . . . . . . . . . . . . 93 Manner of Receiving Aid . . . . . . . . . . . . . . . . 93 Budgeting, Accounting and Auditing of the Current System 94 F. MEDIUM-TERM EXPENDITURE PLANNING AND FORWARD BUDGETING . . .4 Macro-economic Framework for a Medium-Term Expenditure Plan (MTEP)............ ...... . . . 94 Prioritization of Government Expenditures through a MTEP 95 0. RECOMMENDATI6NS FOR ACTION. . ......... . . . . . 96 Strengthen and Restructure Budgetary Management . . . . 96 Establish a Government-wide Accounting System . . . . . 98 Establish the Accountability of Government Institutions 98 Establish a New Expenditure Control Mechanism . . . . . 99 Improve the Mechanism for Coordination and Control of External Aid. . ............ . . . . . . 99 Set up a Prioritization Mechanism and Improve the Budgetary Process. . ........... . . . . 100 Restructuring of the Civil Service System..... . . . 101 Set up a Preliminary Model for Mid-Term Expenditure Planning............ ...... . . . . 102 Prepare and Implement a Technical Assistance Program . . 102 CHPTER VI - MACROECONOMIC FRAMEWORK AND PROJECTIONS 1992-96 . . . . . . 103 A. INTRODUCTION............. ...... . . . . 103 -V B. THE NACROBCONOMIC FRAMSEWORK UNDBR STABILIZATION AND STRUCTURAL ADJUSTNT .. . . . .. . . 103 The Policy Agenda for Sustained Growth . . . 103 C. BASE CASE NRCROSCONO1IC PROJECTIONS . . . . . . . . . . . 104 D. FISCAL PROJECTZONS . . . 105 Thi Government's Resource Envelope . . . . . . . . . . . 105 Government zpenditures .1 . 07 Fiscal Deficit and Sustainability. ........ . . . 107 B. LW CAS MACROECONOMIC PROJECTIONS.... . . . . . . . . . 107 P. CONCLUSION. . ............ . . . . . . . . ..111 Annex A - Organizational Chart - MIFIN . . . . . . . . . . . . . . . 112 Annex B - General Directorate of the Budget Organisational Chart . . 113 Annex C - Example of Positions Table for Each Institution . . . . . . 114 Annex D - Example of Table of Positions Summary . . . . . . . . . . . 115 Annex 8 - Authority to Make Virements.... . . . . . . . . . . . . 116 Annex P - Details of Draft Forward Recurrent Budget . . . . . . . .. 117 Annex G - Steps for Implementation of Medium Term Financial Planning 110 CHAPTER I: OVERVIEW OF THE ECONOMY AND GOVERNMENI FINANCES A. INTRODUCTION 1. Nicaragua is among the poorest coLuntries in Latin America, with a per capita GDP of around US$400 in 1991. The country is physically the largest in Central America and the most sparsely populated. No census has been performed since 1971, so the total population can cnly be roughly estimated. Estimates lie between 3,500,000 and 4,000,000 persons. Population growth is the fastest in Latin America (3.4% per annum), and is expe..ted to create severe pressures on the Government's ability to provide the growing population with basic services, including water and sanitation, primary education and primary health care. The economy has traditionally been built around the agricultural sector, which accounts for 30% of GDP. 2. During the 1980s, the Frente Sandinista de Liberacion Nacional (FSLN) tried to establish a centrally controlled economy. The combined impact of these institutional changes, inappropriate economic policies, the Contra war and the US trade embargo, led to a crisis: by the end of the decade, production was well below the 1970 level, exports were running at about half of the pre-1980 level, hyperinflation had reached 33,700 percent in 1988, international reserves were depleted and there was an extremely high debt accumulation. 3. In less than two years, the Chamorro Administration (which took office in April 1990), has been able to reverse most of these trends. The key to stabilization has been an impressive adjustment in fiscal policy, together with the substantial flow of contributions from the donor community. 4. One of the most important challenges that the Government faces is to restructure the public sector. It should focus on efficiently delivering a reduced number of services and strengthening the public sector management capacity and the public expenditure management institutions. The main purpose of this review is to help the authorities of Nicaragua to improve the allocation of public resources and strengthen public sector management. At present, the system leading to expenditure decisions is incomplete and has important deficiencies. As the Government is, and will be for some time, dependent on external resources, one of the most necessary tasks is to strengthen the system of managing ard coordinating external aid, to assure that it is used effectively. 5. Most ministries are institutionally very weak, with poor methods of planning and control. The quality and quantity ot services provided by the public sector is poor. This has been aggravated by the way the ministries have administered the recent budget cuts, preserving public employees wages and fringe benefits and reducing expenditures in goods and services vital to provide the respective public services. -2- B. BACKGROUND 6. The new Nicaraguan Government that took office in April 1990, headed by Mrs. Chamorro, faced extremely difficult challenges. It inherited an enormous macroeconomc d4sequi3ibrium front the last months of tie Sandinista Administration (see Figures 1 to 5). Moreover, stabilization had to be achievel at the same time as the Government tacled the difficult task of attaining peace between the warring Contras and the FLN army, and alleviating the consequences of a drop in the standard of living to a third of its 1977 level (see Figure 1). 7. The issues that needed to be urgent2y addressed were nany. The overell fiscal deficit was above 30W of GDP. International .eserves were at a very low level. Inflation had reached hyper-inflationary rates aftor two failed attempts at stabilization in 1988 and :989 (see Figure 2). Exports were down to half their level of the late seventies and were less than half of current imports (see Figure 3). The trade balance deficit had remained for a full dicade as a level between 20W and 30W of GDP (see Figure 4). Consequently, external debt had increased from one to seven times the GDP in the 1984-1989 period (see Figure 5). On top of the above, the country's infrastructure was physically destroyed by twelve years of internal war and lack of maintenance. Substantial and selective brain drain had occurred during the last decade and had diminished the human resource base, particularly of prcfessionals. Market institutions were extremely weak or had completely disappeared after a decade of central planning. 8. The Governuient's initial efforts to correct the economy's large internal and external imbalances were unsuccessful. Political instability, the magnitude of the inherited macroeconomic disequilibrium and insufficient attention to fiscal matters, resulted in a very loose fiscal policy. The Central Government deficit increased by 11.5, to 15% of GDP in 1990, mainly due to substantial wage increases by the outgoing Government, and to a 8* of GDP drop in revenues. These imbalances resulted in the acceleration of inflation from 1,700% during 1989 to 13,500 in 1990. Furthermore they caused continued deterioration in the balance of payment position, with a further loss of reserves in 1990 of about US$218 million, largely in the form of accumulated external arrears (external arrears were US$4 billion at the end of 1990). 9. 1991. After attaining internal political consensus and encouraged by the support from the internati anal community in the Consultative Group meeting in December 1990, the *..vernment decided to implement a strong stabilization and adjustment pxogram. On the basis of this, the financial community decided to support arrears clearance with the Bank and IDB. The Government's main goals for 1991 were: a) to stop hyperinflation; b) to arrest the decline in GDP; c) to strengthen the balance of payments; d) to initiate a prograr of structural reforms; e) to re-establish relations with external creditors; and f' to alleviate poverty. -3- Index of ODP 1970-100 10 100 60. 40- 1011 7243 7 s 7i6 7o8 78bt dis2 W"7 -9 92 LGP - GDP PER CAPITA Figure 1 NICARAGUA: INFLATION RATE Figure 2 NFCARAGUA. FOB EXPORTS AND IMPORTS (00. 10\ \I 700 ,' 200- 1001 707 1980 195 1990 Figure 3 | F | "" iOBEXPF.S AD IMORT -4- NICARAGUA: TRADE BALANCE (AS Percent of GDP) 30 20 0 -10- .30 l970 '1d75 1980 11990 Figure 4 NICARAGUA.: TOTAL EXTERNAL DEBT (A P«eentof ODP) 00 700 500 400, 300- 200O 1980 192 1984 196 1988 199 1992 Figure 5 NICARAGUA: Government Expenditures (as % of GDP) so 601 ýO72 7-4 ý 4 76 78ý -*O 9 71 73 75 79 81 63 65 87 89 91 Total - cunent - Capa Figure 6 -5- 10. In early March 1991, the Government launched a stabilization program. The main components of the program were: a) a 400% devaluation of the Cordoba, an up-front adjustment in public sector wages (on average 200%) and of public sector prices and tariffs, followed by fixed exchange rates and wage policies aimed at reducing inflationary expectations; b) a fiscal policy targeted at eliminating domestic financing of the overall public sector deficit and rationalizing the size of the public sector, and c) a credit policy aimed at assisting in the reduction of inflation to low monthly single digit levels by the end of the year and stopping the contraction of international reserves. 11. To date, the results of the stabilization program are encouraging. Inflation, after corrective price increases in March and April, turned into deflation in the following four months, and now appears to be converging to about one percent per month. (The 12-months inflation rate has continuously decelerated --after peaking at 63,800% in March, it declined to 773% by December 1991). The black market for foreign exchange has practically disappeared. Net international reserves have stopped declining, and gross reserves were at about four months of imports in 1991. GDP declined only slightly (by less than 1 percent) in 1991, despite a strong recovery in industrial and commercial production, due to the drought that affected agricultural production. 12. Foreign aid has played a key role in achieving these results. It has played the dual role of 1) helping the stabilization effort by filling the gap between absorption and production without much pressure on foreign reserves and, 2) buffering the economic costs and social tensions of the stabilization effort. On the basis of the encouraging results described above, the international community supported the clearance of US$313 million of arrears with the Bank and IDB in early September, and the IMF approved an 18-month Stand-by arrangement in late September 1991. 13. Fiscal policy has been a key ingredient for achieving the above results. Tax revenues have substantially increased, reaching 19% of GDP in 1991 (up from 14% in 1990). Government current expenditures decreased from 44% in 1990 (including extra-budgetary military expenses) to 25.7% in 1991 (including cash payment of interest obligations to the multilateral lending organizations). 14. With respect to the structural adjustment program, the new Government had to address the problems caused by a centralized command economy and a small and over-regulated private sector. In total, the State controlled approximately 31% of GDP in production and trade activities. 15. By late 1990, the Government achieved broad consensus on the necessity of moving Nicaragua toward a competitive market economy. Based on actions taken and on proposed actions to deepen structural adjustment, IDA approved an Economic Recovery Credit (ERC) in September 1991. Important advances have already been made in the implementation of the program. 16. In the trade regime, barriers to private sector entry have been eliminated. The maximum import tariff has been reduced to 50% and is programmed to decline to 40% in early 1992. A 10% tariff floor on imports was also instituted in August 1991. In the financial sector, a new Superintendency law was passed to permit entry to new private banks. Four privace banks are in operation and two additional licenses have been approved, as of April 1992. A program for the restructuring and downsizing of state banks, including work force reduction and the sale of certain assets, has been approved. The Central Bank iE also being reorganized and strengthened. In the area of fiscal rfform, on the revenue side, a complete overhaul of the tax system is practically completed and efforts are underway to improve tax administration. On the expenditure side, substantial reductions in the defense budget have been achieved. A far-reaching program of work force reduction is well under way (13% of the Central Government employees, approximately 8,700, have already joined the voluntary employment reduction program). 17. Progress made so far is encouraging, even though the tasks ahead continue to be huge. One of the most important of these tasks is to redimension the public sector, diminishing its span of control, increasing its efficiency in providing services, strengthening its institutions and management, and focusing it on the most pressing tasks of rebuilding infrastructure and alleviating poverty, while transferring most other tasks to the private sector. This report constitutes an attempt to assist the GON in addressing these issues. C. OVERVIEW OF GOVERNMENT FINANCES Overall Trends 18. During the sixties and early seNenties, Nicaragua followed conservative fiscal and monetary policies, allowing low inflation rates and relatively small current account deficits in the context of a fixed exchange rate regime. However, after the 1972 earthquake, policies changed as a consequence of the reconstruction efforts and Central Government expenditures (as a percentage of GDP) started to grow at a modest pace (see Figure 6). A second change took place when the Frente Sandinista de Liberacion Nacional (FSLN) took office in 1979: an expansive fiscal policy was implemented that increased the fiscal deficit from an average of 5.2% of GDP in the period 1974-78 to 28.6% in 1983. Current expenditures grew from approximately 10% of GDP in 1974-78 to nearly 40% in 1983 (see Table 1). With the exception of 1989, the deficit remained above 16% of GDP and reached its peak in 1990 at 31.7% of GDP. 19. The deficit was the consequence of an expansion in public expenditures intended to improve social indicators, an increase in public investment and increased expenditures on defense, and took place despite an important increase in tax and other current revenues. Since 1985, and as a consequence of the Contra War, important changes occurred both in the level and composition of expenditures. The need to finance the war and the - 7 - increasing macroeconomic disequilibria (inflation above 200%, balance of payments current account deficit above 25* of GDP), forced the FSLN Government to cut expenditures other than for defense. By 1986, expenditures in defense were 18V of GDP, five points of GDP above the 1984 levels. A large share of the burden of the adjustment fell on capital expenditures, that after a large cut of 6* of GDP in 1985, continued on a decreasing trend until 1990. 20. By early 1988, the Government initiated a stabilization effort. However, because of the lack of enough depth and consistency, and partly as a consequence of the effects of Hurricane Joan, the adjustment effort turned out to be unsuccessful. The year 1988 ended with a Central Government deficit of 26.5 of GDP and with a record 62.4% average monthly inflation rate. The 1989 Expenditure Adjustnent 21. In 1989, the Government attempted a new stabilization plan. This new attempt was triggered by: a) the lack of confidence generated by the failure of the 1988 stabilization program; b) the extremely weak external position; c) the fact that GDP had fallen by more than 13% in 1988; and d) the increasing demonetization that was taking place. The 1989 adjustment represented the most serious stabilization effort implemented by the FSLN Government. Unfortunately, the Government eventually lost control of monetary policy and subsequently the whole fiscal effort was completely reversed in early 1990. 22. The main features of the 1989 fiscal adjustment (see Table 1) were: (a) The current account (savings) of the Central Government improved from a 20.2% deficit (as a share of GDP), to a 3.6% deficit. More than seventy-five percent of the 16.5 points of improvement are explained by current expenditure cuts. The overall deficit before grants improved from a 26.5% deficit in 1988 to a 6.7% deficit in 1989 (as a percent of GDP): an adjustment of almost 20 percentage points of GDP in one year; (b) In terms of incidence, most of the adjustment took place on defense in the context of the Contra War coming to an end; and (c) An adjustment in current transfers that can be largely explained by the fact that during 1988, this item reflected the expenses caused by Hurricane Joan (a once and for all type of expenditure). The 1990 Expenditure Impulse 23. During the first months of 1990, before handing the Government to Mrs. Chamorro, the FSLN Government undertook a highly expansive fiscal policy, in the Central Government and in the Social Security Institute (INSSBI). By April (the month when the change of Government occurred), the wage bill had - 8 - increased by 230% in real terms, as compared to April 1989. In the same period, total current expenditures increased in real terms by 106%, capital spending by 54%, and pensions by 741%. 24. The new government was unable to undo this policy immediately. By the end of 1990, the current account of the Central Government deteriorated from a deficit of 3.7% of GDP in 1989 to a deficit of 16% of GDP in 1990 (not including extra-budgetary outlays in military expenses that represented approximately 13.3% of GDP). The overall deficit before grants rose from 6.8% to 16.2% from 1989 to 1990 (also excluding extra-budgetary expenses). Both an increase in expenditures and a significant drop in tax revenues contributed to this result. 25. Wage payments by the public sector as a share of GDP more than doubled in 1990, as compared to 1989 (to its highest historical level in terms of GDP). Transfers also increased significantly. Regarding current expenditures, only goods and services experienced an adjustment as a share of GDP (jee Table 1). Capital expenditures of the Central Government also dropped, from 3.1% to 1.3% of GDP. The 1991 Fiscal Program 26. Despite the fragile macroeconomic position with which the 1990 fiscal year closed, the 1991 official budget did not consider the needed adjustment on the expenditure side. In fact, current expenditures were planned to increase by almost 7% as a result of an increase in wages and salaries (18%), goods and services (31%) and current transfers (18%). Only block allocations (Defense, Gobernacion and unforseen expenditures) were reduced (by 19%, if one excludes extra-budgetary outlays, which disappeared). 27. However, in early 1991, the Government recognized the need for a new stabilization program. Under the new program starting in early March, particularly important was the one to five devaluation of the cordoba oro with respect to the dollar, and the adjustment of the expenditure program by factors below five. This expenditure adjustment de facto modified the original budget, reducing it by 25%. The stabilization program also allowed the Government to end the indexation of expenditures to the dollar (included in the budget law) and to set a new financial ceiling in nominal terms. 28. A key structural feature of the 1991 program was the implementation of a voluntary compensation scheme for public employees who leave the public sector (Plan de Conversion Ocupacional - PCO). The program allows future savings with a once and for all expenditure that has mainly been financed by a USAID grant. 29. By September 1991, the GON reached a Stand-by agreement with the IMF. As a core performance condition in the fiscal area, a financial ceiling of US$341.2 million equivalent was agreed for 1991 (excluding the PCO, which was financed by grants an6 interest payments). This ceiling was complied with. TABLE 1 Nicaragnas Central Goverment Operations (In Percent of GDP) 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 REVENUE 11 12.9 22.2 24.4 25.7 31.2 35.2 32.3 32.4 27.7 21.1 24.3 15.7 21.3 Current Revenue 11.6 21.7 24.0 25.3 31.0 35.0 32.1 32.2 27.7 21.1 24.2 15.7 21.0 Tax revenue 11.1 19.8 21.5 22.6 28.5 32.4 29.4 29.2 26.2 20.2 22.9 14.3 19.3 Direct taxes 2.1 4.5 4.7 5.1 6.2 7.1 6.6 7.1 5.9 3.9 5.4 3.7 4.1 Indirect taxes 8.2 14.7 14.5 15.8 20.3 23.6 21.3 20.5 18.7 15.5 16.3 1".3 15.1 Remarked Revenue 0.8 0.7 2.2 1.7 1.9 1.6 1.5 1.6 1.6 0.8 1.1 0.3 0.0 Other Current Revenue 0.5 1.9 2.6 2.7 2.6 2.6 2.8 3.0 1.5 0.9 1.3 1.4 1.7 Capital Revenue 1.3 0.5 0.4 0.4 0.2 0.2 0.2 0.2 0.1 0.0 0.1 0.0 0.2 EWPENDITURE 1/ 21.3 36.0 33.2 38.1 59.8 58.6 54.7 49.6 44.5 47.7 31.0 47.3 27.0 Current Expenditure 19.2 30.4 28.5 32.1 38.6 42.7 45.0 43.0 39.7 41.3 27.9 45.2 25.0 Wages and salaries 7.2 7.6 7.8 7.7 8.4 8.8 9.6 8.6 6.5 3.8 3.9 9.7 6.6 Goode and services 7.6 10.4 4.7 6.0 9.4 10.4 11.8 10.4 10.4 11.5 11.2 9.7 14.2 Defense 0.0 6.3 7.6 7.8 11.0 12.4 16.1 17.7 18.2 16.2 9.6 18.9 6.2 Current transCers 1.6 3.7 5.0 5.7 6.6 8.4 4.8 5.0 4.3 9.1 3.1 6.8 4.0 Interest 2.8 2.4 3.5 4.9 3.1 2.7 2.7 1.3 0.3 0.1 0.0 0.0 0.1 Capital Expenditure 1.4 5.4 4.6 5.9 21.0 15.5 9.2 6.5 4.6 6.46 3.1 2.1 1.9 y Net lending 0.5 0.3 0.2 0.1 0.2 0.5 0.5 0.1 0.1 E.0 0.0 0.0 0.1 CURRENT ACCOUNT DEFICIT (-) -7.6 -8.6 -4.5 -6.7 -7.6 -7.7 -12.8 -10.9 -12.1 -20.2 -3.6 -29.6 -3.9 OVERALL DEFICIT BBFORE GRANTS(-) -8.4 -13.9 -8.9 -12.4 -28.6 -23.5 -22.4 -17.2 -16.7 -26.5 -6.7 -31.7 -5.7 FOREIGN GRANTS 0.0 0.0 1.3 1.1 1.2 0.8 0.6 1.1 0.5 0.5 3.3 14.8 0.0 OVERALL DEFICIT AFTER GRANTS (-) -8.4 -13.9 -7.6 -11.3 -27.3 -22.7 -21.8 -16.1 -16.3 -26.1 -3.4 -16.8 -5.7 TOTAL FINANCING 6.6 7.6 7.6 11.3 27.3 22.7 21.8 16.1 16.3 26.1 2.9 16.8 5.7 EXTERNAL 21 0.0 0.0 0.1 4.2 2.9 1.5 2.7 1.2 0.1 0.4 -0.0 0.0 0.0 INTERNAL 6.6 7.6 7.5 7.1 24.4 21.2 19.1 14.9 16.2 25.6 3.0 16.8 0.0 1 Includes the Municipality of Nanagua. Military expenditures are included in Current Expenditures but not, in either, Goods & Services or Wages. 21 Refers only to loans for own use of Central Government. - 10 - The 1992 Budget 30. In December 1991, Congress approved the 1992 budget, complying with the US$325 million ceiling agreed with the Bank and the IMF (excluding the PCO and interest payments). This has permitted the maintenance of fiscal discipline on current expenditures. The wage bill has been reduced, and important adjustments in goods and services have been made. 31. Table 2 compares the 1990 execution, the 1991 execution and the 1992 budget. This comparison shows that although the overall level of expenditures has decreased, the powers of the state (Assembly, Supreme Court, Presidency) have been increasing their expenditures in real terms. Most of the adjustment has fallen on the Ministries, and in particular, on the Ministry of Defense, the Ministry of Police and Internal Affairs (Ministerio de Gobernacion - MIGOB) and the Ministry of Construction and Transport. D. COVERAGE OF THE REPORT 32. This report focuses on fiscal management, public sector resource allocation and selected sectoral issues. Public sector enterprises and local administrations are not specifically addressed in this review. Succeeding reviews can more appropriately focus on these issues. 33. Public expenditure aggregates and their economic and sectoral composition are analyzed in Chapter II. This provides the necessary background for the analysis of the structure of expenditures. Subsequently, both time series and cross-section analysis is made of the size and structure of current and capital expenditures, with a view to making recommendations on the most appropriate economic and sectoral allocation of resources. 34. Chapter III reviews public expenditure issues in the agricultural, health, education, transport, water and energy sectors. It assesses the performance of these sectors, describes the organizational framework, discusses policies, reviews the patterns of expenditures and makes suggestions for improvement. Chapter IV takes a closer look at past public investment trends and contains a detailed analysis of the 1992-94 investment program. 35. In Chapter V, the institutional aspects of public expenditure planning, budgeting and monitoring are examined. Particular attention is given to the administration and control of the flows of external resources. Recommendations are also made with respect to civil service management. 36. Finally, in Chapter VI, a resource envelope for public expenditures has been projected in a medium-term macroeconomic framework. - 11 - TABLE 2 CURRENT SXPENDIIURE BY INSTITUTION (Millions of US Dollars) Institution 1990 1991 1992 Actual Estimate Budget State Bodies 18.60 19.40 24.50 National Assembly 3.20 5.30 6.15 Supreme Electoral Council 3.40 1.60 2.41 Supreme Court 3.40 4.50 6.37 General Comptroller 0.90 0.70 1.36 Presidency 7.70 7.30 8.21 Ministries 323.80 258.70 255.05 Construction 28.30 19.00 12.64 External Cooperation 0.90 1.60 1.74 Agriculture 6.40 4.90 4.59 Economy and Development 2.00 1.80 2.56 Education 51.70 51.40 54.96 Health 77.50 68.40 73.05 Finance 8.60 8.90 9.03 External Relations 12.30 16.80 15.71 Labor 2.00 2.10 2.19 Defense 48.90 42.91 Police 133.00 33.70 34.42 Attorney General 1.10 1.20 1.25 Adjunct Agencies 6.90 15.60 14.54 Natural Resource Institute 0.70 2.00 1.62 Land Reform Institute 0.70 1.90 1.44 Nicaraguan Institute for Sport 1.10 2.30 2.25 Inst for Cultural Promotion 0.90 1.40 1.63 National Technological Institute 2.80 4.27 Inst for Municipality Promotion 1.10 1.20 1.32 Nicaraguan Institute for Women 0.05 0.05 0.12 Inst for Autonomouse Zones 0.15 0.60 0.62 Comision Nac del Combatiente 1.20 0.80 0.72 Inst of Statistics and Census 0.50 0.40 0.54 CNPPDB 0.00 0.05 0.00 Nicaraguan Inst for Repatriation 0.50 1.00 0.00 Gob. Aut. del Atlantico Norte 0.60 0.00 Gob. Aut. del Atlantico Sur 0.50 0.00 Others 80.70 51.70 39.91 Total 1/ 430.00 345.40 334.00 1/ 1992 Budget includes US$9 million for Employment Conversion Program -12- CHAPTER II: THE STRUCTURE OF GOVERNMENT EXPENDITURES: ANALYSIS AND RECOMMENDATIONS A. THE STRUCTURE OF CENTRAL GOVERNMENT EXPENDITURES Overall Position of the Central Government 37. During 1991, the Central Government ran a 1.4% deficit (as % of GDP) in current account and 3.4% overall deficit before grants (as % of GDP). For 1992, the GON is expected to have a small surplus in the current account and a deficit before grants equivalent to the magnitude of the investment programV. If all the PIP is implemented, this will amount to 5.8% of GDP, but as implementation will probably be partial, the deficit should be lower. 38. Revenues appear to be relatively high for a country at Nicaragua's stage of development, and given the need for substantial investment in infrastructure, the improvement of the mid-term financial position will depend on reducing current expenditures. The Government has taken steps to reduce current expenditures, but larger efforts are required to accommodate the required investment program without: i) risking deterioration of the mid-term financial position of the Central Government; ii) crowding out the incipient private sector activities, and iii) generating downward pressure on the real exchange rate, hindering Nicaragua's export-led growth. 39. Particular care should be taken in the design of the investment program and its financing, to prevent increasing interest payments or the recurrent costs of investments to affect the mid-term fiscal position. Moreover, an excessively large fiscal impulse, even if generated by capital expenditures, may cause pressure on non-traded goods (and wages) and hence, generate downward pressure on the real exchange rate. This would be particularly damaging to the export sector in the context of a fixed exchange rate regime. Most importantly, overall expenditures should not be decided solely on the basis of the availability of internal or external financing. Rither, the impact of the demand impulse on the macroeconomic variables and the possibility of crowding out the private sector, given the overall supply capacity, should be taken into account. 40. Overall Central Government expenditures represented 27% of GDP in 1991 (90% of which were current expenditures). Given that this includes no interest payments and that Social Security still represents a relatively low share of expenditures', this ratio appears to be high in relation to the Latin American Region (see paras. 68 and 69). Therefore, current expenditures will require further downward adjustment as a share of GDP. However, until J/ The above figures do not include expenditures under the employment reconversion plan (PCO) that were 3.2% of GDP in 1991. g/ Latin America is characterized, on average, for spending 4.3% of GDP on social security while Nicaragua is spending less than 1% of GDP. -13- national and sectoral priorities are defined, adjustment efforts are limited to cutting waste in the context of existing programs. 41. Revenues. During 1990, the Government introduced a tax reform that helped to solve some of the structural problems of the tax system. These problems included: i) high and differentiated base for different economic sectors, ii) too high rates, iii) double taxation on dividends, iv) too many taxes, and v) too many exonerations. Further improveme-ts can come, in particular, from substituting the specific sales taxes for a general sales tax. Also, improvements in tax administration would contribute significantly to revenue. The Economic Composition of Current Expenditure&-' Personnel Services 42. Personnel services represent 41% of current expenditures, or 9.1% of GDP (see Table 1). Two variables determine the evolution of this component: public sector wages and employment. 43. The direct wage bill in 1991 (including Defense and Gobernacion) adjusted by the thirteen month effect, represented an average monthly salary of around U$S138. Given a monthly GDP per capita of approximately U$S33, the ratio between the direct average salary and the GDP per capita was about 4.2. If this value is adjusted for the shorter work-day (6.5 hours instead of 8) in the Nicaraguan public sector, then the ratio is increased to 5.2. Further adjustment to include fringe benefits and collective agreement benefits would further increase this ratio. Judging by comparisons with other countries (Costa Rica, Chile, Guatemala, Panama), this ratio looks high and a level of about three would appear to be more in line with the region. 44. One of the expected outcomes of the March 1991 devaluation was an adjustment of the real public sector wage that had increased significantly in the latter months of the FSLN Administration. However, in August, partly due to the faster than expected drop in the inflation rate, average real salaries in the Ceaur"l Government (excluding Defense and Gobernacion) had increased slightly (1.8%) with respect to the February level. This reflected a 20% rise in real wages in Education, a 9% rise in Health and a 26% drop in the other institutions (in Defense there was a 30% drop). As the Ministries of Health and Education represent 80% of the total. Central Government employment, wage policy towards them drives the overall average. 45. Employment in the Cent. .1 Government grew by 37% between 1980 and 1990 (approximately 18,500 people), at a time of a substantial reduction in the overall production level. In 1991, the Government implemented a voluntary compensation scheme (PCO) that up to September 1991, had been used by 16,900 1/ Data has been aggregates somewhat differently to how MIFIN usually presents the budget. A detailed description of the differences is attached as a note to Table C.1 in the statistical appendix. -14- workers of the overall Public Sector, of which 8,700 correspond to the Central Government. Therefore, approximately one-half of the eighty's growth has been reverted in 1991. Employment in the Central Government (including the Ministries of Defense and Police) was approximately 93,000 at the end of 1991. TABLE 1 CENTRAL GOVERNMENT - As Percent of ODP - 1991 1991 1902 Million US$ Budget Current Revenue 326.3 20,9 20.3 Tax Revenue 301.7 19.4 19.5 Non-Tax Revenue 14.4 0.8 0.3 Current Transfer 10.6 0.7 0.5 Other 0.1 0.0 0.0 Current Expenditure 349.2 22.3 19.1 Personnel Services 142.4 9.1 7.0 Abroad 7.9 0.5 0.3 Defense 22.4 1.4 1.2 Police 18.0 1.2 1.0 Rest of C.G. 94.1 6.0 4.5 Non Personnel Services 56.2 3.6 2.6 Material and Supplies' 73.6 4.7 2.4 Current Transfer" 66.9 4.3 3.5 Interest Payments 5.0 0.3 1.1 Unforeseen Expenditure 5.1 0.3 2.5 Current Account (22.4) (1.4) 1.2 Capital Revenue 4.7 0.3 0.0 Capital Expenditure 35.2 2.3 7.1 Deficit (52.9) (3.4) (5.8) Memo: GODP (Millions of US$) 1559 1869 1/ Includes US$15.46 million of police and US$26.6 million of defense in 1991. 2/ Does not include the Employment Conversion Plan (ECP) of 1991. (Civilian, 26.4 and Military, 26.9 millions of US$). 1992 budget does include US$9 millions for ECP. 46. This initiative, will be very helpful in rationalizing the size of the public sector wage bill, and will introduce more flexibility into the budget. To assure its success, several issues need special attention. First, once people leave the public sector, the position that they held should disappear. It is not clear whether MIFIN has the ability to administer positions effectively (see Chapter V). Second, the autonomous entities that have been included in the plan could spend the savings in higher salaries. Third, it is possible, given the voluntary nature of the program, that the more qualified staff, rather than less, may have decided to leave. -15- Goods and Services 47. Expenditure in goods and services is relatively high, at 8.3% of GDP in 1991 (see para. 69). To analyze the details, we lack some valuable information regarding approximately one-third of the expenditures --those of the Defense and Gobernacion ministries. Hence, the discussion below refers to the remaining two-thirds of expenditures on goods and services. The item, goods and services is divided into: a) non personnel services; and b) inaterials and supplies. 48. Non personnel services. The expenses in non personnel services represented, in 1991, 16% of current expenditures, or 3.6v of GDP (see Table 2). The main components were: road maintenance, water, electricity, per- diems, and publicity and advertising (they add up to 73% of the total expenses in non personnel services). 49. Between 1990 and 1992, this item fell by 7% or US$3.7 million. However, as road maintenance decreased by US$16 million, the remaining items show important increases. The most notable increase occurred in publicity and advertising (US$3 million). TABLE 2 CENTRAL GOVERNMENT (Millions of US$) 1990 1991 1992 Estimate Budget Non Personnel Services 51.2 56.2 47.5 Telephone 0.9 1.5 1.8 Water 6.0 7.7 5.2 Electricity 3.6 4.0 5.4 Per diem 6.5 5.9 7.6 Publicity & Advertising 0.5 5.9 3.5 Rent Local Off. Buildings 1.8 2.6 3.4 Road Maintenance 24.7 17.3 9.0 Others 7.2 11.3 11.6 Material and Supplies 30.8 31.1 44.7 Food 5.4 5.2 10.6 Tires 0.4 0.6 1.2 Gas and Lubricants 3.0 3.0 5.7 Spare Parts 0.4 0.6 ..2 Medicines 15.8 12.4 13.8 Others 5.8 9.3 12.2 -16- 50. Expenditure in water in 1991 was US$7.7 million, and in 1992 it will be US$5.2 million. Between January and July 1991, the Central Government consumption represented 7% of total national corsumption, Lit payments by the Central Government represented 40% of INAA's tot.1 revenues. The Central Government is clearly being charged an implicit tariff that is much higher than the maximum tariff. This situation needs to be corrected, and measures should also add-ess two other causes of high payments: i) the fact that schools serve as free water dispensers for the community, and ii) the lack of control on the volume of water quoted in INAA's bills, in particular by NED and MINSA. Corresponding changes have to be made in INAA to address the loss in revenue. Savings could also be obtained in per-diems, since payments are often made without actual travel taking place. 51. Materials and suplies. This item represented 21% of total current expenditures and 4.7% of GDP (of which 2.7% of GDP belongs to the ministries of Defense and Gobernacion) in 1991. In this category, medicines, food, gas and lubricants, represent 66% of expenditures. This category increased slightly between 1990 and 1992. 52. The official budgetary execution figures show excessive expenditure on medicinss (0.8% of GDP in 1991), in particular if one considers the epidemiological profile of Nicaragua (diarrhea being the most important disease). Moreover, substantial extrabudgetary expenditures are known to occur, financed by grants. It has also been reported by officials of the Ministry of Finance that the allocation process of medicines lacks enough controls. 53. Food expenses correspond, to a large extent to a subsidy for health employees. 54. Finally, the relatively high level of expenses associated with vehicle operation and maintenance (0.3% of GDP, not considering Defense and Gobernacion) seems to be mainly the consequence of an excessive number of vehicles. Only recently has MIFIN started to control the number of vehicles in some ministries. It has become apparent that there was over-reporting of the number of vehicles, so that more money for gasoline, tires, and maintenance would be received. Current Transfers 55. Current transfers represented 19.2% of total current expenditures and 4.3% of GDP in 1991. The main components correspond to social benefits (benefits for employees, consequence of collective agreements), social security contributions (the contribution of the Central Government as an employer), transferd to INSSBI (to finance special pensions and 80% of the wage payments of the Welfare unit), Universities (which correspond to a legally earmarked contribution and AFA (an in kind benefit for public employees that disappeared in October :991). These components represented 73% of the total current transfers in 1991. 56. Expenditures in this item decreased by 13.5% from 1990 to 1991. However, several items require a close examination. For example, the -17- transfers to Universities (1.3% of GDP) are too high, particularly if they are compared to expenditures in primary education (about the same percentage of GDP, see Chapter III). 57. The falling trend in expenditures for transfers to INSSBI may be short-lived. Given that INSSBI has granted to its affiliates a pension increase, there is pressure on the Central Government to increase the special pensions it funds. Moreover, the Teaching Career (Carrera Docente) Law, which includes very generous provisions for the retirement of teachers, may cause an increase in expenditures. A study is being carried out to assess the exact impact of this law. The Government had agreed to take action if it turned out to affect negatively the fiscal equilibrium. Given the importance of the activities of INSSBI, it is treated separately below (see paras. 231- 236). 58. Another expense that needs attention is the subsidy for urban transportation (the so called "fichas" program). The cost of the program was US$3 million in 1991. It is a subsidy of the full cost of a bus ticket and benefits only ENABUS cu3tomers. It is a loosely targeted subsidy that benefits all teachers at all levels in Leon and Managua and all the students in secondary and higher education. Block Allocations 59. At present, this category includes mainly Defense and Gobernacion. MIFIN plans to improve gradually the reporting for these ministries. Gobernacion has already been included in the 1992 budget with the same degree of detail as other ministries. It is expected that in 1993, Defense will be reported in the same way. 60. In 1991, Gobernacion and Defense represented 5.3% of GDP and, in total, both ministries represented 23.6% of total current expenditures. Even though they have been reduced from US$133 million to US$83 million from 1990 to 1991 and US$77 million in 1992 (4.1% of estimated GDP), there is probably room for further adjustment. Two-thirds of the Defense budget is closely related to the number of positions (wages, clothes, food, etc.). Given the decision to continue reducing the number of positions, further cuts should be expected. Approximately one quarter of the total expenses are related to vehicle use and maintenance (gasoline, spare parts, etc.). This is largely influenced by the kind of equipment the institutions use, mostly of Eastern block origin, which are highly inefficient in terms of their operating and maintenance costs. Hence, a policy towards reduction and eventual substitution of the existing ve.hicle stock will be of critical importance from a financial point of view. 61. Gobernacion is in charge of the police. The police forces represented approximately 52% of the Ministry's budget and 61% of the overall positions (11,500) in 1991. Besides the police, Gobernacion is in charge of the penitentiary, the fire brigade, migration, assistance to municipalities and other responsibilities. Again, as in Defense, the budget tends to be largely influenced by the number of positions and the operating and maintenance costs of equipment. -18- 62. It is important to note that both Defense and Gobernacion perform entrepreneurial activities which do not show up directly in the Budget. These enterprises (that produce clothes, boots, furniture, etc.) are fully owned by the ministries. Their budgets appear solely as the cost of the service or the product provided. At present, these enterprises are being encouraged to sell to the public. Even though officials in the ministries said that they received no implicit subsidies, this should be carefully analyzed. The existence of suppliers that may benefit from implicit subsidies, such as free services (e.g. rent or labor), constitutes a disincentive for the private sector, and may result in higher overall expenditures for the Central Government. B. COMPARATIVE ANALYSIS OF THE STRUCTURE OF EXPENDITURES Introduction 63. This section analyses the evolution of the structure of expenditures in Nicaragua and compares this structure to those of other Central and Latin American countries. Current expenditures will be analyzed in both their economic and functional classifications. On the basis of the analysis, recommendations will be made to improve the allocation of resources within the budget. 64. The level and composition of expenditures has fluctuated widely over the last twenty years. In particular, the change in Government in 1979 saw a marked shift in the levels and composition of government spending. In the seventies, total expenditures as a share of GDP increased moderately, averaging 16 percent. Beginning in 1979, total expenditures increased sharply, reaching a peak in 1983 of 60 percent, and in general declining from then on, and averaging over 45 percent for the decade (see Table 3). Moreover, there were dramatic changes in the composition of expenditures. For example, Figure 1 shows how the breakdown between capital and current expenditures evolved since 1970, with current expenditures becoming a significantly larger fraction (55% in 1975, 93% in 1991) of total public expenditures. Current Expenditures: Economic Classification Trends and Composition 65. Current expenditures (CE) as a percent of GDP increased dramatically from the seventies to the eighties. The average of the ratio of CE to GDP, from 1970 to 1979, was 10.6 percent, compared to 37.7 percent between 1980 and 1990 (see Table 3). Most of the increment can be attributed to the tripling of expenditures on goods and services and on defense/police as a share of GDP (see Figure 2). The overall real growth of defense expenditures is striking; Figure 2 shows an index of constant per capita expenditures (1970=100), with a maximum in 1987 of 651. Almost as marked is the rise in the index of goods and services, with most of the climb taking place between 1979 and 1985 (Figure 3). Defense dccounted for about 13 percent of total expenditures in the seventies. In the eighties, it averaged TV ILE 3. RICARACUAsa SUlAARY IUDIC&TORS Average Average Prel. Proj.. Average Indicator 1970-1975 1970-1979 1979 1981 1983 1986 1989 1990 1991 1992 1980-86 1987-91 1980-90 GDP (11. 1980 Cordobas) 22,689 23,949 19,882 21,914 22,738 21,250 17,334 17,358 17,289 17,928 21,755 18,272 20,578 Total Expenditures (2 of CDP) 14.81 16.42 21.32 33.22 59.8Z 49.62 31.02 47.3% 27.0% 27.9Z 47.22 39.5% 45.5% Current Expenditures Percent of GDP 8.9? 10.62 19.2? 28.5? 38.62 43.02 27.9% 45.22 25.0? 19.12 37.22 35.8? 37.7? Percent of Total 58.5? 64.51 89.92 85.8? 64.5? 86.9Z 89.92 95.5% 92.5% 68.5? 78.8? 90.7Z 82.82 Capital Expenditures 1/ Percent of GDP 3.92 4.3? 1.42 4.62 21.02 6.52 3.1? 2.1% 1.9% 7.1? 9.7 3.6Z 7.7% Percent of Total 26.1? 25.11 6.3% 13.72 35.1? 13.0? 10.1? 4.5% 7.0? 25.3? 16.1? 9.8? 10.1? 11 : Excludes net leading. - 20 - NICARAGUA Structure of Expenditures 70 72 74 78 78 80 82 84 86 88 90 92 71 73 75 77 79 81 83 85 87 89 91 Curfent Capital Figure 1 NICARAGUA: Current Expenditures Evolution and Composition -0. 45- 40 35- 15. 10- 5- 0, 70 72 74 76 78 80 82 84 '86 88 90 92 71 73 78 77 79 81 83 85 87 89 91 Goods & Sewices M Wages & Salares Defense & Police Interest )Transfers Figure 2 Index of Per Capita Expenditures 10= 100 500- 200 500 70 72 74 76 78 80 82 84 86 88 90 92 71 73 75 77 79 81 83 85 87 89 91 -TOTAL -WAGES&S -GOODS&S - CURRENT Figure 3 -21- 33 percent and reached a maximum of 40 percent in 1990. In the same manner, goods and services increased from an average of 18 percent in the seventies to 32 percent in the eighties. On the other hand, wages and salaries decreased from 27 percent tr 14 percent in the same period (see Table 4). 66. It is important to be aware that during the eighties, Defense and Police were not itemized (or were included as a whole in goods and services, as in 1990), severely biasing the measures of "Wages and Salaries" and "Goods and Services" with respect to their real level. Consequently, a comparison between the seventies and 1992 is more relevant as data are not distorted by this problem. In those twenty-two years, one continues to observe a rise of Goods and Services from 18% to 27%, but the decrease in Wages and Salaries is not as serious, from 27% to 25%. 67. The trend of wages and salaries departs significantly from the trends of the region. However, many expenses that are wage complements are included in the budget as goods and services. There is evidence suggesting that government employees receive a significant quantity of benefits in the form of food, per diems without travel, clothes and other benefits. An estimate of these expenditures was calculated by using budget data for the Health Ministry in 1991. It was found that these benefits are more than 14 percent of the budget. In other words, wages and salaries as a share of total current expenditures should be 14 percent higher, while goods and services should be 14 percent lower. Applied to the budget as a whole, this 140 is equivalent to 4% of GDP. However, to use figures based on the Health Ministry will likely produce an upper limit to the magnitude of fringe benefits included in total expenditures on goods and servicesa. Consequently, to obtain a figure for the Central Government as a whole, possibly half this figure would be more acceptable, increasing wages and salaries from 7% to 9% of GDP and reducing goods and services from 7.5% to 5.5% of GDP. With this correction, the changes between the seventies and 19912 are that goods and services increase from 181 to 20%, and wages and salaries increase from 27% to 34%. Cross-Country Comparison 68. In relation to other Central and South American Countries, Nicaragua went from being an average country in the seventies to an outlier in the eighties. In 1975, Nicaragua's ratio of total expenditures as a share of GDP (18.1%) was slightly below the average for Central America (18.3) and that of all of Latin America (20%). Current expenditures were lower in all categories, while capital expenditures were a little above average (see Table 5). In the eighties, however, the picture changed markedly. Nicaragua's total expenditures more than doubled by 1981 tc 33% of GDP, which was well above the region's average. j/ This is because the food and clothing budget is relatively large in the Health Ministry. These two items include much of the fringe benefits that have been detected. TABLE 4. ICARAGUAl SUHMRY IlDICA1MS 1RACT OF 1TAL B TUEI IRES Average Average Prel. Proj. Average CO1CEPT 1970-1975 1910-1979 1979 1951 1983 1986 1989 1990 1991 1992 1980-86 1967-91 1980-90 I Current Expendicures 56.5% 65.2% 89.91 85.82 64.52 86.9Z 89.92 95.5Z 92.52 68.5% 83.62 90.22 89.8Z 1. Consumption Expenditures 41.02 45.62 69.22 60.52 48.22 74.22 79.72 81.2t 77.02 51.92 69.22 79.42 78.92 Wages and Salaries 27.72 27.22 33.62 23.42 14.12 17.42 12.72 20.62 24.42 25.12 17.3% 13.62 13.82 Goode and Services 13.32 18.32 35.62 14.12 15.62 21.12 36.22 20.62 52.7Z 26.92 20.52 32.32 31.72 Aeig. Global Pres. 0.02 0.02 0.02 2.62 5.62 6.32 4.22 4.72 0.02 0.02 5.82 6.22 5.02 Road Maintenance 0.02 0.02 0.02 1.52 0.92 3.12 10.12 5.52 0.02 0.02 2.52 10.62 8.22 Other 0.02 0.02 0.01 10.02 9.22 11.62 21.92 10.42 11.92 0.02 11.82 18.92 18.62 EPS y NINT If 10.42 8.22 0.02 23.02 18.42 35.82 30.82 40.02 23.02 11.22 31.42 33.52 33.42 2. Current Transfers 12.3? 11.42 7.72 15.02 11.12 10.12 10.22 14.42 15.09 12.52 10.52 10.72 10.62 Private 3.12 2.92 2.02 1.52 2.72 2.12 6.12 4.02 7.59 8.02 2.02 5.52 5.32 External 0.82 0.52 0.1% 0.11 0.1t 0.02 0.32 0.12 0.32 0.42 0.12 0.32 0.32 Public 8.52 8.02 5.6Z 13.42 8.32 8.02 3.72 10.32 7.12 4.12 6.52 4.92 5.02 To IlSSBI 0.02 0.62 1.42 1.62 1.22 2.62 2.1t 3.52 1.52 0.02 2.11 2.2t 2.22 To Municipalities 0.02 0.0z 0.02 0.22 0.22 0.82 0.12 0.12 0.12 0.02 0.72 0.12 0.12 To Public Utilities 0.02 0.02 0.02 0.42 0.01 0.72 0.0% 0.12 0.1t 0.02 0.72 0.21 0.22 To Reat of Pub. Sector 0.02 4.02 4.22 11.22 6.92 3.92 1.62 6.5% 5.42 0.0Z 5.02 2.3% 2.52 t 3. Interest on Public Debt 5.22 8.32 13.02 10.42 5.22 2.62 0.02 0.02 0.52 4.02 3.92 0.1Z 0.32 Internal 0.72 1.82 6.02 2.42 3.92 2.42 0.02 0.02 0.02 0.02 2.92 0.12 0.32 External 4.52 6.42 7.02 8.02 1.32 0.22 0.02 0.02 0.42 4.02 1.02 0.02 0.12 I1 Capital Expenditures 26.11 25.12 6.32 13.72 35.12 13.02 10.12 4.52 7.02 25.3Z 16.12 9.82 10.12 1. Fixed Capital Formatlbu 14.82 16.22 4.82 10.92 11.32 6.42 5.42 2.82 6.12 20.92 10.12 5.72 5.92 Machinery & Equipmekt 1.62 5.22 0.2t 0.82 3.2% 0.42 0.92 1.22 0.02 2.42 1.0t 1.12 0.92 Projects & Construction 12.92 11.02 4.62 10.02 8.12 6.02 4.52 1.72 0.02 18.52 9.02 6.02 5.02 2. Transfer Payments 11.41 8.82 1.62 2.92 23.82 4.72 4.72 1.62 0.92 4.42 6.02 4.12 4.22 Private 0.12 0.12 0.22 0.01 0.12 0.02 0.51 0.42 0.02 0.02 0.02 0.52 0.42 Public 11.22 8.72 1.42 2.8Z 23.71 4.12 4.22 1.31 0.92 4.42 6.02 3.71 3.81 To Municipalities 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 To Public Utilities 0.02 0.02 0.02 0.02 0.02 0.32 0.32 0.42 0.92 0.02 0.42 0.42 0.42 To Rest of Pub. Sector 0.02 0.02 0.02X 0.02 0.02 4.42 3.92 0.32 0.02 0.02 4.02 4.12 3.32 III. Net Lending 15.42 9.72 3.8 0.5% 0.42 0.1t 0.02 0.02 0.52 6.22 0.42 0.02 0.12 Memos Public Debt Amortisation 5.52 7.12 2.62 3.42 2.02 0.82 0.12 0.12 0.42 6.22 1.32 0.ZZ 0.22 Internal 2.32 2.32 1.22 1.02 1.22 0.22 0.12 0.02 0.42 0.02 P.51 0.12 0.12 External 3.22 4.82 1.42 2.42 0.82 0.62 0.02 0.0' 0.02 6.22 0.82 0.12 0.12 Other Expenditures T 0 T A L 100.02 100.02 100.02 100.02 100.02 100.02e100.02 100.02 100.02 100.02 100.02 100.02 100.02 I/ From 1970 to 1979 and 1992, expenditures in Defense and Police are included in Goods and Services, and Wages and Salaries. From 1981 to 1990 Defense and Police appears as a separate item. For 1991 Defense and Police have been added as a block to Goods and Services. -23- 69. In 1991, Nicaragua's total Central Government expenditures were 27 percent of GDP, which is still well above the historical average for the region (about 20%). However, it is significantly lower than the country's average for the eighties. Current expenditures are also slightly above the 1989 regional average. The two areas which remain particularly large are expenditures on defense and on goods and services. In 1991, these remain much larger than the region's norm, and are budgeted to remain high in 1992. It is apparent however, as was mentioned before, that goods and services contain a portion of expenditures which fall more accurately under workers benefits and could be categorized as wages and salaries. According to the estimates included in para. 67, goods and services may not be the problem. Rather, the size of wages and salaries could be the problem, when these include employee benefits. They total about 9 percent of GDP, which is well above the average for Central and South America. 70. In addition, it is worth noting that in per capita terms, in the context of a severe reduction in GDP per capita, both overall expenditures and Current Expenditures were, in 1991 (and are expected to be in 1992), at the same level as they were in 1970. Capital expenditures, on the other hand, which have been below the per capita 1970 level for several years, are expected to rebound in 1992, back to the 1970 level (see Figure 4). Current Expenditures: Functional Classification. Trends and Composition 71. Functional expenditures have similar trends to those of current expenditures. They increased strongly up to the mid-eighties and fell thereafter, maintaining, on average, a substantially higher level in the eighties. Social services in the seventies averaged 5.3 percent of GDP, while in the eighties they increased to an average of 11.2 percent (see Table 6). The trend in infrastructure expenditures (transport, energy, and water and sanitation) is comparable, with one distinguishing characteristic; after the peak in 1984 they declined sharply. General government services averaged 3.5 percent between 1970 and 1978, and increased to 9.6 percent in the eighties. 72. In the social sectors, expenditures on health grew steadily in the mid-seventies with a sharp rise in 1980, to twice the average of the decade. However, in the eighties expenditures on health did not continue to increase. In fact, they remained steady at about 5% of GDP. In per capita terms they declined slightly on average (see Figure 5). Total per capita expenditures in health peaked in 1983 (at 339, with 1970=100) and declined steadily thereafter to about 100 in 1991. Expenditures in health were protected in the 1989 stabilization. Therefore, they remain today at a level slightly above the 1970 level. 73. Education expenditures followed a similar trend. An index of expanditures shows a peak of 158 (with 1970 as the base year) in 1984, and a trough of 50 in 1989. In 1992, they are projected to be 64. During the rise of expenditures, education expenditures rose less than the aggregate, and then accompanied the fall in the aggregate. Although education expenditures have TABLE 5. NICARAGUA: SUMMARY INDICATORS PERCENT OF GDP Average Average Prel. Proj. Average ---------- ***--*** ---- ---- ---- ---- ---------------------------- ------- ------- ------- CONCEPT 1970-1975 1970-1979 1978 1981 1983 1986 1989 1990 1991 1992 1981-86 1987-91 1981-90 Social Service@ 5.25 5.32 4.22 10.22 11.42 12.42 7.42 14.92 9.22 8.22 11.62 10.22 11.22 Education 2.42 2.52 2.62 4.22 5.02 5.52 2.7Z 6.9Z 4.2% 3.7Z 5.02 4.52 4.92 Health 1.62 1.62 1.12 4.5Z 4.61 5.32 4.02 6.82 4.9Z 4.5Z 4.72 4.92 4.82 Housing 0.92 0.9Z 0.02 1.02 1.52 0.52 0.0% 0.02 0.02 0.02 1.42 0.12 0.92 Other 0.32 0.32 0.52 0.52 0.32 1.02 0.72 1.22 0.12 0.02 0.5% 0.72 0.71 Infrastructure & Production 4.02 4.12 4.92 7.6% 18.12 6.92 5.01 4.8Z 3.92 5.62 11.62 5.5% 9.3Z Primary 1.22 1.12 0.32 2.12 6.72 2.32 1.62 0.9% 0.52 1.22 3.92 1.52 3.02 Industry & Comaerce 0.7% 0.62 0.12 1.82 5.82 0.82 0.22 0.22 0.12 0.3% 2.82 0.32 1.82 Construction & Transport 1.82 2.2% 4.4% 3.72 5.7% 3.62 3.22 3.52 3.12 3.52 4.82 3.62 4.42 Other 0.22 0.22 0.02 0.02 0.02 0.32 0.02 0.32 0.1% 0.72 0.12 0.12 0.12 a DefQnse & Police 1.62 1.82 3.2% 7.62 11.02 17.72 11.92 18.92 5.92 4.32 12.12 14.22 13.82 4- General Services 3.52 3.52 6.02 4.42 9.32 11.3% 6.62 8.72 8.02 6.92 9.52 9.42 9.62 Goverment Entities 0.32 0.4% 0.52 0.2Z 0.22 0.4% 0.42 0.92 0.22 0.22 0.42 0.5% 0.42 Other 41 3.02 3.22 5.62 4.22 9.12 10.82 6.3% 7.82 7.72 6.72 9.2% 9.02 9.2% Debt Service- Amortiction 0.72 1.02 2.11 3.52 3.12 1.3Z 0.0% 0.01 0.02 2.9% 3.02 0.12 1.81 TOTAL EXPENDITURES 14.8Z 15.72 20.3% 33.2% 59.82 49.62 31.02 47.32 27.02 27.92 49.02 39.52 46.42 11 : In new Cordobas which are equivalent to 1000 Cordobas 2/ : In Thousands of Nov Cordobas. (i.e. Cordobas x 1,000,ooo) 3/ : In Cordobas Oro. Figures for 1991 are preliminary projections of actual expenditures and 1992 are Budgeted. 41 : In 1989 includes 155 million of extra budgetary expendituree TABLE 6 Cross-Country Comperison of Central Govertment Expenditure A. Functional Current Expenditure welfare Health Agriculture Total General Defense & Social Ss forestry hanufac- Expenditures Services & Police Education Health Security & Welfare Housing A Fishing turing NICARAGUA 18.1 2.5 1.7 2.6 2.2 1.8 4.0 1.4 1.8 0.2 1975 Avg Central A. 18.3 2.5 .. 3.4 1.7 2.5 4.2 1.0 1.6 0.4 Avg L. A. 19.6 2.7 .. 3.3 1.6 4.3 5.3 0.8 1.1 0.4 NICARAGUA 26.5 4.9 8.1 2.3 3.4 0.6 4.0 0.0 1.4 0.2 1989 Avg Central A. 19.1 2.2 1.5 3.0 2.7 2.5 5.2 0.9 0.9 0.3 Avg L. A. 18.2 2.0 2.0 2.9 2.4 2.4 4.8 0.8 0.8 0.5 1992 INICARAGUA 27.9 6.9 4.3 3.7 4.5 1.2 1.0 S. Economic Expenditures CURRENT EXPENDITURES CAPITAL EXPENDITURES V1 Country Total Total Goods & Wages & Intererst Subsidies Total Fixed Land & Transfers Expenditures Current Services Salaries Payments Transfers Capital Assets Intangilbles NICARAGUA 18.1 9.9 2.3 4.0 1.3 2.3 8.2 3.2 0.1 5.0 1975 Avg Central A. 18.3 12.9 2.9 6.6 1.0 2.5 5.4 4.0 0.1 1.4 lAvg L. A. 19.8 14.3 2.9 6.8 1.1 4.6 5.5 3.5 0.1 1.4 NICARAGUA 26.5 24.1 9.6 3.2 0.0 3.2 2.4 1.1 .. 1.2 1989 Avg Central A. 19.1 16.0 2.5 6.9 3.2 3.4 3.1 2.0 0.2 1.0 Avg L. A. 18.2 15.3 2.6 6.8 2.8 3.1 2.9 2.0 0.2 0.9 1992 INICARAGUA 27.9 19.1 4.4 7.0 1.1 3.5 7.1 5.8 1.2 -26- recuperated since, they remain substantially below 1970 levels (see Figure 6). 74. Housing expenditures, on the other hand, had two peaks, one in 1975 and another in 1986. Both preceded and followed by sharp increases and precipitated declines, respectively. 75. Defense and police expenditures continued to grow through 1986, and did not have a trough in 1989, as did other categories of expenditures. Defense and police expenditures will be at their lowest level in 20 years in 1992, when it is expected that per capita expenditures will be only 9% above the 1970 level (an index of 109). 76. All expenditures increased up to 1983, when the need to finance the war and increase expenditures in defense diminished expenditures in most other sectors. Defense expenditures grew up to 1986, and then joined in the downward trend, that in several sectors was reversed in 1990. Therefore, substantial shifts in the structure of expenditures have occurred in the last ten years. Evidence of this is clearly shown in Figure 7. The pie charts in Figure 7 show how different the structure of the expenditures is in 1990 from that of 1970. In 1970, expenditures on infrastructure were 28 percent of total expenditures, while in 1990 and 1991, these were 10 and 14 percent, respectively. Similarly, defense and police expenditures accounted for 13 percent in 1970 and 40, 22 and 15 percent in 1990, 1991 and 1992, respectively. The social sectors have gone from 35% in 1970 to 31% and 30% in 1990 and 1992, respectively. General services have increased from 21% (1970) to 25% (1992). 77. The incidence of the adjustment that occurred between 1990 and 1992 fell most intensively on Defense and Police and Construction and Transport (in particular, road maintenance). On the other hand, general services (the Presidency, the National Assembly, the Supreme Court, MCE, MRE, and the institutes) and education expenditures have not only increased their share of total expenditures, but have also increased their absolute level of expenditures. Cross-Country Comparison 78. Relative to the region, Nicaragua's functional distribution of expenditures changed drastically. in the mid-seventies, the country mirrored Central and South American countries in all sectors except education, where Nicaraguan educational expenditures were slightly below the average share of GDP (2.6% vs. 3.3%). In contrast, the average expenditures through the eighties in general services and defense and police are three and five times higher, respectively, than those of LAC. Expenditures on education, health and economic affairs, for the most part, experienced comparatively small increases. However, expenditures in the social sectors doubled (as a percentage of GDP) between 1976 and 1987, to more than double the Latin American average. In 1989, total expenditures and consequently expenditures on all sectors, fell sharply. General services declined by more than 50%, but remained significantly above the region's average, while declining outlays to the social sectors placed these below the region's average (e.g, in education 2.3 v.s. 3.0 percent of GDP). In 1991 and 1992, overall expenditures in - 27 - Index of Per Capita Expenditures 1970=100 500 60 400 100. 0 2 ! 4 «76 78 80 82 84 88 88 90 92 71 73 75 77 79 81 63 85 87 89 91 - CAPITAL - CURRENT - TOTAL Figure 4 Nicaragua: Expenditure Index (1970 = 100) 3» 300.- 250. 150 100.- I V 70 71 72 73 475 78 81 82 83 84 85 86 87 8889 90 1 92 - H~aJh Per Capa - Health Figure 5 Nicaragua: Expenditure Index (1970 =100) 250 200- 150 70 71 723 74 75 76 78 81 82 83 84 85 86 87 88 89 90 91 92 EducatWon Per Capit - Educaon Figure 6 - 28 - Figure 7: Evolution of the Structure of Expenditure Structure of Expenditure Structure of Expenditure 1970 1985 Educaion ISMAEducation (10.4%) DDbt Seice (49%) So. Swvies (3.8%) W M.3%) Soc. Services (34.8 Gen. Sevices (24.4%) Do- mie m)D b wyw 4A1fHousin (3.4%) **M) (13.) Infat & Prod. (17.5%) Unfrast & prod. (28.3%) Defene/okie (9.4%) Figure 7a Figure 7b Structure of Expenditure Structure of Expenditure 1990 I I1992 Toal Ep.2,5o m 27.9% of ODP Education (14.6%) r-O"~Eucgo (13.8%)b Syk (0 OmSrvc (0.0%(14%- ) Deb Seric (10.3%)5% Gen. A 044%) ~~~Soc. service (31.4)so.eiese) Healt(14.3) arm srAce (24.8%) Health (16.0%) D FPoe (40.0%) nfat&Prod. (10.2%) Dees/ole 1.%)**** Figure 7c Figure 7d -29- Nicaragua will be higher than the region's historical average, and social sector expenditures will be above the average by about 2 percentage points of GDP. The share of public expenditures on general services and defense will continue to be significantly larger than the regional average (more than double). Capital Expenditures 79. Central Government. Unlike current expenditures, the capital expenditures did not change markedly from the seventies to the eighties. From 1970 to 1979, capital expenditures as a percent of GDP oscillated at around 4.3, while during the eighties, they averaged 7.7 percent. With the exception of 1983 and 1984, there was not much variance around the trend. In 1983, the share of capital expenditures in GDP sharply increased to 21 percent and 15.5 percent in 1984 (see Figure 4). Most of the large expenditures in these two years were in the form of transfers to public enterprises. Although fixed capital formation (mostly projects and construction) rose significantly from 1982 to 1984, from 4 to 8 percent of GDP, capital transfers increased from 1.9 in 1982 to 14.3 percent in 1983 and 7.4 percent of GDP the following year (see Figure 8). 80. In comparison to average current expenditures, which grew by more than 300 percent from the early seventies to the eighties, capital expenditures increased by only 90 percent. The disparity in these rates of growth implies capital expenditures as a fraction of total expenditures decreased significantly. The distribution of capital expenditures also changed. The share of expenditures attributed to fixed capital formation (machine and equipment and construction and projects) and transfers have varied greatly over time (see Figure 8). Investment in machinery and equipment averaged about 5 percent of total outlays in the seventies, compared to 0.9 percent in the eighties. In the same manner, projects and construction decreased from and average of 11 percent of total expenditures in the previous decade to only 5 percent in the eighties. Transfers (public and private) also experienced similar declines, with the exception of 1983 and 1984, when transfers to public enterprises accounted for 24 and 13 percent, respectively, of the total. 81. Over the period 1970-90, the norm for the region's capital expenditures as a percent of GDP has been about 4 percent. Nicaragua paralleled this norm during the seventies and often was slightly above average. In the early eighties, Nicaragua's expenditures rose sharply to twice the average. This trend, however, has been recently reversed. In 1989, 1990 and 1991, capital expenditures declined steadily. In 1991, they were about half of the historical average for LAC. In 1992, they are projected to increase to more than double the Latin American average. 82. Overall Public Investment. Much of the above discussion on Central Government capital expenditure parallels that of the overall public sector. Non-financial public sector investment averaged about 5 percent of GDP in the seventies and was divided roughly in the same proportions between the Central Government and the autonomous government enterprises (see Chapter IV, Table 4). The structure of investment remained constant over time, with - 30 - NICARAGUA Structure of Capital Expenditures 10 71 73 75 77 79 a 83 65 67 65 91 K Tranfre Project & Conetr Mach & Equipmen Figure 8 -31- agriculture, construction and transport and the autonomous enterprises (TELCOR, INE, INAA) performing about 3/4 of all investment. 83. In the early eighties, investment grew tremendously. In 1983, investment in agriculture was 10 percent of GDP, compared to 1.1 percent the previous year. Investments by MEDE11 rose from about .5 percent to over 3 percent, most of which can be attributed to the Ministry of Internal Commerce. MCT investment morr; than doubled, and the rise is distributed roughly equally among the institutions that make up the ministry V. The increases in 1984 are again due partly to MCT and to MIFIN. 84. After 1985, investment fell rapidly, bottoming-out in 1990, ihen it was only about 3 percent of GDP. In 1991, the overall NFPS investment rebounded to 5.7 percent, which although higher than recent years, remains below the country's historical average. in addition, both for Central Government and NFPS investment, recent perx:ormance is below LAC's average.2' 85. In 1992, Central Government capital expenditures are budgeted to be over 7 percent of GDP and NFPS capital expenditures at about 12 percent. These levels are much greater than both the region's and the country's historical avrrages. C. SUMMARY AND CONCLUSIONS 86. The Sandinistas and the current Chamorro Administration changed substantially both the levels and the composition of government spending, with respect to their predecessors. From the early seventies to the eighties, expenditures as a percentage of GDP more than tripled (see Table 1). Since 1990, total Central Government expenditures declined by about 50 percent. Nevertheless, in 1991 and 1992, Nicaraguan expenditures will remain significantly above the LAC historical norm. 87. Regarding the structure, the Sandinista Government more than doubled defense expenditures, so that they reached an average of one-third of total current expenditures in the second half of the eighties. This came at the cost of a reduction in the share of social sector, infrastructure and production-related expenditures. The Chamorro Government in the 1992 budget has returned to a budget structure that is similar to the seventies structure, but where general services and defense-related expenditures have increased at j/ To arrive at a comparable figure for "MEDE," the Ministry of Industry, Ministry of Foreign Commerce, Ministry of Internal Commerce and the Fishing institute were summed. g/ Investments by MCT were derived by adding investments by: the Ministry of Transport, the Ministry of Construction, and the Ministry of "Vivienda y Asentamientos Humanos." 2/ Source: Trends in Government Expenditures and Revenues in Latin America, 1975-88. Yellow cover, World Bank report No. 10145-LAC. November 26, 1991. -32- the expense of the expenditures in the social sectors and, principally, in the infrastructure and production-related expenditures (see Table 5 and Figure 7). 88. In terms of share of GDP, the sectoral distribution has been traditionally biased toward defense and general government services, and at 11.2 points of GDP in 1992, is well above the region's average (3.7* of GDP) and the country's 1970 average of 5.3 points of GDP. The expenditures in the social sectors (education, health, etc.), on the other hand, will account for approximately 10 points of GDP, slightly above the region's average and well above the seventy's average. Capital expenditures, on the other hand, increased moderately from the seventies to the eighties and has been a little above the region's average, except for in the late eighties and early nineties. In 1992, this trend is expected to change, with overall public investment surpassing the LAC trend. 89. The trends described above, comparisons with the averages for the region, combined with the analysis of each item presented in Chapter I, suggeu: that several changes should be made with respect to the level and structure of Central Government total expenditures. 90. With respect to size, the overall level of expenditures remains too high. The public sector commands control over too many of the countries resources (projected to be around 37% for the NFPS in 1992). Per capita expenditures are at the same level as 1970, when GDP per capita has decreased to a third of the 1970 level. Moreover, in a public sector with severe institutional and management problems (see Chapter VI), its size remains significantly above the average for Latin America. In particular, the projected budget deficit before grants will have to be diminished in the following years. The only reasonable way to reduce the projected budget deficit before grants is by reducing current expenditures, because: a) it is expected that external aid (in particular grants) will diminish over time; b) the large public investment needs should be accommodated without crowding- out private investment; c) debt service will increase gradually in the following years; d) the large investment effort will require a substantial increase in operations and maintenance expenditures; and e) the effort to increase exports needs to be assisted by a competitive real exchange rate that may be impossible to maintain if there is a high level of government expenditures. 91. It will not be as easy to reduce further expenditures in the public sector beyond this point. Most of the easy reduction in defense and police, and in employment has already been done. Hence, there is an urgent need to determine global and sectoral plans in order to determine priorities that could be used to cut entire programs, which ia the only way to substantially decrease and restructure expenditures. 92. The average wage in the public sector, inclusive of all non -wage fringe benefits appears to be high. This is shown in the high ratir of average wage to GDP per capita, in comparison to other regional couni:ries. While this is probably the case for most workers (specifically of those that do not have migration as an alternative), the use of GDP per capita as a norm is not valid for determining salaries of workers that could consider migrating -33- (more educated and higher level workers). Nicaragua is paying too much with respect to the country's resources, but this level says nothing of how much is required to be able to retain the most able. Consequently, there is an issue of level and of structure of government pay. In sum, an issue of revising the civil service career path. The need to pay a high wage with respect to income per capita in order to retain able workers, together with the need to decrease overall expenditures, points to the absolute urgency of diminishing the role of the state and the size of public sector employment. 93. With respect to the intersectoral allocation of resources, there is a need to continue to reduce expenditures in defense and police and to tackle the issue of the size of general services. The inflated number of institutes, whose budgets have been growing in later years, should be rationalized. The creation of INATEC, for example, implied the creation of an extra administrative layer. Aside from reducing expenditures, resources could be redirected to education and investments in water and sanitation, areas that should be considered high priorities. 94. Other expenditures could be reduced as policies are modified. For example, in order to enhance equity and efficiency, the subsidy for urban transport should be better targeted and should be reduced to represent only a part of the total price (so that every beneficiary pays at least a small part of the ticket). 95. Expenditures in the social sectors should receive special attention. It does not appear that the problem is a lack of resources, even if we ignore the substantial amounts of money that dcnors are giving to the sector. Resources in education are not adequately distributed, with too much being allocated to higher education, adult education and central administration. Moreover, the non-discriminatory transport subsidy to students and teachers could be rationalized and the savings redistributed. With respect to the health sector, the fact that expenditure per capita in health is at a similar level to that of the seventies, is not apparent in the constant complaints about the lack of resources. This is probably the case because of the weaknesses in the expenditure control systems and the emphasis on higher cost programs (see Chapter III). In particular, the item of medicines deserves much closer study, as the GON has already determined. The area of social security also requires an in-depth study, because of its potential effect on expenditures. 96. With respect to intrasectoral expenses, the central administration in several ministries is too large. Some of them, consequently, do not have enough money to actually perform their jobs. Other items for which nearly all ministries show excessive expenditures are water and vehicles. Lastly, the growth in the item of "publicity and advertising" requires closer scrutiny. - 34 - CHAPTER Al: SECTOILAY ISSUES A. INTRODUCTION 97. The chapter covers the agriculture, health, education, transport, water and sanitation, and energy sectors. In addition to a brief analysis of the sector's performance, each section reviews the institutional issues and the pattern of public expenditures. Recommendations regarding the management, the overall level and the pattern of public expenditures are presented. This chapter confirms the diagnosis discussed in previous chapters --that is, the lack of planning of expenditures, the inadequate funding for recurrent expenditures, the influence of foreign aid on project selection, the weakness of management and the weakness of institutional structure. The chapter also points to specific problems, such as the divergence between stated sectoral priorities and the actual allocation of resources (in particular within the education and health sectors). B. AGRICULTURE Institutional Framework 98. From the beginning of the Sandinista Administration in August, 1979, the agricultural sector was radically transformed. Four new institutions were created: INRA (Instituto Nicarag0ense de Reforma Agraria), IRENA (Instituto Nicaragrense de Recursos Naturales y del Ambiente), PROCAMPO (Programas Campesinos) and MIDA (Ministerio de Desarrollo Agropecuario). In 1981, in order to accelerate the agrarian reform process, MIDINRA (Ministerio de Desarrollo Agropecuario y Reforma Agraria) was created by merging MIDA and INRA. 99. From 1981 onward, MIDINRA also created a large number of agricultural state enterprises, which totaled approximately 85 by 1990. All state enterprises' activities reached a level of 31W of GDP in 1990, of which the agricultural enterprises constituted about half. 100. In 1988, in the context of an economic adjustment plan's framework, TRENA merged into MIDINRA. During that year, two new organizations were set up within MIDINRA: a National Program for Peasant Development and Agrarian Reform (PNFCRA) and the National Agricultural Commissions.! 101. In February 1988, the Technology Development Fund (FDT) has created to ensure adequate research funding. Since 1991, FDT has been funded 1/ These Commissions are mixed organizations, created by MIDINRA in May 1988, for consultative purposes between Government, producers and agricultural organizations. They are financed by a 2W tax on certain exports and extraordinary contributions by the Central Government. - 35 exclusively from a 2W tax on certain exports. In 1992, the fund will be utilized to finance the research centers which have been transferred to the Agricultural Commissions as of September 1991.F 102. In June 1990, with the change of Government, MIDINRA was divided into four institutions: MAG (Ministerio de Agricultura y Ganaderia), INRA, IRENA and the Agricultural Secretariat of CORNAP. Thus, agrarian reform, agricultural development, natural resource conservation and the administration of agricultural public enterprises all function independently. 103. MAG's primary role is to transiorm agricultural policy and economic structure towards a free market. The National Agricultural Commissions, under NAG (Cotton, Coffee, Livestock, Non-Traditional Products and Basic Food Crops) are in charge of their sub-sector's or commodity's research and development. INRA is responsible for developing and deepening agrarian reform. IRENA is given autonomy to manage and control national resources and protect the environment. The state enterprises are now administered by CORNAP which aims to privatize them. Recent Trends in Current and Capital Expenditure 104. The trends in public expenditure in the agricultural sector since 1981 are presented in Table 1 (see also the Statistical Annex). The overall expenditure would be considerably larger, particularly in the eighties, if the large subsidies implicit in agricultural credit were included. At that time, the state banks channeled considerable subsidies and transfers to cover losses to the farms created by the agrarian reform and the state enterprises. The state enterprises received their financing only partly through NIDINRA, as they received transfers from the agricultural banks, the Central Bank, and NIFIN. 105. The steep increase in expenditures from 1981 to 1983 is essentially due to the vast capital investment program in agricultural state .nterprises, particularly in 1983. Due to the beginning of the downturn of the economy from that year onward, expenditure progressively tapers off, reaching an all-time low in 1989, the year of the Sandinista stabilization effort. Overall expenditures increase significantly, however, in the 1992 budget. This increase is generated by the combination of a low level of current expenditures (similar to the all time low of 1989) and a very high level of capital expenditures, only surpassed in its relationship to GDP by the investments of 1983. 106. The ratio of capital to recurrent expenditure is reasonable if taken as an average over the 12-year period. This ratio is almost 50%. However, if the 1983 state enterprise capital expenditure is removed, the ratio falls to 25W. The 1992 ratio of 75%, therefore, is totally atypical. a/ FDT is basic for the development of technological activities. During 1991, MAG's budgetary allocations were arounA- 27 million cordobas, while FDT resources reached 20 million cordobas. TABLE 1 EXPENDITURE IN THE AGRICULTURAL SECTOR, 1981-92 (Millions of 1980 Cordobas) at 82 83 84 85 86 87 as 89 90 91 92 CUJRENT EXPENDITURE 380.1 578.7 704.1 771.5 389.6 272.8 204.1 129.6 72.8 90.9 0.0 74.6 Wages and Salaries 113.2 186.0 210.8 193.8 188.9 143.9 82.1 33.1 22.9 55.2 0.0 33.6 Goods and Services 63.9 97.8 177.0 162.8 127.6 87.8 59.4 60.3 36.4 22.0 0 0 25.7 Current Transfers 203.0 294.9 316.3 414.9 72.9 41.0 62.6 36.2 13.5 13.8 0.0 15.2 CAPITAL EXPENDITURE 32.4 250.8 2,283.7 311.0 201.8 125.3 3.4 54.9 27.5 25.2 0.0 260.7 Machinery and Esipment n.a. 11.2 32.7 39.0 2.6 2.1 n.e. 25.2 2.3 6.2 0.0 0.2 Civil Work n.a. 12.3 26.6 30.5 23.5 72.3 n.a. 24.5 16.1 19.1 0.0 251.2 Other Capital n.e. 227.3 2,224.5 241.4 175.7 50.9 n.e. 5.2 9.2 0.0 0.0 9.3 TOTAL EXPENDITURE 412.5 829.5 2,987.9 1,082.5 591.4 398.0 207.5 184.5 100.3 116.2 0.0 335.3 AS PERCENT OF GDP Current Expenditure 1.7 2.7 3.1 3.4 1.8 1.3 1.0 0.7 0.4 0.5 0.0 0.4 Capital Expenditure 0.1 1.2 10-0 1.4 0.9 0.6 0.0 0.3 0.2 0.1 0.0 1.4 Total Expenditure 1.9 3.8 13.1 4.8 2.8 1.9 1.0 1.0 0.6 0.7 0.0 1.8 - 37 - It would be a welcome development if it were not for the questionable quality of the investment program. Within recurrent expenditure, transfers are the largest line item from 1981 to 1984, explained by the large subsidies supported by MIDINRA. Salaries comprise the largest budget item since 1985 (and up to 1992). Expenditure in goods and services and operating costs have been progressively reduced, and appear to be at a very low level. Main Sector Issues Sectoral Strategy, Action Plans and Coordination 107. The main element that stands out in the public agricultural sector is the lack of strategy. There is a wide dispersion of objectives, geographic coverage, target populations, plans, programs and projects, which makes it difficult to establish what the sectoral priorities and objectives are. It is very important to provide these priorities within a sectoral strategy, in particular because the reactivation of the agricultural sector is believed to be the main hope for a rapid economic recovery. 108. Some of the principal reasons for the present lack of organization are: (a) the change brought about by the new administration and economic development model, (b) the splitting of the main sectoral institution (MIDINRA) into three (NAG-agriculture, INRA-agrarian reform, IRENA-natural resources), and soon more institutions (the commodity-specific commissions); and (c) the lack of qualified personnel. However, at this point, what is most urgently needed is a sectoral strategy with the supporting analysis which defines the short and medium-term objectives, and the roles of the different institutions in meeting those objectives. This is particularly urgent because each institution is defining its own strategy and action plan. From the information that is available on these preliminary strategies, there are large areas of overlap, conflicting objectives and priorities, and a vast number of small investment and technical assistance projects whose impact and effectiveness is unclear. 109. The following step is to match the elements of the strategies described above with the investment and technical assistance programs. Even though the above-meL-tioned strategies do give some idea of direction and objectives, the investment program does not. For the most part, it is a vast collection of projects (depending on the source, from 35 to over 100, including technical assistance projects, which often include investment) which are donor driven and financed, and are almost exclusively carry-overs from the previous admin'atration. Generally, they are area-specific, cover a small group of beneficiaries or a specific aspect of production (e.g., fertilizer use, bean varieties), although there are a number of integrated rural development projects. There are a minimal number of new projects which match the new strategies or that attempt to organize the dispersion of efforts into national services. IRENA is the only institution to have attempted this consolidation (e.g., national forestry service rather than a number of small forestry projects). MAG is unaware of all the projects that exist, particularly those executed regionally. This is worrisome as preliminary figures show that the external cooperation budget is over two times NAG's - 38 - total 1992 budget (US$31.5 million vs. US$15.7 million). Therefore, losing control of the external cooperation budget in effect means losing control of the sectoral investment program. 110. The lack oi a coordination system at the political (ministers) and technical levels is a result of MIDINRA's split into various institutions without the provision to create a planning and coordination mechanism. A MAG, INRA and IRENA technical coordination group was set up in August, 1991, but it has not functioned in practice. There is no official definition or decree of who should coordinate/guide the sector. MAG would institutionally be the most adequate coordinator, though technically it is not prepared to undertake such task. Type and Composition of Expenditure 111. Ministry of Agriculture and Livestock (MAG). Reflecting the lack of a strategy and plan of action for the sector and the Ministry in particular, there are major problems with the type and composition of expenditure in the agricultural sector, in particular in MAG: (a) the relation between recurrent and capital expenditure; (b) an inability to use the available external financial resources; (c) a wide dispersion of efforts and investments of limited effectiveness which follow no strategy or plan of action; and (d) the lack of budgetary control and the implementation capacity of a very large budget. 112. Recurrent vs. Capital Expenditure. In 1992, the ratio of recurrent to total expenditures has declined to 22%. This, more than redressing an imbalance in favor of current expenditures, has reversed the problem. The composition of the budget remains a problem because of the recurrent cost implications of the large investment program. 113. Financial Resource Availability. One of the principal constraints stated in MAG to developing its services and field programs for its clientele is the lack of resources, human and financial. As for financial resources, officials point to the reduced budget allocated to them each year, in particular the investment budget. This is true as far as allocations from the Ministry of Finance (MIFIN) are concerned. However, MAG operates in reality with three financing sources: the first is MIFIN; the second, and by far the largest, is external cooperation funds; and the third is the FDT. There is no central office which can list or describe all of the external sources or FDT funding of projects, nor is there data available on the magnitude of external cooperation. However, a first approximation derived by the Ministry of Finance for NAG shows for 1992 an external cooperation budget over two times the budget of the entire Ministry (US$31.5 million vs. US$15.7 million), or three times its investment budget (US$11.1 million). PDT's 1991 funds, which totalled US$4.0 million, almost equaled the Ministry's recurrent budget of - 39 - US$4.4 million. Thus, MAG will handle directly and indirectly approximately US$51.2 million in 1992, one of the largest ministerial "budgets." 114. Recurrent Expenditure. Within the recurrent budgets the distribution of expenditure could be improved. For example, expenditures on extension services (Actividades Comunes - Servicios .gropecuarios), although significant (US$0.7 million or 15% of the total budget), are less than what is needed for an effective service in the field. At the same time, "Central Activities" (administration and the Minister's offices) are too high, with almost half (49%) of the entire recurrent expenditure budget. 115. INRA. Within the recurrent expenditure, which totals US$2.4 million, the distribution is inadequate: 72% of the budget is assigned to "Central Activities," which includes administrative headquarters, planning and regional coordination services and the office of the Director. This effectively leaves INRA's three field assistance programs to reformed sector farmers with insufficient funds to operate. Up to 63% of the budget per field program goes to salaries. This serious imbalance within recurrent expenditures should be corrected by assigning more funds from the headquarters to the three field programs. 116. IRENA. The balance between recurrent and capital expenditure is the highest of the three institutions, such that 87.4% of the budget is capital expenditures. While this is commendable, there is a clear lack of balance between the large investment program and IRENA's recurrent expenditure budget. This will undoubtedly create severe problems when donors stop providing funds for recurrent expenditures. It is unlikely that, if and when that happens, IRENA can effectively operate on such a small administrative budget of only US$2.3 million. It appears that the GON is withdrawing local funds from the sector because of tha existence of strong donor support. However, it should be clear that the recurrent costs generated by the large investment program will shortly creace demands on the budget. Concusions and Recommendations 117. Sectoral Strategy and Plan of Action. An overall vision of where the economy, and particularly, the agricultural sector are going should be the first priority at this point. The corresponding plan of action for each institution is the next priority. This would b .ve identified the priority areas of action and the necessary investments Lnd expenditure in the sector. 118. Type and Composition of Expenditure. Regarding the sector as a whole, the level of expenditure appears to be excessive (if external cooperation funds are included) in particular if referred to their poor results. This is reinforced by the fact that resources are being poorly planned and ineffectively spent. The type and composition of expenditure is in most cases of low or unknown effectiveness, inappropriate for a market- orientee economy, and costly. Most importantly, only a small percentage of the target population is reached. - 40 - 119. INRA should concentrate its efforts on completing the land distribution and titling process. In addition, INRA should adjust its operations to the new land tenure legal framework, enforce it and move quickly to solve the many land conflicts which exist. This should be complemented by the government's commitment to enforce legislation guaranteeing proprietorship. 120. IRENA's mandate is wide and difficult even for a larger, more experienced institution to meet. It too should concentrate its efforts on a few priority areas, particularly as it has limited implementation and logistical experience and support. 121. The agriculture sector starts from a privileged position by Central American standards, in that the size of the sectoral institutions (in functions, enterprises and personnel) have already been dramatically reduced. Care should be taken in not increasing either the functions or the employment of these institutions. Even though certain programs must be expanded, options such as contracting out the service (e.g. extension, certain research, training) to the private sector should be seriously considered. 122. Monitoring, evaluation and control of implementation and expenditure, is not being done at present, and large amounts of funds are spent with no control. Monitoring would permit adjustments in project execution to ensure cost-effectiveness. Evaluation would help to determine which type of project is most effective in the Nicaraguan environment. 123. INRA, and especially MAG, must interact more closely with IRENA to ensure the conservation of natural resources and the environment. Because of limited resources and other factors, this has largely been ignored and the environment has suffered considerable degradation as a consequence. C. HEALTH Overview 124. Throughout the 1980s Nicaragua experienced declining infant mortality rates and increased life expectancy. Gains were achieved through the expansion of free health care coverage. In recent years the gains are being reversed, and, in 1991, with an infant mortality rate of 72 per thousand, Nicaragua does not compare well with other countries in the region. The major cause of death is acute diarrheal disease. Food availability and protein consumption have been declining. Maternal and child malnutrition and maternal mortality are increasing. 125. As health services were expanded, expenditures on pre-'entive care, sanitation, and the maintenance of facilities were being postponed. Moreover, the distribution of resources between urban and rural areas was unequal, with the latter dependent on donor aid and NGO implementation. As resources have become increasingly limited, problems associated with this strategy are now - 41 - apparent: (a) hospitals are deteriorating due to excess demand from cases with preventable diseases and from inadequate maintenance; and (b) the failure t. change the population's health, nutrition and sanitation habits increases the risks from preventable diseases when the quality of government-financed care declines. Institutional Framework 126. Since 1979 the Government, through MINSA, has guaranteed about 95% of public health financing. It has also controlled most sector activity, including the purchase and distribution of pharmaceuticals. This strategy has gone beyond the role of the Government as responsible for public health, and the Government has adopted the role of providing free private goods and services indiscriminately. 127. In 1991, potential coverage extended to about 80% of the population through a network of functioning, staffed health care facilities down to communities of less than 3000. The primary delivery system consists of over 800 postas and health centers, supported by 31 regional and national hospitals at the secondary level. The administrative structure, until recently, included nine regions and 91 areas de salud, each area administering resources assigned by the region for 1 or 2 municipalities. The previous administration also organized local communities to carry out national health goals. MINSA's five-year Master Plan includes institutional restructuring into SILAIS that woule decentralize the system. Unless steps are taken to remove the existing regional administration, this could create an additional administrative layer. 128. MINSA has about 20,000 staff (July 1991). Decision-making has been highly centralized, with services and resources concentrated at the secondary level and in Managua. Institutional weaknesses exist in management, financial and project planning, information systems, and operation and maintenance. Performance has been affected by a bureaucratic, top-down approach to the provision of service; poor supervision at the service level; high staff turnover; poor intra-and intezsectoral integration and a policy of free medical care. Responses to problems have typically involved administrative restructuring and commitment of additiona± resources to conventional medical, rather than public health solutions. Recent Trends in Current and Capital Expenditures 129. Expansion in health services has been made possible by government spending. From 1980 to 1988, the sector received an average of 11% of government-budgeted expenditures. In 1991, the ratio rose to 17%, or 49% of public spending in the social sectors. The health sector generally has maintained its budgetary position as a percentage of GDP and of public spending, but increases have not compensated for a high population growth rate and the fall in GDP over the decade. Consequently, although as a percentage of GDP, 1992 expenses in health are at a level comparable to the average of the eighties (4.5% of GDP), per capita expenditures are at one third of the average level in the eighties (but only 20% below the average for the seventiev). Bilateral and multilateral assistance has played a critical role - 42 - in hospital construction in rural areas and in -he provision of technical assistance and salary support. 130. Spending priorities have emphasized: 1) operational expenditures over maintenance --domestic resources have been used to sustain salaries and worker benefits rather than maintenance of hospitals or equipment; 2) curative over preventive and hospital over primary care (hospitals have dominated health care expenditures, absorbing 50% of MINSA's ordinary resources in 1990 and 1991. Programs of primary health care received 25% in 1991. The direct wage bill of 31 hospitals is almost double that of the 800-unit primary wage bill. Moreover, the ratio of the primary health care budget going to curative goals is 7:1 over that allocated for prevention; 3) administration --from 1986 to 1991, administration costs have peaked at 17%, with most of the costs concentrated at the regional level (an estimated 30% of MINSA's doctors hold administrative positions that remove them from service); 4) specialists vs. generalists --generalists hold less than a 60:40 advantage over specialists, and 76% of the specialists are concentrated in Leon and Managua; 5) medicine and drugs --MINSA estimates that US$42 million (US$10.75/person) ig needed for the public sector alone, although this is more than four times what would usually be considered necessary to meet basic needs; and 6) sector personnel over patients --there is a clear tendency, under conditions of budgetary constraint, for the preservation of workers' goods and services over those of patients (about two-thirds of the budget goes to employees, and in 1991, each employee received the equivalent of US$2,265, or US$190 per month). 131. The 1991 budget shows a looseness that is in contradiction to the perceived scarcity of funds. Rationalizing expenditures for water, medicines, food, clothing, per diem for workers, and overtime pay, in addition to the contracting out of some services, would save US$17 million to US$18 million a year. This would permit increased allocations for fuel, maintenance and supplies. A new health care strategy would be more cost effective, since the cost of curative care per incident of diarrheal disease in a hospital is a minimum of 46 times the cost of preventive care at a health post. Main Sector Issues 132. The main sector issues are: (a) the need to reallocate limited public resources to reverse rising infant and maternal mortality from preventable causes; (b) the low level of hygiene education and sanitation; (c) the definition of the appropriate role of public spending in health care; (d) the need to prevent deterioration of physical infrastructure and lower excessive demand; (e) the financial/health implications of overreliance on curative strategies; - 43 - (f) the imbalance in budgetary position between personnel benefits and patient services; (g) the excessive requirement for pharmaceuticals, and "leakage" of pharmaceutical products from the public to the private sector; (h) the geographical/social disparity in food distribution ane health services; (i) the implementation of programs without consideration of budgetary constraints, financial impacts or a plan to sustain benefits; (j) the need to charge for non-basic services to recover costs and reduce excessive demand. 133. The reliance upon curative care for what are preventable diseases increases both the capital and recurrent costs of health service, and fails to have an impact on major health problems. The existing high cost approach to health prcolems is in itself a major problem that should be urgently tackled, because: (a) overall service quality is affected when expenditures are directed toward the expansion of facilities (like hospitals); and (b) subsequent budgets do not expand proportionately to operate and maintain these new facilities, making these investments ineffective. Consequently, resources are at first misallocated to low priority investments and thereafter no resources are allocated to maintain such investments. Expansion is done without consideration of present and future resource constraints, a potential source of much sectoral instability, as it affects the capacity to retain experienced staff, to maintain program continuity and to build on the benefits from past expenditures on staff training. 134. The proposed SILAIS structure is a tool to decentralize the structure of the Ministry. However, unless the existing regional level is dismantled, it will add the costs of another bureaucratic level. The SILAIS' capacity to develop low cost approaches to solving health care problems will have to be developed. The Budget and Investment Program 135. The objectives of MINSA's Health Master Plan for 1991-1996 are to upgrade all facilities and equipment, professionalize all staff, better integrate hospital and primary care units and increase local (SILAIS) control over health care priorities and solutions. However, the planned budget does not include sanitation or maintenance costs, training of "brigadistas" and "partera ', and community education is allocated only 0.4% of the total budget and 1.3% 2 the technical assistance and training component. This confirms that the pr irities are towards a doctor-oriented curative system, rather than toward the less costly and more effective preventive system. 136. The investment program proposed in the Master Plan is for US$130 million, of which 75% is to be externally funded. Despite inadequate funds to maintain existing services, no analysis was done of the recurrent costs _S 44 - that will result from the plan's new manpower, skills, modern equipment and expanded facilities. Since the health system cannot support the higher recurrent costs, the impact of sipporting these activities on the government budget may be significant. However, MINSA, with domestic and external funds, is already implementing parts of the plan, often directing new investment to regions and groups that rank low in its order of priorities. Conclusions and Recommendations 137. Reduce Scope and Improve Management. Public health priorities should be clear: safeguarding the public from the spread of transmissible and environmentally caused diseases and protecting those without resources to protect themselves. This more modest mandate will probably enhance the chances of solving the enormous management inefficiencies present in the public health system. 138. Health Care Strategy and Short-Term Investment Plan. The existing health structure rests on the implicit strategy that attempts to prevent people from becoming sick from preventable causes are not cost-effective and therefore, the system will provide the services to cure them and prevent death. However, this implicit strategy is flawed as it is in reality much more cost-effective to try and prevent the diseases (such as diarrhea), that constitute the most important cause of death in Nicaragua. Consequently, the strategy is biased toward curative care and diverts allocation from interventions that would have the greatest impact on Nicaragua's disease profile. Investments being realized in hospitals are not only criticizable form a strategic point of view, but also from a financial point of view. Operating costs are already severely limiting the quality of service, so investment decisions that require further expenditures to operate should be carefully screened. 139. Cost Containment and Reallocation. Education to alter habits and prevent diseases would permanently lower what have become fixed annual costs associated with curative care. For example, part of the cost of salaries for maintaining emergency rooms open on an emergency basis for epidemics of preventable diseases could be reallocated to pay for the following: 100 community water and sanitation systems; quadruple the present amount spent on community health education and worker training; quadruple the amount budgeted (and diverted) for hospital maintenance; and an additional $520,000 in savings. 140. Suspend unnecessary investment: (a) investment programs to treat what are considered untreatable cancers; (b) most hospital construction and expansion, particularly if the justification is saturation with diarrhea patients; (c) investment in management information systems at the top intended to improve data collection at the bottom. Activities that should proceed include restocking health posts and centers; improving pharmaceutical storage, inventory control and system of distribution; and staff training. 141. Preventive Primary Health Strategy. Emphasis should be assigned to integrated nutrition, hygiene education, family planning and growth-monitoring. Community outreach from the health post, with better-trained volunteers in - 45 - communities, should also be emphasized. Poor mothers and infants should be the initial priority. After their needs are met, unused funds can be put to other uses. 142. Revenue Generation and Pricing. There should be an effort toward recovering costs. Limits on fees encourage excessive demand for unneeded services and consequently create the impression that supplies are inadequate. Failure to charge for curative care limits the incentive to use leos expensive preventive measures. No fees translate into no revenues and diminished quality of services. Appropriate fees will reduce excess demand that contributes to the premature deterioration of facilities and will produce revenues to support operation and maintenance of them. The sector could recover up to US$14 million, * with minimal fees for certain services, without discriminating against the poor. Fees should be structured in such a way as to discourage more costly treatments when cheaper alternatives exist. They should encourage the early use of the health posts and discourage use of hospitals as an alternative. For this, MINSA should calculate unit costs per service and activity. 143. Recurrent Costs. MIFIN should require that all of the Ministry's expenditure plans include recurrent cost projections and that the cumulative impact be clear before being impleme-ited piecemeal. In the case of MINSA' s five year plan, estimates indicate the need for recurrent maintenance costs for vehicles, equipment and buildings in excess of one million dollars each year. The total amount budgeted for 1991 was US$418,000 for equipment and vehicles, and this was largely diverted to other uses. 144. Staff. MINSA should develop a comprehensive human resource policy - that should address, among others, the fo.lowing issues: (a) More outreach is needed for remote areas and supervisors should be required to leave their offices to see what is occurring in these areas. Payment of per diem should be contingent on leaving the office; (b) Volunteers need training, supplies and support; (c) The number of specialists needs to be reduced. A percentage of specialists should be placed on a retainer basis, committed to providing certain services when needed. in return, they would continue to retain the right to use hospital facilities and to bring private patients to the hospital, in private beds, for a percentage of the fee; (d) The number of hospital doctors should be reduced in Managua and Leon. (e) While some benefits may be a supplement to workers' low salaries, their distribution is difficult to manage. A negotiated agreement should be reached to monetize many of these benefits (e.g., food), reduce the monetized portion by some percent, and call it all salary. - 46 - 145. Implement a Pharmaceutical System. The need for more medicines has been stressed by the sector, although it is known that a large amount of donor financing is being channeled to provide medicines for hospitals. Aside from the issue of over-prescription and overuse (due to, among other things, the lack of fees), this scarcity is due to the waste and misuse of medicines since there are very loose controls in the system of drugs selection, procurement and distribution. The system of procuring and distributing medicines should be overhauled (the GON has already started to work in this area) . Moreover, prescriptions should be controlled and pricing policy changed to institute charges, that should reflect ability to pay. 146. Incentives for Prevention. Incentives should be given in support of changing habits. Communities, instead of receiving a new hospital that does not fit their needs, should be rewarded with the facility after they reduce their infant mortality rate (IMR) from diarrheal disease to a certain level through a preventive program. 147. Management of Foreign Aid. Lack of adequate management of foreign aid is becoming a critical problrm. Aid in 1991 was equivalent to 39% of the budget. D. EDUCATION 148. The Nicaraguan Education Sector has traditionally baen very inefficient. The major policy objective of the Government of the FSLb was to increase coverage, but the methods used created new problems. Even though during the first five years of the FSLN program, enrollments increased substantially at all levels, by 1986, decreasing enrollments were a matter of great concern. The expansion of the Nicaraguan educational system during the early eighties, particularly the expansion of primary and adult education, was due to the use of several educational alternatives based on community support and volunteer teaching. However, dropout and repetition rates remained exceptionally high. Hence, progression rates continued to be extremely low. Institutional Framework 149. The formal education system in Nicaragua comprises General Basic Education, Technical Education and Higher Education. General Basic Education comprises one year of pre-primary education, six years of primary Education, three years of secondary education and two years of preuniversity education, under the supervision of the Ministry of Education (MED). MED is also responsible for teachers' education in 11 schools (Escuelas Normales) and an in-service training program. 150. NED lso regulates and generates fixed curricula for the private sector, which ib attended by 14W of those enrolled in primary education and 26W of those that attend secondary schools. In the private sector, over half of the primary schools enrollment (57W) and one half (499) of the secondary - 47 - are subsidized ("subvencionadas") by the Ministry. MED has traditionally subsidized them by paying their payrolls at the level of public wages. 151. Until 1990, MED was also in charge of technical education, which has now been combined in the newly created INATEC, together with vocational education, formerly administered by SINACAP under the Ministry of Labor. INATEC's president answers directly to the President of the Republic. Funding for INATEC comes from the national budget, which funded technical education, and a 2% tax on labor payrolls, paid by the private sector, which financed vocational education. The Social Security Institute (INSSBI) collects this tax for INATEC. Currently, this amount is directly deposited into an account without any Treasury control. 152. The higher education system includes four public universities, two private universities, and two centers of higher technical studies. All are funded by the Government but are totally autonomous. Private universities were integrated into the national system in the early eighties, and they have remained privately managed since then. 153. The system is coordinated and governed by a policy body, the Consejo Nac!:nal de Universidades, that consists of representatives of the universities and centers, and the heads of the national union of Nicaraguan Students, the Teachers' Association, and the University Workers' Association. Its operations, departments and programs are outside of government control. 154. Higher education (including private universities) is mandated by law (Ley No 89, 1990) to receive no less than 6% of the revenues of the general government budget. Recently made independent of the Ministry of Education budget, the universities' budget is allocated among the various universities according to criteria established in the law, which include the number of students and operating costs, though the standards are very loosely applied in actual practice. In the execution of the budget, the Council is only ex-post accountable to the "Contraloria General de la Nacion." 155. Universities receive transportation scholarships for students and professors. They are also exempted, by law, of payment of public utilities, including water, electricity, and telecommunications. Recent Trends in Current and Capital Expenditures 156. Educational expenditures in real terms peaked in 1984 and steeply declined thereafter until 1990, to one third of its peak level (see Table 2). After a surge in 1990 due to the wage increases by the outgoing Sandinista Government, it was settled at one half of its peak level and slightly above the average level of the late seventies. Consequently, real expenditure per capita has dropped drastically (see Figure 6, previous chapter). 157. In terms of incidence in the government budget, education expenditure has stood at 10-14% for most of the last 20 years. In terms of its per capita in GDP, education fluctuates between 2-3% of GDP in the - 48 - seventies, reached levels of 5-6* in the mid-eighties, dropped to 2.2% in 1989, and in 1992 stands at 3.7% of GDP (see Table 2). TABLE 2 EDUCATION'S SHARE OF GOVERNMENT EXPENDITURES AND GDP Year Educational Annual % of Gov't % of GDP Expenditures Growth Expenditure (mil. 1980 cord.) (%) 1970 454 18.1 2.3 1975 611 6.1 13.1 2.4 1978 680 3.6 10.3 2.6 1979 576 -15.3 14.2 2.9 1980 773 34.2 11.1 3.7 1981 1009 30.5 13.4 4.6 1982 867 -14.1 10.2 4.3 1983 1182 36.3 12.2 5.2 1984 1337 13.1 10.0 6.0 1985 1207 -9.8 10.1 5.6 1986 1306 8.2 12.3 6.2 1987 1130 -13.5 12.0 5.3 1988 623 -44.9 7.5 3.6 1989 410 -34.2 8.8 2.2 1990 1196 191.7 14.6 6.1 1991 954 -20.2 20.5 5.5 1992 895 -6.2 17.9 5.0 Sourga: MED, MINFIN, Mission estimates, Arien and Matus (1989). Note: Educational expenditires are by the Central Government (in all tobles) and include higher education. Main Sector issues Intrasectoral Resource Allocation 158. In terms of educational expenditures, primary education accounts for the largest share. However, it was sharply reduced in the last decades (it was 62% in 1970, 44% in 1978, and stabilized at around 32% from 1980 to 1990). In 1991, the share was projected to be 36% for the whole year. This reduction in the share of primary education should be reversed. 159. Higher education replaced secondary as the second largest educational expenditure starting in 1980. This situation remained until the nineties, when it matched the share of primary education. Out of the projected budget for 1991, 28% was allocated to this level. It is by far the most expensive educational level (in costs per student), a fact that raises several equity and efficiency issues. - 49 - 160. General administration accounted for 2% in 1970, peaked at 26% in .1980, remained stable at around 16% during the 1980s, and increased to around 20% to 25% in the early 1990s. Thus, general administration accounted for a higher proportion than secondary and technical education (see Table 3). Given the lack of contrcl of central administration over the educational system, there is a need for a deep reorganization of the ministry to be able to do more, and at the same time release resources to the educational levels. TABLE 3 SHARE OF EDUCATIONAL EXPENDITURES BY LEVEL IN PERCENT LEVEL 1970 1978 1980 1982 1984 1989a) 1990a) 1991b) GENERAL ADMINISTRATION 2 14 26 16 14 31 * 31 ** 16 SPECIAL EDUCATION 0 0 1 1 1 1 1 1 PRE-PRIMARY 0 0 1 1 2 2 2 3 PRIMARY 62 44 34 32 33 30 26 34 SECONDARY & TECHNIC 15 22 19 15 14 6 12 14 NORMAL 1 2 1 1 2 2 4 2 ADULT 0 0 3 7 7 2 3 2 HIGHER 16 12 15 20 21 18 18 28 OTHER INST. 2 7 2 7 7 9 4 0 TOTAL 98 101 102 100 101 100 100 99 a) The data here are more than usually inconsistent across sources, especially in terms of what was categorized as general administration. Changes in that category would affert all othera so more than the usual caution in interpretation is required. b) The 1991 breakdown is based on projected budgeted expenditures, not actual. * If "Compensations and Rewards', which are transferred to all programs, is excluded, this percentage goes down to about 20%. ** If "Machinery and Equipment' and 'Construction" are excluded, this percentage goes down to about 25%. 161. The second most expensive educational level in relative terms is teachers' education. In 1989, educational expenditure per student in teachers' education was 5.4 times the expenditure per primary school student. This area also needs a profound reorganization. 1992 Budget Structure 162. Out of the total MED 1992 budget, 41% goes to primary education and 2.3% to pre-primary, showing a marked improvement in resource allocation. Teachers' education comprises 2.4% of MED's budget. However, under the headings of transportation and per diem, another 5.8% of the budget is allocated to "professionalization." Therefore, the actual amount to be spent is 8.2%. Only 7.0% goes to secondary education. Very little is known of adult education in the last three years, and an allocation of 3.8% seems to be high for a program that does not appear to be currently operational. Out of - 50 - the total budget, 74% is spent in salaries and the associated social security transfers. Higher Education 163. The amount of budgetary resources allocated to higher education appears as one of the most notorious inequities of the system. Universities have the lion's share in terms of budget, though they have a relatively low internal efficiency (only 15% to 20% of students graduate per cohort), a purportedly low quality graduates because of inadequate texts and credits recognized for community participation, too many professors per student for a system that practically has no graduate education, too many administrators per professor, and a system of scholarships that garners about 15% of the budget and has only been successful in increasing enrollments in agriculture at the expense of becoming the most expensive higher education in the country. 164. The system is currently totally free. This constitutes a regressive income transfer, since all citizens are paying for the provision of university education to a proportion of students who can afford it. Private and public universities in Nicaragua charged fees before the FSLN Government took office. This university system is a clear area for re-privatization in some cases, and for cost recovery in the public system. The GON should consider the development of a system that generates the appropriate incentives for public universities to charge a fee and give scholarships with those resources, to those who cannot pay. MED's Administration and Management 165. MED is the largest employer in the country. In April 1991, it employed 32,573 people, almost half of all of the public sector. About 1,800 employees have left in the context of the Plan de Conversion Ocupacional (PCO). 166. The current structure of MED is not operational, because: i) of an inappropriate administrative design and ii) inefficient informational systems and administrative procedures for control. 167. Central administration reports that it is unable to carry out supervisory responsibilities due to budget constraints, even though it receives a substantial share of the budget. One of the problems is that the organizational chart concentrates too many activities in the Planning division, which was literally a vice-ministry during the FSLN regime. With the new Government, in the actual administrative practice, the division plays neither an integrating or supervisory role. It also doesn't provide appropriate data for supervision. The result is that a wide dispersion of responsibilities at the central level make it difficult to reach objectives. 168. Concerning the information system, there is a lack of adequate indicators that may help in assessing the quality, coverage and efficiency of education, personnel and finances. NED also lacks the computer infrastructure - 51 - required for an information management system and requires training and upgrading of its personnel. 169. In terms of administrative procedures, there is no experience in the handling of biddings, and purchases are traditionally made without regard for strict normative frameworks to which the staff may resort in all cases. The Ministry of Education is one of the weakest of all ministries when it submits expense accounts to the Ministry of Finances. Almost all of the investments that have been made with the help of international cooperation have been managed from the outside, by the cooperating institutions, and their budgets are not always registered within the Ministry's or the nation's budget. When cooperating agencies provide funds to be managed by the Ministry, they do not always establish rigorous measures that may help to justify expenditures and give an account of expenses. 170. This structure is being reformed at present with the financial and technical support of USAID. The organizational chart that will shortly be approved by the Ministry will remove the four advisory offices, and transform the Planning Bureau into an Advisory Office. 171. Several decisions remain to be made in order to make the new chart operational. Since there is no integrating unit below the Minister, this promotes an excessive centralization at the Ministers' office and a lack of lower level administrative integration. This may mean that "de facto," some unit close to the Minister, like the one that handles information and projects, may play that role. These processes, however, could lead to an unexpected overdevelopment of top level administrative units, in a Ministry that already has an oversized central administration. The Ley de Carrera Docente 172. The Ley de Carrera Docente (No. 114, from November, 1990) regulates the professional career of teachers that are not at the higher educational level. The law guarantees a job to graduates from the Normal Schools, and it allows the retirement of teachers who are 55 years old and have taught for 25 years or of those who have taught for 30 years, regardless of their age. Retired teachers would receive 100% of their last basic salary. These benefits have also been extended to those who have already retired. The law generates a system in which different attributes of teachers, such as seniority, training, honors, and the like, are given a set of fixed points. The law will cost at least an extra US$1.85 million per year. 173. The law will be structuring a set of differentials between those who are accredited and those who are not, that goes in the right direction in the longer run, to providing incentives for better trained teachers. 174. It will also generate, however, a higher demand for the "professionalization" courses, since these are the entry to the benefits provided by the law. This will clearly mean higher expenses of "upgrading," with procedures that have not been proven to work appropriately and that are clearly expensive for the system. It will also increase the "wage bill" in - 52 - the near future by at least 10%, the average difference between the salaries of "empiricos" and "graduates". 175. However, the highest costs will be generated by the payments to those who are currently retired and who are receiving less than 100% of their basic salaries. Social Security only covers payments starting at 60 years and for up to 70% of salary, and the Law indicates a 100% retirement starting at age 55. NED would have to cover the difference between what INSSBI is now paying and the higher level determined by the Carrera Docente law. Moreover, between 500 and 1,200 teachers qualify for automatic retirement with 100% of their salaries according to the law. In this case, MED might also have to cover the full amount of the pension between the ages of 55 and 60. Instituto Nacional de Tecnologia 176. The proposed budget for INATEC for 1992 is US$4.3 million. Salaries account for 48.2% and transfers for 38.3%. This does not include the tax collection from the wage tax earmarked for INATEC. Moreover, from last year's tax revenues, at least US$1 million was not used by INATEC. These tax collections should, given the substantial amounts involved, be registered by the Treasury, and taken into account when deciding the size of INATEC's budget. 177. Through this tax, and the money it receives from donors, INATEC is admixiistering a large budget. However, the sector is characterized by high costs of training, mainly due to unused capacity. Furthermore, there is a high ratio of administrative personnel per instructor. INATEC's budget and efficiency should be carefully analyzed, as there appears to be an opportunity for reallocation of resources to other sectors (i.e. primary education). Conclusions and Reconunendations 178. Improve the efficiency of the system and the allocation of resources. Efficiency is very low. Teachers and space are both underutilized due to poor training, low student/teacher ratios, and poor maintenance of facilities. Retention rates could be improved by better teacher trRining and a better school environment, which would include books, supplies and a targeted feeding program. An increase in pupil/teacher ratios to about 40:1 or even 45:1 should be sought in those areas where it is possible due to higher population etensities, particularly in the light of a recent research that indicates lictle relationship between class size and academic performance. This would reduce unit costs, lower the need for more teachers and classrooms and free up money for improved salaries, training, and school feeding programs. 179. Restructure the current system of teachers' education and salary structure. A drastic change of the present alternatives should be promoted in order to re-structure the occupational and educational choices of teachers. In the long run, "professionalization," as defined under the current system, should be abolished. In the short term, it should probably be changed to some - 53 - system of "distance education" (as NED is currently considering), and a general exam to provide accreditation at different levels should b3 introduced. Such procedures would free as much as US$2.5 million, or 5%, of the 1992 Budget. The organizational structure should recognize different careers for accredited and non-accredited teachers and the salary structure should recognize higher differences. This latter aspect will be accounted for by the wage increases to be given by the "Ley de Carrera Docente," but this system can be improved. 180. Change the wage structure that will result from the OLey de Carrera Docente.0 Emphasis should be on the ability to teach and not on degrees as established in the Career Law. MED should consider establishing an examination for teachers, and give high points according to performance in this test and not to previously acquired degrees. Such an exam could also provide accreditation for those "empiricos" who demonstrate their abilities as teachers and disqualify teachers who do not qualify above a certain level. 181. Evaluate and design a new pensions and retirement system. The "Ley de Carrera Docente" establishes a retirement system whose effects on MED's finances and human resources have not been evaluated at all and could threaten the survival of the whole system. In order to solve some of the problems that this might generate, the part of the Ley de Carrera Docente that deals with retirement matters should be suspended until a new, more informed and rationalized system is developed. 182. Promote a more equitable distribution of benefits within the system by charging fees for university education and including in their budgets public utilities and other fringe benefits. The GON should concentrate efforts where social returns are highest and more equitably distributed, i.e., on basic education, while encouraging the development of a fee system, with scholarships for those who cannot pay. Universities should be accountable for their actual public expenditures and they should be charged for all public utilities, as is the case in the rest of the educational system. 183. Examine the value of adult education. Little is known about the current state of adult education. Given the "flow" problems that the primary level system has, however, it may not be the best allocation of resources. This program could free resources, up to 3.8% of the budget, to be reallocated to primary or pre-primary education. 184. Improve MED's management and organizational structures. Current organizational changes should be oriented towards simplifying the structure and reducing personnel and costs at the central level. Managerial changes should be focused towards improving the management information system and decision making and implementation capacities at the central level, prior to any further decentralization. Standardized systems that would simplify the monitoring and control of decentralized units should be developed. Achievement tests at different educational levels could complement regular supervision, would facilitate the control of deviant cases and could be used - 54 - as a performance indicator for teachers and schools. Private sector subcontracting should be promoted in testing. 185. Design a system for the reduction of private school subsidies. Current subsidies for private schools (that are given as a proportion of the wage bill) may be a way of getting more quality with relatively fewer resources. For equity reasons, however, the authorities should promote an incentive compatible system to wean private schools from subsidies and encourage them to begin charging fees to students, at least for those that do not serve the poor. Remaining subsidies should be targeted to the poor. 186. Design a control system that facilitates private sector development. Regulations and control of the private sector should be based, in the long run, on the quality of their output, allowing users of the system to judge what are the best institutions that fit their needs. This should enable the development of a dynamic private sector, particularly in areas such as technical and vocational education, which are more directly tied to labor market demands. 187. Improve the allocation of resources in technical education. Changing conditions and the new organizational structure indicate that this level should rely more on the earmarked payroll tax revenues it receives and consequently receive less funds through the Central Government budget. A significant reallocation of resources could be generated in this way, forcing an improvement of the internal efficiency of the system, through, among other things, a reduction in the number of administrative personnel. The allocation of resources should also be improved, using the tax revenues to fund recurrent costs and investments. The payroll tax revenues and its use should be included in the Budget. E. TRANSPORTATION Institutional Framework 188. Responsibility for management of transport sector infrastructure and operations lies with the Ministry of Construction and Transport (MCT). The Ministry is organized into seven departments (Direcciones Generales), two of which are administrative and five are technical. There are also six regional offices and three special zonal offices. 189. The Ministry has a total staff of 645 employees. The employment structure shows a low proportion (36W) of professional workers and technical assistants, and a high proportion (56W) of administrative and service employees. The number of directors is also excessive and results from the appointment of directors to each of the subdepartments. The number of subdepartments could easily be reduced by half, probably with an increase in operational efficiency. - 55 - 190. The distribution of staff between departments is disproportional to the work load they should have. In particular, there is an insufficient number of employees (38) concerned with the supervision of transport operations, especially the implementation of vehicle regulations and roads. 191. The regional offices of MCT employ a total of 189 staff. This number is excessive, and again, includes too many administrators (70) and service staff (52). 192. The total number of ministerial employees can be reduced in a number of ways. First, the functions of the ministry should change, with emphasis being put on the strict implementation of a few important regulations, and by the undertaking of more infrastructure design and construction by the private sector. The large design team in the Department of Civil Aviation is the clearest example of excess. Second, the number of subdepartments can be reduced, as suggested above, to about half the present number. This will reduce the number of directors and their supporting administrative and service staff. Third, the functions and operations of the administrative departments should be revised, as it appears that many of their activities are either unnecessary or duplicate activities of the administrative staff of the technical departments. 193. The activities of the regional offices also duplicate those of the central office. If the ministry wishes to operate with a decentralized structure, the central administration could be reduced by about 40 people by eliminating this duplication. There are large unexplained differences in the structure of the staffs of the different regional offices. Rationalization of the staffing levels of the various regional offices should allow the total regional office employees to be reduced by about one-third, or about 55 people. Recent Trends in Current and Capital Expenditures Current Expenditure 194. Table 4 shows the actual MCT expenditure in 1990, the budgeted expenditure for 1991, and the preliminary budget projections for 1992. Expenditures are shown by activity and by cost center or department. The current expenditure of the MCT accounted for 5.7% of central government total expenditure in the 1991 budget. The relatively low proportion of expenditure on transport is not unusual in a country with a low GDP per person. 195. In addition to the direct expenditure on the MCT, there was an additional 1.2% of government expenditure on the operating subsidy to ENABUS, equivalent to 20% of the MT expenditure. This is a very high level of subsidy and is difficult to justify, in particular given the poor service of ENABUS. Private urban bus operators charge tariffs almost double those of ENABUS and receive no subsidy to serve the same population. - 56 - TABLE 4 CURRENT EXPENDITURE - MINISTRY OF CONSTRUCTION AND TRANSPORT a) By activity 1990 1991 1992 Personal services 79% 56% 56% Salaries 56% 49% Other 23% 7% Non personal services 6% 27% 21% Vehicle repairs 3% 3% Materials 7% 11% 14% Fuel 4% 5% Other Transfers 8% 6% 9% Total 100% 100% 100% b) By Cost Center 1990 1991 1992 Central administration 27% 27% 34% Regional offices 24% 23% 22% Training 6% 3% 3% Economics and Planning 6% 3% 4% Land Transport 12% 4% 4% Air transport 9% 6% 7% Water transport 7% 4% 4% Road maintenance 7% 26% 17% Housing and buildings 2% 3% 5% Total 2,533 100% 100% 100% Source: Ministry of Finance 196. Although it does not explicitly appear in the national accounts, there is also a large operating subsidy to the railway. This is paid in the form of a maintenance contract, for which the Government pays a much higher price than that actually incurred by the railway. The revenue from this maintenance contract represents about 63% of total railway revenue. Notwithstanding this subsidy, and even taking account of the staff reductions made in 1990, the railways operating deficit in the first six months of 1991 was over US$1 million. - 57 - 197. The proportion of MCT current expenditure on staff costs was reduced from 79% in 1990, to a projected 56% for 1991 and 1992. This percentage reduction is a result of an increase in other costs. notable vehicle maintenance costs, and not a reduction in staff costs themselves. 198. The review of the staff structure of the MCT in section 2 indicates that there is considerable scope for a reduction in staff costs, particularly in the central administration. Central administration costs accounted for 27% of MCT current expenditure in 1990, and is projected to increase to 34% in 1992. In contrast, current expenditure on road maintenance will fall from its exceptional 26% in 1991 to a more normal 17% in 1992. In 1990, it was only 7% of total MCT current expenditure. 199. The regional offices of MCT account for 22% of its current expenditure. Many functions of the central administration are duplicated in the regions, and this duplication should be eliminated from one or the other. A high proportion of the regional cost is on routine road maintenance, which should be returned to private contractors as soon as possible. This activity is highly suitable for contracting to small workers cooperatives, some of which can be formed by ex-employees of the regional offices of MCT. Operations and Maintenance (OM) 200. All available estimates of 1991 O&M expenditure indicate a range of between approximately US$10 million and US$21 million. Even the higher of these figures is much less than that either proposed by the MEDS for each of the years 1992 to 1994 or that recommended in this report for the same period. A very approximate guide to the amount needed to maintain the existing infrastructure in an average condition can be obtained by determining the annual periodic maintenance cost at current unit prices, assuming that adequate routine maintenance is undertaken. 201. Table 5 provides a guide to the results of such a calculation. It shows that annual expenditures of almost US$60 million would be needed to maintain all of the existing infrastructure, and that more than 90% of this would be on the road network. This is about the maximum feasible annual capital expenditure on all transport infrastructure and assets, including improvement and expansion, and it does not take account of deferred maintenance expenditure over the last 20 years or more. The estimated O&M expenditures reach a level that has never been approached in previous total annual transport infrastructure investments. Conclusions and Recommendations 202. The existing infrastructure, in all transport modes --roads, railways, ports and airports-- is in bad condition after many years of lack of adequate maintenance and misuse. 58 - TABLE 5 ANNUAL PERIODIC MAINTENANCE COST OF PRESENT TRANSPORT INFRASTRUCTURE ------------------------------------------------------------------------------- Unit Replacement Annual Replacement Cost Average Life Cost Mode Component Unit Quantity US$ Years US$m ---------------------------------m-m--------------------------------me---- Road Paved roads km 1,598 100,000 10 16.0 Gravel roads (a) km 2,801 40,000 5 22.4 Gravel roads (b) km 5,171 15,000 5 15.5 Earth roads km 5,716 0 5 0 Bridges m 10,000 2,000 25 0.8 Rail Track km 293 200,000 15 3.9 Ports Berth m 1,500 500 20 0.1 Airports Runway length m 5,000 500 15 0.3 --m-m-----------m----------------monom------------------ -ome------ome TOTAL 59.0 203. The Ministry of Construction and Transport is responsible for providing and maintaining most of the transport infrastructure and for regulating transport operations. It has a highly bureaucratic structure and a duplication of activities between its central and regional offices. A change in its organic structuLe would reduce costs and increase efficiency. 204. Current expenditure of MCT is dominated by staff costs, both because it has an inefficient structure and because it is not spending sufficient on maintenance activities. Capital expenditure over the last ten years has been a fraction of that needed to maintain the existing infrastructure. 205. The principal policy issues are: i) funding of infrastructure maintenance and development; ii) determining if it is worthwhile to maintain the railway; iii) providing adequate facilities for export air freight; iv) increasing the supply of urban transport capacity in Managua; v) rehabilitating Corinto Port, and vi) providing port facilities on the Atlantic Coast. 206. The recommended investment strategy should be to invest in projects which will stimulate production in the short term. Furthermore, preference should be given to maintenance rather than development projects, because these usually produce higher economic rates of return. F. ENERGY SECTOR Overview 207. Nicaragua's energy sector faces a deep crisis. While a relatively reliable supply of petroleum depends totally on imports, the power service has - 59 - deteriorated severely in recent years, with frequent service supply interruptions and low reliability. Power rationing in the National Interconnected System (NIS) has reached an average of 10%, while the energy deficit amounts from 10% to 15% of consumption. In addition, thermal energy imports from Costa Rica amount to about 17% of total daily electricity consumption. In response to this poor service, industrial, com,',ercial and even some residential consumers have been investing in a growing generating capacity composed of a variety of expensive thermal units. Other problems that depict the current crisis of the power sector are: (a) An increasing level of energy losses (currently 24%, an increment of more than 5 during the last three years); (b) Overstaffed public institutions, in spite of the recent reductions of personnel; and (c) Overall institutional weakness. Institutional Frmework 208. The Nicaraguan Energy Institute (INE) is responsible for the energy sector. INE was created in 1979 as an autonomous state entity, responsible for the policy formulation, planning, research and execL'ion of activities related to the construction and operation of the power facilities, energy imports and exports, and management and utilization of energy resources. INS's organic law rules out all private participation in the power sector, thus guaranteeing a public monopoly. INE is attached to the Ministry of the Presidency of the Republic and has both regulatory and production functions in the energy sector. 209. INE's General Directorate for Hydrocarbons is responsible for this sub-sector, which is composed of private foreign companies (ESSO, SHELL, TEXACO, CHEVRON aad TROPIGAS) and state-owned enterprises (PETRONIC, LUBNICA, TISA and ENIGAS). All oil refining is done at a privately-owned refinery (ESSO). PETRONIC is responsible for all imports, which includes mostly crude oil, but also some petroleum derivatives and surplus exports. Main Sector Issues Role of the State 210. Current problems of the energy sector, and particularly the power sub-sector, are linked to its organizational and legal framework. The existing public monopoly model presents serious limitations that affect the sector's efficiency. In the past, the power sub-sector has been seen as an instrument for implementing subsidies and/or controlling inflation, and not as a commercial operation. There is a confusion between the regulatory and corporate role of the state in INE's organization, since INE acts simultaneously as energy ministry, regulator and power utility. This situation has reduced substantially the efficiency incentives in the power - 60 - sector and reveals the need for reassessing the role of the state in the energy sector. Operational Efficiency 211. The overall efficiency of TE's power operations is poor. INE currently employs 3,500 people. Its costumer/employee ratio of 85 is quite low compared to that of more efficient Latin American utilities (around 150- 200), and the prevalent in industrialized countries (400). However, this ratio has been recently improved since it averaged 56 during the period 1985- 1989. Annual sales per employee amount 302 MWh, are also low compared to the Latin American average of 906 MWh. Another measure of INE's inefficiency is the high level of electricity losses, which has recently increased to 24%. 212. To address these problems, it is important that the Government treats the poer sector as a commercial operation. This could be achieved within the instLtutional reform recommended below. Conclusions and Reconuaendations 213. The critical situation of the power sector supply makes it imperative to undertake with great efficiency the investment program, without incurring in major cost overruns and, in particular, without major delays. In this respect, it should be noted that it is not clear whether INE has the required technical and managerial capability for undertaking this task, especially in the fielIs of project control and specific technical aspects related to the expansion projects. It is considered that a great part of the rehabilitation projects can be managed satisfactorily by INE's production staff. However, INE's technical and managerial capability for undertaking larger expansion projects is weak. To address this problem, INE should provide all possible support to the effort of institutional strengthening, particularly in the fields of accounting, budget control, information systems and in the engineering and supervision of generation expansion projects. 214. Short-term measures that could contribute towards INE's improved operational and financial performance are: (a) Undertaking further reductions of personnel; (b) Undertaking an effective power losses reduction program; (c) Eliminating the existing distortions in electricity tariffs (this implies mainly the elimination of the subsidy to municipalities which do not pay for public lights); and (d) Undertaking a short term institutional strengthening program focussing in improved budgeting, a managerial information system, and auditing and control systems. In the medium term, this program should include the strengthening of INE's planning capability (demand and expansion optimization), power systems maintenance and losses control. - 61 - 215. It is recommended to keep electricity tariffs at their current level, which appear to be close to narginal costs. Any higher level would tend to reward inefficiencies. It seems reasonable that further modifications in the tariffs level and structure should be undertaken only after a proper study on long run marginal costs is completed (included in IDB's technical assistance program). 216. A great part of the power sub-sector problems stem from its legal and institutional framework. The existing public organization imposes serious constraints for a better sector performance. It is therefore necessary to study the best arrangements for a legal and institutional reform for Nicaragua's energy sector. This reform should consider two main points: (a) The clear separation of the state's normative, regulatory and corporate roles. This could be achieved through the creation of a ministry of energy independent of INE-power utility, and probably the creation of an independent regulatory body. A new structure of this type should redefine the roles of government, energy enterprises, public or private, and consumers, as well as promote an efficient development and use of energy resources. The specific normative and regulatory functions of these two new entities shoud be defined through further studies. Essential features for a new structure should be transparency and openness; clear articulation of reform objectives, including tariff policy; and a new legal structure that eliminates current barriers and defines the procedures for reducing government involvement. The general orientation should be towards decentralization and market-based incentives. (b) Promote private participation, particularly in power generation and distribution. This policy implies a modification of INE's organic law, which currently guarantees a public monopoly in power. Technical assistance should focus on the definition of the appropriate legal and regulatory framework required for implementing the above recommendations. 217. INE has taken some steps in reducing the former strict regulation of the hydrocarbon sector. Accordingly, an ongoing liberalization plan has already eliminated a system of coupons and quotas, and distribution margins have been partially liberalized. Current plans include the complete liberalization of margins, a tax policy reform, the promotion of alternative supply and, finally, a full liberalization of prices. These plans should be encouraged and supported through technical assistance. The future of Nicaragua's hydrocarbon sector should be matter of a study to address the components of INE's liberalization plan, as well as law amendments, best institutional arrangements, including PETRONIC's functions and margins and the privatization of the sub-sector state-owned companies, and supply options. - 62 - G. WATER AN) SANITATION Overview 218. Water and sanitation service coverage in Nicaragua ranks among the lowest in Latin American countries, with potable water service available to less than 55% of the population, and sewerage or sanitation available to only 27%. Urban facilities experience high system losses and rural areas are severely underfinanced. These conditions, combined with a low level of sanitation education and the lack of enforced public health safeguards, have led to high mortality rates from water-borne diseases. 219. INAA is the enterprise that is in charge of water and sewage. It receives financial assistance from the Central Government and many external donors. The institutional relationship between the three should be clarified. The current ambiguity permits INAA to claim that it covers all of its operating costs through tariffs and receives only a small subsidy for rural areas from the Government. In effect, it is receiving substantial assistance from the Central Government to fund its investment program (e.g., payment of the IDB counterpart requirement, interest and debt service) and through excessive payments for the use of water by the central government :nstitutions. External funds are contributing to fund operating costs and counterpart funds, in particular in the rural areas. This contributes to understating and distorting the real cost of providing services and undermines financial discipline. The result is that real operating costs are understated in the period prior to when projects are turned over for operation by INAA. This does not help the strengthening of an institution that is institutionally weak in all areas (including planning and project preparation, financial and commercial systems, financial planning and management, operations and maintenance). Main Sector Issues 220. Main sector issues include the neAd to improve coverage and service quality, serve rural areas and the poor; increase health impacts; sustain investment project benefits through recurrent cost recovery, solve sewage and sanitation problems; and define the appropriate roles of FISE, the private sector and donor financial and technical assistance. 221. The investment plan is heavily weighted toward improving service and water quality for areas currently receiving service. The emphasis on rehabilitation and O&M is well-chosen because, without this commitment, all future investment will be wasted. However, at the existing levels of implementation and financing, about two-thirds of the rural population will remain without a drinking water system well into the next century. Project Sustainability: Income Ge:*aratlon and Subsidies 222. The continue sustainability of the urban investment program lies in the degree of efficiency achieved in reducing water and commercial losses and consequently, in increasing revenues. Without new revenues, systems will - 63 - again fail for lack of maintenance, and the burden will fall on the government budget. 223. The total recurrent costs of all proposed investments --in combination with existing recurrent costs-- should be sustainable in the medium term. All hidden costs and revenues must be clarified regardless of source including all operating costs covered by donors as counterpart or external costs, all excessive tariff revenues being transferred by public sector agencies, and all debt service. Tariffs should be set to meet these needs. The lowest tier should be based upon the ability to pay of the poorest households. The remaining tariff structure should be designed based upon average incremental cost pricing to achieve objectives of equity, economic efficiency and financial viability for the utility. In addition. a realistic plan for meter replacement and connections, and a reliable system of meter reading, billing and collection, must be developed, including any manpower requirements to ensure commercial section success. Donors that require or use their own funds as counterpart funds must have the amounts and uses registered with MIFIN so that future cost requirements can be monitored. Also, any transfers f-am the government budget should list the amounts associated with particular projects and project needs. Water Supply and Health 224. All major infectious agents are water-borne, water-washed, water-contacted, and sanitation-related diseases. Water and sanitation improvements can be cost effective in reducing the incidence of diarrhea by 27% and mortality by 30%. However, under current practice, the health impacts of the investment plan will be minimal if the extension of water supply and sewerage services increases the pollution load in receiving waters downstream. The impact of each new facility should be evaluated in this context. Conclusions and Reconnendations 225. Interventions that should be focused upon, ranked according to preliminary judgments of cost-effectiveness, include: (a) Hygiene education; (b) Soap; (c) Standards, licensing, inspection and enforcement (latrines, irrigation practices, well drilling, water quality, discharge of treatment plants and new industries, receiving waters); (d) Low cost urban sanitation and waste disposal with phased technology; (e) Latrines for rural communities of over 400; (f) Preparation of water and sanitation system proposals for local groups for FISE financing and creation of a revolving credit fund; (g) Rehabilitation of treatment facilities not covered by IDB and CIDA, where operation and maintenance costs are assured through water charges and industrial discharge fees; (h) Meter program not covered under IDB and CIDA projects; - 64 - (i) Rehabilitation of sewer systems, including points of storm-water infiltration to improve protection and increase remaining available capacity; (j) Water system repair/rehabilitatior to cut existing losses of systems not covered by IDB or CIDA projects, and expansion to unserved areas to the extent that additional water is made available. These priorities are based upon need and potential impact, appropriateness of phased investment, sustainability without subsidies, and equity. 226. Financing through FISE, the Private Sector and Community Infrastructure Banks. Financing should emphasize the use of sector funds, FISE funds and private contractors. Financing from FISE could go to a sponsoring municipality or community, which would provide credits of 25% and 50% of the funds as no interest loans to be repaid over 10 years. On rural projects, FISE should consider permitting bids by qualified community construction teams who would pay in one-half of the wages as capital to start a community development bank. Rural and urban communities with systems should be responsible for full cost recovery of O&M. 227. FISE's investments are off-budget. These water project investments should be tracked by MIFIN, just as are donor-financed projects, in order to assess their impact on future recurrent costs. The following information should be supplied: (a) costs associated with annual requirements for staff, salaries, equipment, materials, pumping, chemicals and other needs; (b) the unit that has been given the responsibility for future operation, maintenance and replacement (INRAA, a municipality, a community group); (c) a plan to show how the recurrent costs will be recovered. 228. The level of dependence on donors --programmatically and financially in rural areas-- is alarming, as the national (domestic) institution is being replaced, instead of developed. INAA/DAR (Direccion de Agua Rural) should assist in proposal development, be trained to set standards, review designs and monitor work quality carried out by the communities or contractors. Donors should have plans for how their technical and financial assistance will be phased out and handed over to municipal water companies, a regional public utility or private water companies, regulated by INAA. 229. Finally, a national investment policy on basic sanitation, a water rights law, and a public utilities commission to regulate tariffs and enforceable regulations on water quality and discharge requirements are also needed. H. SOCIAL SECURITY 230. The Instituto Nicaraguense de Seguridad Social y Bienestar (INSSBI) is in charge of administering the social security system and certain welfare - 65 - activities. Formerly, it also administered a health system for members, but these activities were transferred to the Ministry of Health (this transfer implied that the 9% health payroll tax would also be transferred to MINSA, but this has never happened in practice). INSSBI also administers a number of enterprises (funeral services, optometrist, lottery, handicrafts, etc.). 231. As it has been an autonomous entity, INSSBI has not been included in the budget, aside from the direct transfers from the Central Gove?nment. However, MIFIN plans to include it in the budget shortly. 232. The institute receives a total payroll tax of either 17% or 8.75% (from employers, employees and the Central Government), according to the enterprises activity and location. It also receives the 9% health payroll tax mentioned above that it is supposed to transfer to MINSA. Revenues are low, and the tax base of 250,000 employees is unrelated to the total employment base. The institute receives resources from the profits of the lottery (of which half should be transferred to MINSA), and transfers from the Central Government. These transfers correspond to resources to finance the so-called special pensions (that are decreed by the Presidency) and 80% of the payroll of the Welfare sector. 233. From Tables 6 and 7, several observations can be made. First, the financial situation of INSSBI is very fragile, in particular if the obligation of transferring the 9% health payroll tax to MINSA is considered. The institution reports a surplus only because of its failure to account for this obligation to MINSA. In the context of such a situation, it is of concern that the institute has decreed a 50% increase in pensions. Among the structural issues that should be resolved by law is the open-ended authority to grant pensions and adjust them, without any reference to the financial or economic situation of the institution. Second, the Central administration constitutes 40% of the total expenses of the Social Security sector. Of the total expenditures, only 50% are pension payments. This suggests that INSSBI employment of 3,000 persons may be too high. Third, secial pensions are 40% of total pensions. Central Government funds a part of them, but those granted to soldiers are funded by INSSBI. The rapid growth of special pensions has lowered that ratio between beneficiaries and taxpayers form 9.3 to 4.2. For 1992, INSSBI expects the Government to grant 25,000 new pensions to ex- soldiers. This would increase the number of beneficiaries in this category by 189% and the total number by 32%. 234. Several problems may arise in the near future. For example, minimum pensions (96% of the total number of pensions) are related by law to the minimum wage. If the minimum wage rises, then pensions would rise correspondingly. In addition, the pensions paid by NIFIN will probably be adjusted, under pressure from the beneficiaries to receive an increase similar to INSSBI pensions. Another potential problem is that the Teachers Career law establishes very favorable conditions for teacher retirement. Finally, INSSBI wants to provide health services (as prior to the Sandinista regime), and through supplying services to the taxpayers, provide them with an incentive to contribute. This should be strongly discouraged unless it is combined with scheme for competitive private provision of the services. - 66 - TABLE 6 SOCIAL SECURITY: REVENUES AND NON-FINANCIAL EXPENDITURES (1991, millions of US dollars) I. Revenues 51.8 1. Payroll tax 48.6 2. Government Contribution for Special Pensions 3.2 II. Expenditures 30.3 1. Wages 4.0 2. Administrative exp. 3.2 3. Other expenditures 3.5 4. Pensions 17.6 5. Transfer to Welfare 2.0 III. Transfer to Health(1) 24.3 IV. Balance (I - IT - III) (2.8) (1) Assumed to be half of the payroll tax revenues TABLE 7 DISTRIBUTION OF TOTAL EXPENDITURES OF INSSBI (Social Security and Welfare) (1991, millions of US dollars) Wages 22.5% Administrative and other exp. 26.0% Pensions 51.5% 100% 7-dinary Pensions 59% Sp,-zial Pensions 23% Military Pensions 18% 235. The very rapid deterioration of the ratio between beneficiaries and taxpayers, and the lack of reserves, will eventually generate a financial crisis. These long-term issues should be addressed and the possibility of permitting private sector participation should be studied. -67- CHAPTER IV: THE PUBLIC INVESTMENT PROGRAM A. INSTITUTIONAL FRAMEWORKFO2 PUBLIC INVESTMENT Background 236. With the installation of the new Government in 1990, the Planning and Budgeting Secretariat (SPP) was dissolved, and the General Directorate of Public Investment (DGIP) was transferred to the newly created Ministry of Economy and Development (MDE). 7nitially, the DGIP lacked staff. Consequently, during 1990 and most of 1991, there were no formal or established procedures to process public investment. Actual Processing of 1992-94 Public Investment Program (PIPF) 237. During 1991, MEDE initiated a formal process for the definition of the PIP for 1992. The elaboration of the PIP was conducted in an ad-hoc manner, however. The task of following the formal procedure was complicated because: a) direct links existed between donors/creditors and executing agencies, consequently financing was available without the need for clearance by MEDE; b) there was no experience in investment prioritization in the executing agencies; and c) there was confusion about the roles of the Ministry of Finance (MIFINI, the Minisrzy of External Cooperation (MCE) and the Central Bank (BCN) in the process of elaborating and supervising the execution of the PIP. Most importantly, MEDE (a new institution) had to assume a leading role in the process without being able to affect directly the funding of projects, as it does not control either the domestic or external financing of the investment projects (controlled by MIFIN; and jointly by the BCN and MCE, respectively). This circumstance deprives MEDE from any power to enforce the PIP without the collaboration of MIFIN, MCE and BCN. Furthermore, MEDE's role will be curtailed until it can provide a framework for the prioritization of projects and give substantial inputs into the prioritization process. Thir framework presently does not exist, as MEDE has been slow, mainly due to institutional weaknesses, to produce a national development strategy and the derived sectoral strategies which should serve as guidelines for PIP prioritization. However, with donor assistance, the GON is doing progress in putting together such a plan. 238. By mid-1991, executing agencies presented an exhaustive list of projects to NEDR. This list lacked prioritization and consisted mainly of carry-on projects and projects for which donor financing was indicated. In other words, the presentation was inadequate and no sectoral strategy had been developed to justify the selection of projects, which were mostly designed by donors. 1/ The PIP is not really a 9k-94 program, because for 1993 and 1994, only ongoing projects are considered. -68- 239. MEDE, in joint meetings with sectoral agencies, prioritined the projects based on a very global criteria. The prioritization criteria were to select projects: a) for rehabilitation of infrastructure (social and physical); b) that have secured external finance or are in the final stage of securing it; and c) that carry-over from the previous years. The prioritization exercise reduced the size of the PIP from US$2 billion plus to about US$200 million. The economic cabinet, based on optimistic projections of the availability of funds, decided to increase the PIP to about US$240 million. 240. The procedures for oupervising the implementation and evaluation of the PIP are being developed. The unit of physical and financial control of projects operates under the General Directorate of the Budget in MIFIN. MCE is planning to develop a similar unit, which would need to coordinate its work-program with MIFIN. MIFIN's units are poorly endowed, are able to capture only a fraction of the projects in the PIP, and perform only a superficial follow-up of project implementation. The GON needs guidance and technical assistance in this crucial part of the project cycle. Major Issues to Be Addressed 241. Coordination among agencies. A sound PIP can only be derived from sound global and sectoral strategies. To provide them, NEDE needs a clear mandate to coordinate the effort of putting together the national and sectoral strategies. The PIP should then translate these global and sectoral strategies into specific investment projects. In this context, the key tasks that MEDE has to perform are to: a) determine the size of the PIP which is consistent with the overall macroeconomic framewo.k (i.e., determine the overall amount of resources available for public investment), on a rolling three-year basis; and b) prioritize investment projects coming from the sectoral agencies according to national and sectoral priorities. To perform these tasks, it has to coordinate closely with the Central Bank, MIFIN and MCS. Moreover, to perform the second task, BEDE needs a clear mandate from the Ministry of the Presidency to enforce agreed upon priorities and allocate domestic and external resources to the priority projects. 242. MEDE and MIFIN need close coordination to ensure that the recurrent cost implications of the PIP are included by MIFIN in its medium-term financial planning exercise on a rolling three-year basis. The present PIP figures do not include the future recurrent cost implications of the investment program, and MEDE sknuld ask the line ministries to include recurrent cost estimates in the future. BEDE has already rejected some investment projects because of the lack of budgeted funds for recurrent expenditures, even though the fixed asset investment had financing. There has been some opposition to this, as it implied renouncing the available donor funds-. a/ As was said above, MEDE needs to be endowed with some powers for it to be able to enforce the PIP once it is agreed upon. -69- 243. Increase institutional capacity for PIP elaboration. Efficient PIP elaboration requires technical assistance to the core ministries, the line ministries, and the public utilities. MEDE is at present strengthening the office in charge of elaborating the PIP, the General Directorate of Public Investment (DGIP). It has appointed a director general, approved a reorganization and allocated personnel and equipment for the DGIP to be fully operative in 1992. The GTZ has a medium-term institutional development technical assistance program to help the development of the DGIP. 244. The line ministries have very weak institutional capacity to identify, prepare, appraise, monitor and supervise projects. To build such a capacity, IDB is in the process of developing a much needed technical assistance component (within its credit projects) in the line ministries with emphasis in strengthening the capacity to prepare projects. The public utilities have better project preparation, implementation and supervision capacity, but standards need to be improved. To improve the institutional capacity in the public utilities, an investment capacity management component is going to be included in project lending by the IDB to these enterprises. 245. Coordinate technical assistance (TA) with development strategy. Preliminary MCE estimates indicate that approximately US$34 million (or 2% of GDP) of external funding was directed toward TA projects in 1991. TA in terms of number of projects is concentrated in the agricultural sector and related areas (natural resources), but in terms of money assistance is going predominantly to the social sectors. With regard to the latter, the project selection in the health sector appears adequate (though too much training is being devoted to hospitals). In the education sector, however, it appears that the emphasis is in professional training and universities, rather than on strengthening of the basic education institutions. 246. The data provided by MCE are preliminary and unofficial estimates, representing initial efforts to centralize statistics for external aid flows. NCE is currently working to perfect these statistics. Accurate and organized management of quantitative information about aid flows is key to MCE's ability to monitor aid and technical assistance. This ability has to be rapidly enhanced, as much of the programmed funding from donor agencies remains undisbursed. MCE has estimated that of a out of a total of US$355 million in programmed funding for 1991 for technical assistance, balance of payments support, investments, and general aid, roughly US$226 million remained undisbursed as of November 1991. This figure represents approximately 64% of programmed assistance funding. B. THE PUBLIC INVESTMENT PROGRAM (PIP) 247. The preparation of the 1992-94 PIP has enabled the Government to have an overall view of the investment projects that are being implemented. The process has revealed that 1CE and MIFIN were unaware of some of these projects in the past. The exercise has also shown that several ministries did not have a full inventory of the projects that were being implemented within their sectors. This problem shows the poor coordination between MIFIN, 1CE -70- and MEDE; the need for improving the management of foreign aid by MCE; and the need for strengthening MEDE and MIFIN's ability to effectively go through the PIP project cycle. 248. The main issues are the size and distribution of the PIP. The GON has selected energy, agriculture, transport, water, and telecommunications (in that order) as the main areas for investment. With the exception of agriculture and transport, that will be reviewed below (paras. 260 to 282), the GON has put together a reasonably solid investment program, with an appropriate sectoral distribution. Faced with the enormous needs of the country, it is not surprising that the initial exercise resulted in a very ambitious program. 249. Regarding the overall size, the US$242 million 1992 PIP (including FISE) appears to be on the high side (13% of the estimated 1992 GDP). Financing problems may be encountered when implementing such a sizeable program, as the projections about the available resources sometimes seem overly optimistic. An overall program of US$200 million dollars (including FISS) would appear, at present, to be more manageable. 250. In addition to the availability of funds for the PIP, another important issue is the implementation capacity of the different institutions. The proposed size of the PIP will force the authorities to spread scarce resources (management capacity, skilled manpower, counterpart funds) too thinly over many projects. Given the many urgent needs faced by the GON, it seems advisable to further prioritize the proposed projects. Prioritization could assure that the key projects are implemented in a timely fashion. Moreover, it is possible that the overall investment program is in fact even bigger than mentioned above, as the PIP exercise may not have captured all of the public sector investment projects in execution or to be executed in 1992; in particular, donor financed projects which do not require counterpart funds. 251. The Government is anxious to use the PIP to alleviate the unemployment situation. However, a large PIP may aggravate the problems associated with the macroeconomic demand management, especially in the context of the recent experience of hyperinflation. A balance needs to be struck, so as to not overheat the economy or crowd-out private investment. 252. With respect to the sectoral distribution (see Table 1), the 1992- 94 PIP focuses on energy (where projects absorb 25% of the total capital expenditures), agriculture (22%), transport (21%), water (17%), and telecommunications (8%).y The section below that analyzes sectoral investment plans covers the first four sectors, or 85% of the Investment Program. This overall distribution appears adequate, especially given the critical situation inherited in the energy, roads, water, and communications sectors. However, the emphasis on public sector projects for the agricultural sector may contradict the objective that the sector should be driven by private investment (see paras. 117-123). j/ All education projects that included building rehabilitation and repair were transferred to FISE, which is off-budget. - 71 - TABLE 1 PUBLIC INVESTMENT PROGRAM (Millions of US Dollars) TOTAL ACTUAL - SCHEDULED ---- AMOUNT 1991 1992 1993 1994 Beyond MCT 13S.51 20.23 53.95 31.75 16.05 13.53 INRA 50.12 14.51 4.39 10.83 5.90 14.49 MINSA 29.35 4.60 10.07 10.68 4.00 0.00 MIPRES 3.05 0.00 3.05 0.00 0.00 0.00 MAG 48.91 0.00 11.13 19.78 18.00 -0.00 IRENA 54.55 0.00 11.24 16.70 20.40 6.21 MIFIN 3.28 0.88 2.40 0.00 0.00 -0.00 MIGOB 1.93 0.03 1.16 0.73 0.00 0.01 INEC 1.26 0.00 1.26 0.00 0.00 0.00 INTURISMO 1.52 0.91 0.61 0.00 0.00 0.00 INAA 133.89 26.70 20.08 28.05 24.51 34.55 INATEC 24.84 0.00 5.00 9.48 6.42 3.94 MEDE 7.55 0.00 2.SS 5.00 0.00 0.00 AN 1.43 0.00 0.30 0.30 0.40 0.43 CSJ 1.00 0.00 1.00 0.00 0.00 0.00 MITRAB 1.15 0.00 0.58 0.S7 0.00 0.00 IND 1.00 0.00 1.00 0.00 0.00 0.00 INIFON 1.54 0.00 1.54 0.00 0.00 0.00 TELCOR 52.40 5.60 28.00 11.30 7.50 -0.00 INE 170.64 33.51 60.44 34.09 29.10 13.50 TOTAL 724.92 106.97 219.75 179.26 132.28 86.66 Sources MEDE -72- 253. The 1992 PIP has a somewhat different distribution from the three- year program. It focuses on energy (28%), transport (25%), agriculture (14%), telecommunications (11%), and water (9%). The program may exceed the implementing capacity of both the Energy Institute (INE) and the Ministry of Construction and Transport (MCT), given the small size of the investment programs that these institutions have managed in the last five years. 254. The 1992 program is reasonably solid in the selection of projects by the autonomous entities, telecommunications (TELCOR), energy (INE), and water and sewage (INAA). However, several of the big projects have an overly optimistic time schedule (for example, the gas turbines project of INE, and the "anillo integrado" of TELCOR). The Central Government's selection of projects is not as solid, and some projects could be postpoAad, as for example the biggest projected investments by MCT in highways (see paras. 278-280). 255. With regard to financing, 55% of the investment program will be financed by donors, 5% by institutional resources (principally from TELCOR and INAA) and for the remaining 40%, no financing has been identified. Of the sectors with large investment programs, transport stands out (see Tables 2 and 3), with 61% of the prog-am without identified financing (INE has 31%, Agriculture 26%, TELCOR 23% and INAA 12% of the program with no identified financing). This means that MCT should probably take a second look at the large number of projects (18) with no financing at all, and postpone those that do not have high priority (see para. 281). Agriculture, INE and INAA have projects with high percentages of foreign financing (74%, 64% and 75%, respectively). 256. The PIP is composed of 114 projects, 67 of which are new. This implies that 41% of the projects are ongoing projects. Practically all agriculture projects are new (which would help in tailoring down an excessively large investment program). The same is true of social services and the group "others." 257. Regarding the size of the projects, 25 of the projects (22%) are large (larger than 10 million) and 35 (31%) are small (smaller than 1 million). Of the 25 large projects, 9 corresnond to INE, 4 to MCT, 4 to INAA, 5 to Agriculture, 2 to Telcor and 1 to INATEC '. The Evolution of the Size and Structure of the PIP 258. The share of public investment in GDP increased dramatically in the mid-eighties (it peaked at 22% in 1983) and then declined as dramatically to a low of 2.3% in 1990 (see Table 4). The much larger investment was absorbed by very different sectors to tht,a that had absorbed most of the investment in the seventies. Investment in infrastructure and power (MCT, INAA, TELCOR, INE) was between 65% and 75% of the total investment in the 1970s. It was reduced to less than 50% (41% in 1987) through the 1980s. The reduction was particularly striking in INAA, TELCOR and INE. These sectors suffered a I/ The analysis is done for the total value of the projects and not the 1992 component. TABLE 2 PUBLIC INVESTMENT PROGRAM 1992 CENTRAL GOVERNMENT. TOTAL Percent Percent Number of Proyects - Percent Share - (Nil US$) Share v/o fin Total New Small Big Part Fin Tot Fin Own Res v/o tin Ext res IRENA 11.242 5.2 31.5 10 9 1 1 8 0 0.0 31.5 68.5 NAG 11,132 5.1 28.4 4 4 1 2 4 0 0.0 28.4 71.6 INRA 4.394 2.0 19.1 6 6 2 0 3 3 0.0 19.1 80.9 HIPRES 3.052 1.4 5.8 3 3 1 0 2 1 0.0 5.8 94.2 INK 60,438 27.9 31.1 13 4 1 8 7 5 4.7 31.1 64.2 MEDB 2,550 1.2 21.6 2 1 0 0 0 1 8.6 21.6 69.8 INTURISMD 609 0.3 100.0 6 0 6 0 0 0 0.0 100.0 0.0 NCr 53,950 24.9 61.0 24 8 4 8 6 0 0.0 * 61.0 39.0 TELCOR 24,000 11.1 22.5 5 2 1 2 2 2 19.6 22.5 57.9 INAA 10.345 4.8 23.4 4 1 1 1. 4 0 0.0 23.4 76.6 INAA 9,740 4.5 0.0 6 2 1 2 0 6 25.3 0.0 74.7 INIFON 1,543 0.7 100.0 1 1 0 0 0 0 0.0 100.0 0.0 MINSA 10,071 4.7 49.6 6 5 0 2 0 3 0.0 49.6 50.4 INATEC 5,000 2.3 100.0 3 3 0 0 0 0 0.0 100.0 0.0 IND 1,000 0.5 100.0 1 1 0 0 0 0 0.0 100.0 0.0 MIFIN 2.406 1.1 100.0 6 5 4 0 0 0 0.0 100.0 0.0 3 INEC 1.257 0.6 51.2 2 2 1 0 1 0 0.0 51.2 48.8 MIGOB 1,163 0.5 100.0 9 7 9 0 0 0 0.0 100.0 0.0 CSJ 1,000 0.5 100.0 1 1 0 0 0 0 0.0 100.0 0.0 AN 860 0.4 100.0 1 1 0 0 0 0 0.0 100.0 0.0 MITRAB 584 0.3 100.0 1 1 0 0 0 0 0.0 100.0 0.0 TOTAL 216,336 100.0 28.9 114 67 33 26 37 21 4.7 40.5 54.8 TABLE 3 PUBLIC INVESTMENT PROGRAM 1992 CENTRAL GOVERNMENT ---------------------- - ---------- ------- ----- -- ----- - TOTAL Percent Percent ----- Number of Proyects ------------ Percent Share (Nil US$) Share v/o fin Total New Small Big Part Fin Tot Fin Own Res w/o fin Ext res Agriculture 29.820 13.8 25.9 23 22 5 3 17 4 0.0 25.9 74.1 Industry & Energy 63,597 29.4 31.4 21 5 7 8 7 6 4.8 31.4 63.8 Infrastructure 99,578 46.0 42.4 40 14 7 13 12 8 7.2 42.4 50.4 Social Services 16,071 7.4 68.4 10 9 0 2 0 3 0.0 68.4 31.6 Others 7,270 3.4 91.6 20 17 14 0 1 0 0.0 91.6 8.4 Total 216.336 100.0 40.5 114 67 33 26 37 21 4.7 40.5 54.8 方、＿ 渥 讓 寫 一觔乙一 一 一 一 一 -75- reduction in their investment as a share of GDP. Only a minor part of thir reduction went to fund investment in the social sectors. A large part went to finance investment in agriculture, to subsidize investment in capital intensive technology in new public enterprises, and to defense. The 1992 program intends to increase investment to a level above the average size of the investment program in the 1980s, which was approximately 11* of GDP. The fact that only two years (1983 and 1984) had a higher investment program as a shire of GDP underlines the fact that tlie ambitious 1992 program will be very difficult to implement. For example, the program significantly increases the share of agriculture in capital expenditurea, to levels similar to those of the early 1980s, where the public sector was administering most of the sector. on the positive side, it will restore the previous (seventies) structure, with 75W going to infrastructure and power. C. THE AGRICULTURE MESTMENT PLAN 259. The sector's public investment program has not benefitted from a formal plan of action that deals with the vast number of problems the sector faces. A sectoral strategy does not exist, and the investment program for 1992 has few examples of projects which deal head on with the main problems, such as the lack of coordination in research and extension, the lack of plans in irrigation, institutional weaknesses, and uncoordinated technical assistance and training. Instead, most projects affront the problems in a piecemeal and generally non cost-effective manner. A major overhaul of the investment program is necessary onc,- a sectoral strategy is agreed upon. 260. HAG, INRA and IRENA'a investment projects represent 22% of the total investment budget for the period 1992-94. In 1992, the agricultural sector will invest 1.5W of total GDP, or SW of sectoral GDP, historically very high for the sector. Given the poor selection of projects, combined with the historically high financing for the sector. it appears that the agricultural investment program should be reduced. Nfinistry of Agriculture and Livestock, 261. One of the basic problems with the existing PIP is that large priority areas are left untouched, while many projects are concentrated in areas of dubious priority. For example, an area of first priority not reflected in the investment plan, is agricultural extensijn. The same is true for research, irrigation, training, etc. These areas have not been addressed by MAG, and are not reflected in its proposed investment program. in addition, projects do not correspond in all cases to the crops or agricultural activities for which the country has clear comparative advantages. 262. NAG's 1992 investment program includes only four projects and totals US$11.1 million. There are two area or rural development projects (US$2.1 million), a national level cattle peat eradication program (US$7.0 million), and a national research center rehabilitation project (US$2.0 million). -76- 263. The cattle pest (a parasitic worm which can damage hides, and if unattended, can become a serious problem) project utilizes 75% of the investment budget. Although the pest is potentially important to cattle, to utilize the lions' share of MAG's investment budget for that one pest appears excessive. The project is part of a United States-sponsored campaign against the pest, and is financed by USAID. This points to the more general problem of the inflexibility that tied aid incorporates in the allocation of resources. With respect to the rural development projects, the record both in Nicaragua and world-wide is not encouraging; they are ineffective as a means to achieve agricultural development. The rehabilitation of the research centers is indeed a priority, and additional funds should possibly be granted. 264. A major overhaul is necessary to address the sector's priorities. This translates into. a) developing the sectoral and institutional strategies and plans of action; b) consolidating the vast number of 100% externally financed projects that do not appear in the PIP into a few priority projects of national scope that will help to solve the sector's constraints. Land Distribution and Tenure 265. INRA's 1992 investment progra 'ncludes five projects totalinq US$4.4 million. They are all integrated rural development (IRD) programs or agricultural development programs aimed at the reformed sector farmers (i.e. farmers that obtained their land in the agrarian reform). World-wide experience has shown that IRD projects are of low effectiveness and returns, costly, and difficult to implement. The costliness is shown by the fact that this budget allows INRA to cover only approximately 5% of its clientele. Natural Resources 266. IRENA's 1992 investment program is the largest of the three institutions engaged in the agricultural sector, with ten projects totaling US$11.2 million, a result of the donor interest in the area and the ability of IRENA to tap into it. Three projects are of a national or generalizad scope, totaling US$4.5 million (40%), and the rest are ongoing area-specific forestry or agro-forestry projects. The sectoral budget as a whole appears to be excessively biased towards the forestry sector, as a result of the donor interest in the area. 267. There are areas of RENA's responsibility which are only marginally covered in the above investment program, namely environmental protection and the creation and care of protected areas. 268. The list of ten projects only represents those which will be provided with counterpart funds from the Central Government budget. The complete list of investment projects that IRENA plans to carry out in 1992 includes 24 projects which will be impl9mented using external funds (if counterpart funds are required, IRENA will probably redirect other external -77- funds available for recurrent expenditure, or other projects)11. It is improbable that IRENA has the institutional capacity to handle this enlarged investment program. Consequently, IRENA should rationalize the number of projects and strengthen the most important ones. Control of Implementation and Expenditure 269. Along with a better directed and coordinated sectoral investment program, the monitoring, control and evaluation of the implementation and financial expenditure of the program is necessary. Only fragmented and poorly staffed units exist, with MAG being in the worst state. In addition to such units in each institution, a global review of the sector is necessary and an institutional mechanism to achieve this must be sought. D. THE TRANSPORT INVESTMENT PLAN Sectoral Strategy 270. The transport infrastructure of Nicaragua has been neglected since before the civil war of 1978/79. Much of the transportation infrastructure -- roads, bridges, ports, and airports-- is now in urgent need of rehabilitation or reconstruction. In addition to the needs of restoring existing infrastructure, there are pressing demands for new facilities and improvements to existing ones. These demands are mostly to provide improved infrastructure to stimulate increased agricultural production and foreign trade earnings. 271. The investment plan has been analyzed on the basis of two prioritization criteria: a) rehabilitation of existing infrastructure; and b) projects which can be completed quickly to stimulate increased production or increase the profitability of current production. Level and Composition of Proposed Expenditures 272. Of the 24 projects included for the 14TC in the 1992 Plan, 21 are for the transport sector. Seventeen are related to the construction or rehabilitation of roads or road bridges, three to the rehabilitation of Corinto Port, and ona to providing more buses. The plan is therefore overwhelmingly dedicated to road transportation. 273. Only six of the 21 transportation projects have any arrangement for foreign financing. Three are already negotiated and agreel, and three more are still being negotiated. The agreed or expected foreign financing of these six projects accounts for only 29% of the planned investment in 1992. Five of the six projects are highways and one is a port sector project. j/ The fact that institutions that have the easiest access to donor money have the ability -o implement a substantial program without going through the scrutiny of MEDE distorts the rationale and diminishes the value of a PIP. The practice should be discouraged. -78- 274. The total expected cost of the 21 projects is US$135 million, of which US$20 million has already been spent, with US$54 million of expenditure planned for 1992, US$32 million for 1993 and US$16 million for 1994. The remaining US$13 million in expenditure on these projects is planned for 1995 and beyond. Only 39 percent of the 1992 investment program is financed by external funds. That percentage is even smaller for subsequent years. 275. It is unlikely that there will be sufficient national or foreign funding for all of th,ese projects. It is also unlikely that NCT could improve its administrative capacity or the national construction industry raise its productive capacity in the shoit term. Possibly only half of the total investment planned could be managed. Project Assessments Rural Road Rehabilitation 276. The project with the highest investment for the next three years is that for the reconstruction of 600 km of rural roads. It is very difficult to estimate the benefits for this type of project. However, most of the investment costs will be financed by the IDB, and it should be expected that they will require rigorous economic evaluations and strict project supervision. The level of investment in 1992 will probably be only 10* of the total project value, the most that can be supported by a pre-financing facility from the IDB. The total project ui'll probably have to be phased over four years because of the difficulties of implementing a project with so many components. Reconstruction of Nejapa-Izapa 277. The most expensive single road project in the Plan (US$13 million) is the reconstruction of the road Nejapa-Izapa. No financing has been found so far for the complementary project of rebuilding the bridges which will cost an additional US$3.0 million. The road is the alternative route between Managua and Corinto. The principal route is in relatively good condition. Therefore, the benefits of reconstruction are likely to be low, as most traffic between Managua and Corinto will continue to use the principal route. The project will not make any significant contribution, so its timing should be deferred. Improvement of San Francisco-Camoapa 278. The next most expensive road project is the improvement of San Francisco-Camoapa. The justification for its inclusion in the 1992 Plan is that it will be the main connecting road between many of the rural roads being improved under the IDB project and the Panamerican Highway. No estimates are available of current traffic levels, but they are unlikely to be very high. When resources are scarce, it is advisable to devote them to projects with assured benefits, i.e. to roads where the present traffic levels are sufficient to justify the investment, rather than where benefits depend on the increase in agricultural production as a response to the reduction in transport costs. -79- 279. Given the lack of financing for the project, the probable delay in the rural road project which it is intended to complement, and the lack of certainty in achieving the potential project benefits, it is recommended that implementation should be delayed. In fact, greater benefits would be obtained by diverting the funds for this project and for Nejapa-Izapa (that account for 28% of the 1992 investment plan), to reconstructing the Panamerican Highway sections which lead to Nicaragua's borders with Honduras and Costa Rica. Financing the Investment Plan 280. The investment that would be reasonable to attempt, given the institutional capacity and the urgency of the projects, is the following: for 1992 US$35.7 million, for 1993 US$60.4 million and for 1994, US,56.3 million. Only US$31 million of foreign funding is either assured or under negotiation for 1992. Consequently, projects which so far do not have foreign financing either agreed or under negotiation should be deferred. This level of expenditure for 1992, about two-thirds of what is now planned, is expected to be within the management and supervision capacity of the MCT and can be largely undertaken by national consultants and contractors. Institutional Changes 281. The principal institutional change to improve the implementation of the plan will be a change in the organizational structure of the MCT and an associated change in the staffing structure. The Economics and Planning Division needs to be strengthened; the Highways Division should evolve into a project management division and undertake little or no project design in house; and similar changes are needed in other divisions, but with less urgency than in the Highways division, and for reasons unrelated to the investment plan. E. THE ENERGY INVESTMENT PLAN 282. INRE's investment program is cc..nposed of 13 projects and amounts to a total of US$124 million for the period 1992-1994. Foreign financing is estimated at 64%. Generally speaking, the program responds to the current supply crisis, since most of the projects are emergency and/or rehabilitation projects, aimed at improving power service quality in the short term. Only three of the 13 projects imply a proper expansion of the system, i.e. a gas turbines project consisting of 2x25mw units and two geothermal developments. Aggregate values of these investment requirements are shown below. Energy Sector - Investment Progran 19512-M (1991 USS Million) 1992 1993 1994 Totat Pre-Investmentl 3.38 1.00 1.50 5.88 Rehabiftation: 41.65 33.94 8.56 84.15 Expansion 18.79 37.19 35.19 91.17 Total 63.82 72.13 45.25 181120 1993-1994 figures based on mission's estimate. Includes ten rehabilitation and/or improved reliabiLity projects, 8 ongoing projects. -80- 283. INE's expansion plan is based on a projected demand growth of 3.4% per year for the period 1991-1995 and 7.7% for 1995-2000. These estimates appear to be consistent with existing growth projections. However, INE's expansion investment requirements may be overestimated because their analysis assumes very high fuel costs --US$25/barrel for fuel oil and US$37/barrel for diesel-- thus introducing a bias in favor of more capital-intensive technologies, i.e., hydropower and geothermal. 284. Eleven of thirteen projects already have secured financing for 1992 (or financing is expected to be secured in a few months). The two remaining projects include a relatively small investment (i.e., the improvement of the Malacatoya power system in a rice growing area --requires only US$0.8 million in local currency), and the gas turbines project. The financing required here amounts to US$13.2 million for 1992, 85% of which is in foreign currency. 285. Generally speaking, INE's investment program is well designed. Its components are all necessary; and many of them urgent. The program can be divided into two groups, namely (i) a set of projects to rehabilitate and/or improve existing generation, transmission and distribution facilities in order to improve in uhe short term the availability and subsequent reliability of the power systems, and (ii) the initial steps for an expansion plan aimed at supplying the energy required for Nicaragua's economic recovery and sustained growth. Nevertheless, the program has the following weaknesses: (a) The program's compcnents are not clearly justified on economic terms, i.e. most of the projects were not decided on the basis of a formal benefit-cost aralysis. The preparation of appropriate feasibility studies, including the confirmation of economic viability, for the gas turbines and the geothermal projects is considered a necessary condition to keep them in INE's investment program; (b) The program, as presented to MEDE, indicates no relative priorities among its components. However, it is clear that judging by their contribution in solving the severe power crisis, some components are more important than others. On the basis of an examination of each component's attributes and in consultations with INS's technical staff, the following projects are considered to be of low priority-Y and could b3 subject to deferment in case of financial or institutional constraints: (i) Rehabilitation of the Transmission System, (ii) Electrification of the Atlantic Coast, (iii) Improvement of the Malacatoya Electrical System, and (iv) Twansmission Line Momotombo-Leon. It should be noted that, with / In the sense that their deferment would not have an important economic impact among consumers or producers (or an impact reduced to specific small localities), and hence, their impact on the overall economy could be considered negligible. The priority criteria used here does not take into account whether the project in question is ongoing nor whether its financing is secured. -81- the exception of the Malacatoya project, all these are ongoing projects; and (c) The investment program's schedule does not appear to be fully realistic. INE's plan considers that the first gas turbine (25MW) should be in operation during the next year, preferably by mid-1992. However, this project lacks secured financing and the required feasibility study, and what is most important, INE has no clear plans on how to overcome these problems. All these issues ndicate that most probably the implementation of the gas turbines will be delayed, thus extending the current supply crisis. 286. The energy sector's publi%. investment program implies an extremely high increase compared to past trends, from US$33.5 million in 1991 to US$60.4 million for the period 1992-1994. This new level will be equal to total expenses, probably the highest ratio achieved in many years. A more realistic program, considering the likelihood of an important delay in the gas turbines, would reduce substantially 1992 investments. Furthermore, if low priority projects had to be delayed, due to financial or institutional constraints, 1992 investments coild be reduced to almost 70* of INB's plans (to approximately US$40 million). 287. INE is particularly weak in accounting, budgets control, internal auditing and information systems, all areas of key importance for an efficient management and control of projects. Therefore, INE will need technical support for the engineering and supervision of almost all generation expansion projects. These deficiencies should be addressed through an institutional strengthening technical assistance programP'. F. TIRE WATER AND SANiTATION MESTMENT PLAN 288. Existing water and sanitation facilities reach a low percentage of the population and, where they do, service quality is poor due to long periods of neglect. Planned investments will rehabilitate the systems, but are inadequate to expand service. Since the highest cause of death is water-borne disease, cost effective alternatives to improve health must be identified and given priority. 289. Most of the population presently unserved is rural, living in small villages of dispersed houses. Virtually all assistance to these areas is financed by external sources. Investment and the rate of implementation are so low that new coverage is hardly keeping paie with population growth. Z/ IDB is currently preparing a powex loan for Nicaragua which considers a comprehensive technica assistance program. This program would include the following components: power market and least-cost planning studies, and institutional strengthening in the areas of budgeting, accounting, financial management, internal auditing and other control systems, management information systems, maintenance, control of non-technical energy losses, tariffs regulation and environmental studies. -82- Marginal urban areas also present similar problems. To address these issues, INAA must develop a systematic approach to project financing to extend service outside of core urban areas. Analysis of Planned Capital Expenditures and Financing: 1992-1994 290. In INAA's investment plan for the period of 1992-1994, the two priority projects are 1) rehabilitation of potable water and sewer systems with expected financing by IDB (US$55 million), NORAD (US$5 million) and GON (US$10 million); and 2) water main rehabilitation and expansion, with financing committed by Canada (Canadian $11.0 million). 291. Level of Expenditures. The total investment plan is US$134 million. Of this US$26.7 million will have been executed by the end of 1991, and US$35 million is not expected to be disbursed until after 1994. Thus, the plan calls for project activities of US$73 million to be executed during the three-year period of 1992-1994. Financing has yet to be identified for only two of these projects (Ocotal and Masatepe) totalling US$5.5 million. 292. Absorptive Capacity. In the last ten years, even when financing has been available, project implementation (such as treatment plant construction) has been markedly drawn out or even abandoned. Consequently, even though there are many needs, a realistic investment plan could only address a small number of them. Given this situation, the size of the investment program in terms of INAA implementation capacity, appears reasonable. 293. Internal/External Financing Composition. Of the 1992 investment plan, about 25% will be financed from internal sources and 75% from external funds. However, the internal share drops to 10% in 1993 and 20% in 1994. For the three-year period, the internal commitment is projected to be US$15.5 million. However, most of these funds will be covered by the donors themselves (including at least 60% of the counterpart funds for the CIDA project). Relationship of Investment Plan to Strategy and Policy Objectives 294. INAA has set as its goal the provision of safe water to 100% of the population and sewerage to 50% by the year 2000. To accomplish its water objectives, INAA would have to increase the total number served by 150% in the next 10 years and improve to safe levels the quality of water: served to 60% of current consumers. To accomplish its sewerage/sanitation objectives of 50%, coverage woule require almost as great an expansion (140%) rer the same period. The attainment of the stated goals appeers extremely difficult, and the formulation of a set of attainable goals should be a priority. Composition of Investment 295. Rehabilitation versus Expansion. Within the context of prevailing sector conditions, the major components of the investment plan seem well-conceived. The two priority projects, comprising 70% of investment, are -83- intended to use efficiency measures to increase coverage from existing water supplies and enhance revenue by stemming physical and financial losses. 296. This approach means that those without service are unlikely to receive it. Service expansion is contingent on the recovery of production losses that can be sold to new users, and the use of new revenues or cost savings to support expansion as a result of tighter commercial controls. 297. Urban versus Rural Investment. In both absolute and relative terms, the significant number of people without safe water or sanitation reside in rural areas. However, only 12* of the total investment plan will go to rural projects. Almost no internal resources, either investment or operating, will be committed to the provision of services in rural areas, since even operating costs are financed by external donor funds. 298. Health Priorities and Proposed Investments. Under current practice, the health impact of the investment plan could be minimal. Analysis of causes of contaminated drinking water supplies indicates that even where water and sewer systems exist, supplies are seriously compromised. Indeed, many of the present concentrated sources of contamination result from the operation of the systems themselves and make thore systems potentially highly efficient transmitters of disease. Large investments in urban water, sewer or treatment facilities, without first removing the sources of existing contamination and altering the conditions that create it, will not provide the expected health benefits. Proposed Cost-Effective Priorities for Nicaragua 299. The incremental cost to Nicaragua of capturing substantial health benefits may be small. The following are the types of interventions that are needed: (a) hygiene education; (b) implementation of a low-cost sanitation and waste disposal program ; (c) latrines in all rural communities of over 400 people with existing or proposed water systems; and (d) repair and rehabilitation of sewer systems, including points of storm-water infiltration. G. THE SOCIAL SECTORS INVESTMENT PLAN 300. The investment programs of the social sectors are of great importance as the development of human capital will be crucial to the long-term development of Nicaragua. These programs are small, and possibly rightly so, as the key issue in the social sectors at present is to agree on an appropriate sectoral policy to guide investments!'. Most importantly, these investment programs appear to be guided by inappropriate priorities. In education, priority should be given to.primary education above any other educational subsector (be it university, technical or vocational). In health, priority should be given to primary health care. §/ Social sector policy issues are treated at length in the following chapter. -84- 301. One of the main issues in the education sectnr has been the inappropriate distribution of budgetary funds between the universities and primary education. Another possible source of imbalance may be the future size of the vocational training institute (INATEC), as INATEC's investment program is larger than that of the Ministry of Education (NED). 302. The current high death and morbidity rates could be significantly reduced with known, low cost preventive health care services. Priority should be assigned to investments in primary health care, rather than to hospitals, contrary to what is done in the current PIP. This priority should guide donor efforts in the sector. - 85 - CHAPTER V: STRENGTHENING AND RESTRUCTURING THE PUBLIC EXPENDITURE MANAGEMENT SYSTEM A. INTRODUCTION 303. Nicaragua is attempting an ambitious reform of its economic structure and institutional organization. Successful conclusion of these reforms require efiiciency in public expenditures and avoidance of the misuse of public funds that are not assured in the existing institutional setup. The operation of the public expenditure management system needs to be restructured and/or strengthened. Moreover, the Ministry of Finance (MIFIN), who will play a leading role in this process, is presently undergoing organizational and procedural changes that have created structural gaps and operational difficulties which need to be overcomeV. 304. The present chapter discusses the most pressing issues that need to be addressed in order to improve the efficiency of public expenditure management, monitoring and control. In particular, the budgetary process is analyzed; the problems of overall Government accounting and bookkeeping practices are evaluated; the weaknesses in accountability of the spending institutions are highlighted; the existent practices and weaknesses of ex-post expenditure control system are reviewed; the issue of coordination and control of external aid is examined; and medium-term expenditure planning is discussed. B. THE BUDGETARY PROCESS Organizational Issues and Functional Borderlines 305. The key to improving public expenditure management, and in particular the budgetary process, lies in an effiiient and effective operation of the Ministry of Finance (together with the Office of the Auditor General - Contraloria General). To this end, it is essential to redefine the general framework of the Ministry's units, in order to clarify the borderlines of their duties and responsibilities and to assess the functions of some important units which have not worked efficiently during recent years (i.e. the General Directorate of Government Accounting (GDA)). 1/ MIFIN's organizational chart for 1991 is presented in Annex A and the organizational chart for the General Directorate of Budget can be found in Annex B. - 86 - 306. The general principles and procedures for budgetary transactions are regulated by r budgetary framework law2'. In addition, each year, the specific principles of budget implementation are stated in the Annual Budget Law. The Budgetary Process 307. Budget Preparation and Budget Calendar. MIFIN prepares a detailed calendar for budget preparation, called The Work Chronology, which is basically a budget cycle. This gives a proper working plan for the General Directorate of the Budget (GDB). According to the calendar, budget preparation begins in June, with meetings by central financial and planning organizations to determine macro-economic revenue 9nd expenditure forecasts. These activities end with the preparation and submission of a proposed budget to the President for approval in early October and submission to the National Assembly. The new budget year and financial year start January 1st. 308. There are some problems with this cycle, such as the relatively late submission of budgets by institutions to GDB, the limited time allotted for the majority of budget discussions with the institutions, and the comparatively lengthy period of discussions in the National Assembly. 309. For the 1992 Budget, each Ministry was provided with a budget ceiling and requested to prepare its budget submission within these parameters. The budget ceilings for the institutions were based on the 1991 Budget figures and take the recent retrenchment exercise into consideration. 310. Program Classifications and Program Analysis. Ministerial budgets are broken down into programs, but there are no program profiles and little justification is presented for the identified programs. As a result, it is not possible to prepare priority lists to allocate expenditures, and allocation decisions are based on general overviews. 311. In order to identify expenditure priorities and to eliminate unnecessary expenditures, it is necessary to: i) complete program definitions, justifications and data on intended output; ii) revise and evaluate the selection of programs in all institutions; and iii) evaluate the costs and benefits of each program to determine its priority status. Thiv task is cumbersome, and should probably be delayed until the institutions' planning abilities have been enhanced. 312. Budget Formats. The format for the Current Expenditure Budget presents insufficient historical data, as budget estimates ave listed only for 2/ The framework law was reformed by the Parliament in October 1991, and a Presidential veto was overridden in November 1991. The reforms to the law are currently being challenged as unconstitutional. The most important reform proposed in the law is that the Assemb)y will be able to modify the overall amount of the budget and not only its distribution. - 87 - the current year. A much preferable system would include the actual or revised figures of the previous two years, so that the expenditure trends of the last three years are clear and comparisons are possible. Without such a system, there is no data base to support analysis and decisions by high level managers. Therefore, a valuable management tool is lost. 313. The format for the Capital Expenditures Budget is also inadequate. Capital expenditures are not placed together in a separate section in the budget and the listed capital expenditures are not categorized by project. In the future, the Budget Document should cover all capital formation projects; the capital estimates should preferably be placed in a separate section of each institution's budget; and there should be columns clearly indicating the project's starting date, expected completion date and total project cost. 314. Release of Allocations. Monthly Projection Tables for allocations approved in the Budget are prepared by the Directorate of Programming and Evaluation (DPE) of GDB. In these tables, the allocations which will be released in that month are shown according to a program and item line breakdown. This is a very useful practice and is being successfully implemented. 315. Monitoring Expenditures through Quarterly Expenditure Returns. It is indicated in Article 7 of the Budget Law that all Central Government organizations ara obliged to submit to MIFIN a quarterly report of results of outpuc performance. These reports are to be submitted prior to the subsequent quarter's allocation release. 316. Although these quarterly expenditure returns represent the most important tool of expenditure monitoring and control, the practice has not yet been implemented and expenditure monitoring is being done on a cash basis via control of checks being issued by the General Directorate of the Treasury (GDT). This allows for macro-level analysis, but is not sufficient for expenditure control. Expenditure monitoring is also done by examining the supporting documents that the institutions submit to the Directorate of Execution (DE). 317. Inter-/Intra-Program Allocation Transfers. After budget allocations, which are divided into programs and item lines, are approved by the National Assembly, transfers are made among them during the course of the year. As set out in the 1991 Budget Law and the Budget Norms, authority to approve these virements, depending on the type, is given to the President, the Ministry of Finance, and the concerned agency. Based on this authority, the composition of budgetary expenditures can be changed considerably during the year (see details in Annex E, page 116). 3uch possibility for major budget modifications in the course of the year have the following major drawbacks: they (i) limit the budget approval authority of the National Assembly; (ii) weaken the basic principle of budgeting (i.e. that the Budget is viable and that budgeted allocat.ions must be sufficient for the entire year:), thereby lessening the seriousness of budget preparation exercises, and (iii) considerably limit the possibility of and benefit derived from comparisons of - 88 - originally budgeted estimates set at tAe start of the year and actual expenditures. In short, the habit of resorting to unforeseen expenditure funds (see para. 321) and transfers at various levels promotes the concept of fluidity, which is not in consonance with the goals of proper budgeting. Selected Budgetary Issues , 318. Lack of linkage between capital expenditure and the current budget. In addition to the fact that capital expenditures are not adequately listed in the Budget Document and that no linkage is established between the Annual Public Investment Program and the Budget, the linkage between the capital expenditure projects, and their effecti on the recurrent budget when they are completed is lacking. When capital invcstments are completed, new demands on the current budget are inevitable. If these new burdens are assumed, but have not been budgeted, the projected budget balance is disturbed. If they are not assumed, the monies spent on investment cannot result in the provision of the intendad service. This results in a dilenma for which GDB can have no easy solution. Therefore, a system to forecast the subsequent current expenditures of each project and give advanced information to GDB is essential (see para. 362-363). 319. The Need for a Clear Distinction between Current and Capital Bxpenditures. The Government of Nicaragua (GON) is planning to implement a very ambitious Public Investment Program in 1992 (see chapter IV). This program will be predominantly financed by external aid. Care should be taken to insure that all expenditures being included in the program are in effect capital expenditures. If all current expenditures financed by external aid are not registered in the current expenditure budget, the GON will not know how much a Ministry is spending to fund its prcgrams and could be faced with unexpected needs for funds, once a source of external aid diminishes. 320. The Budgets of the Ministry of Defense and the Ministry of Police. The budgets of the Ministry of Defense and the Ministry of Police are especially important, both because of their volumes (one-fourth of the total national budget) and the fact that their budgeting procedures are conducted outside the general budgetary principles. 321. The budgets of both of these Ministries have been indicated in the past as only a one-line entry in the budget document. By 1992, expenditure breakdowns are going to be placed into the budget document, based on a request by the National Assembly, and it is expected that these practices will be improved. However, there still will not be any program breakdown. Therefore, it will not be possible to make budget analyses and implement budget cuts based on prioritization. 322. Budgetary Procedures for OUnforeseen xpenditures. There is a separate sAction entitled "Unforeseen Expenditures" ("Imprevistos") in the Budget Document below the primary Budget section for Spending Agencies. This unforeseen expenditures "budget," which amounted to 1.5W of the budget in 1991, is considered to be a reserve fund at the disposition of the President. - 89 - There are no set guidelines regarding where these funds may be used, and it appears that not all is spent on truly unforeseen occurrences. Moreover, expenditure control for this contingency fund is made )y a unit within the President's Office rather than following the standard procedures by GDB, and actual expenditure reports are not submitted to GDB. The presence of such a contingency fund, separate from the National Budget, is not in conformance with standard budgetary procedures, since it is counter to the concepts of budgetary unity and expenditure classification and the practices of expenditure control. 323. Budgetary Monitoring of Autonomous Entities. The funding of Autonomous Entities (AE) is managed via budgets separate from the Central Budget under MIFIN. Currently, AE receive allocations in the form of block transfers registered in the Transfers section of the Budget (12% of the total 1991 budget). 324. The Directorate of Autonomous Entities (DAE) was established in March 1991 in GDB to monitor the Treasury transfers granted to these entities and to provide them with technical assistance. The Directorate has been preparing the formats for expenditure and management monitoring and AE will be expected to fill these formats and submit them to the DAE monthly. Initial indications are that this is a good program and should be extended to all AE receiving transfers. C. GOVERNMENT ACCOUNTING AND ACCOUNTABELITY OF THE SPENDING INSTITUTIONS Lack of a Comprehensive Government Accounting System 325. Each ministry handles its own bookkeeping through its Financial Director, who is an officer of the institution in charge of financial and administrative affairs and is attached to the Vice-Minister. Budget transactions in their entirety, budget preparation and execution, bookkeeping and accounting, and the function of expenditure control are attached to this Financial Director. This results in a situation in which the Minister, in effect, clears his own accounts. 326. Although bookkeeping should ba done with the guidance and cooperation of the Financial Director, it must be an independent function, and should be handled by accountants attached to MIFIN posted to each spending institution. These Accountants should also prepare the consolidated year-end final accounts for submission to the Parliament. 327. In addition, problems have occurred due to the lack of a responsible unit for government accounting. The GDA has not performed its functions in recent years nor has it prepared final accounts. As a result, the accounting function was partially assumed by the DE of the GDB and partly by the GDT, via ad hoc decisions. It is urgent to define very clearly the borders of the duties between GDA and GDT, or as is being planned, to abolish the GDA and explicitly reassign its tasks. - 90 - Accountability of Spending Institutions .328. Final accounts are not prepared in accordance with the usual procedures (outlined below) and t.ie Auditor General's Office has not assumed any responsibility to audit the final accounts of the Ministries on behalf of the National Assembly. Therefore, spending institutions are not held accountable for the way they spend funds. Consequently, the present system is not able to clear the Ministers of responsibility in their handling of public funds. D. EX-POST EXPENDITURE CONTROL 329. One of the most important issues in public expenditure management in Nicaragua, along with the need to redefine organizational duties and responsibilities, is the lack of expenditure monitoring and control. Ex-post expenditure control in Nicaragua must be institutionalized for it to be effective, particularly in regard to legal and veracity control. The implementation of expendit,ro monitoring and control is considered to consist of three separate concepcs: i) monitoring the macro-level revenue/expenditure balance and controlling the overall budget deficit (or surplus); ii) monitoring the use of allocations given to institutions by the Parliament to ensure that they stay within the limits and not resort to overdrafts; and iii) controlling the legality and veracity of each in.dividual payment made from the government budget to determine if the actual exprnditures are in conformance with laws, regulations and norms. 330. The borderline between the core units which are dealing with budgetary practices and expenditure control, such as the DE, the DD to the Ministries, GDT (which is assuming the function of GDP), the financial sections of the spending Ministries, and the Auditor General's Office, have to be identified carefully. Otherwise overlaps, gaps and vagueness will be inevitable. Detailed examination of the current duties of the offices involved in expenditure control and recommended improvements are presented below. Monitor the Macro-level Revenue/Expenditure Balance on a Cash Basis 331. The DPR prepares monthly allocation tables and submits them to the Director of GDB. Subsequently, expenditures are made based on them. The DE monitors the checks issued and prepares actual expenditure tables for submission to the Director of GDB. In addition, the General Directorate of Revenues (GDR) prepares revenue collections, again on a cash basis. Both the Director of GDB and the Dire.tcr of GDR submit these tables, which are prepared on a cash basis, to he Advisor to the Minister. The Advisor, in turn, makes surplus/deficit valuations taking into consideration these monthly revenue and expenditure results which are broken down into specific classifications (such as current, investments, transfers, etc.). - 91 - 332. The monitoring function at this level is being efficiently performed by the Ministry of Finance, and the system appears to be working well. Monitor the Use of Credits Given to Institutions by the Budget Law 333. The institutions prepare and submit monthly bupporting documents for their monthly actual expenditures to the DE, and this unit prepares, monthly, actual, consolidated and cumulative "expenditure tables" based on documentation from the institutions. The DE monitors the allocations monthly, based on these tables. 334. This reporting system assists MIFIN to analyze the situation and point out which institutions have exceeded their allocations on a program basis and which institutions have resorted to excessive of funds between items during the year. Exceeding the allocation limits is not very common since GDB holds a strong position in respect to ministries and other institutions. In this area, budget administration is operating at an efficient level. Controls on the Legality of Expenditures 335. The legality and veracity control of individual payments, both while payments are being made and after they are completed, have been the weak points of the control system. Administrative changes have given rise to considerable functional gaps and problems in the expenditure control system. The current system, especially with regard to the various units responsible for expenditure control, is vague. As a result, many essential elements of control are in effect not being conducted by any one of them. 336. In the existing system, the following units share the responsibility for expenditure monitoring and control: 1) the Financial Officer and Vice-Minister in charge of administration in each institution; 2) the Internal Auditor of the concerned ministry, if there is one; 3) the Director of Execution of GDB; 4) the Director Delegates who have recently been assigned to selected ministries by GDB; 5) the General Directorate of the Treasury; and 6) the Auditor General's Auditors. 337. A reorganization and redistribution of tasks should clear the limited and unclear control conducted by these organizations. This basically would involve activating the Office of the Auditor General, abolishing the internal auditors and resolving overlapping functions between the DE and the GDT. ContW_ of Personnel Enohtnents 338. Creating and Abolishing Positions. The 1991 Budget Law (No. 121 Article 13) states that the administration of the central registry of positions and personnel of the General Government is given to the Ministry of Finance and the list of permanent employee positions approved as part of this law can not be modified by the Ministries and organisms, with the exception of - 92 - the Legislative, Judicial, and Electoral Branches. In other words, MIFIN is the authority to grant new positions to the Ministries and make necessary modifications. Within GDB, the duty of creating and abolishing Government positions is currently being assumed by the Directorate of Policies (DP). 339. Trends of employee numbers are followed up by the General Directorate of Information (GDI), but au,horities do not follow it on the basis of authorized positions ("1cargou"). In effect, no distinction is being made between Establishment ("cargo" or position) and Staff (individuals). This is a very serious drawback from the Budget preparation point of view and for the entire system of civil service management and needs to be corrected rapidly. Otherwise, it will be impossible to keep track of the distribution of positions among institutions. As a result, the assessment of the impact of the retrenchment program will be difficult and it will not be possible to prevent organizations from using unauthorized positions on their own initiative. 340. In order to properly control the use of positions and avoid employment without authorized positions ("cargos"), the procedures pertaining to the creation and cancellation of positions must be handled very carefully. The prerequisite for this is a detailed, reliable Establishment Register (inventory of positions). Each position granted to an institution must be based on a written decision. This will allow GDB to monitor the legality of the use of the positions, to assess the conversion program more effectively, and also to make more realistic estimates for personnel emoluments during budget preparation. These authorized positions have to be approved as part of the budget law each year, and their numbers should be indicated in the Budget Document, Ministry by Ministry and grade by grade. 341. As a consequence of the lack of an inventory of positions, there is no norm for salary scales. For example, it is understood that in the payroll table, there are 335 different salary scales for 550 secretarial positions. E. COORDINATION AND CONTROL OF EXTERNAL AID 342. There is a need to establish a mechanism for coordinating and controlling external aid, particularly to preclude the spending ministries from dealing directly with donors, and by-passing the Ministry of External Cooperation (MCE). Given the current and expected size of the flow of foreign aid, its adequate administration is central to the efficiency of public expenditure management, and a good administration will probably secure the continuity of the flow, a key to the sustainability of the current macroeconomic program. 343. Currently, if donors do not voluntarily go through MCE and MIFIN, MIFIN has no control over the situation, as there is no central accounting system for external aid. This has led to abuse wherein some goverLme! t officials are receiving double salaries. Based on experiences of other countries, it can be stated that problems may increase to serious proportions unless corrective measures are taken. By-passing established channels and - 93 - other related malpractices are the kinds of activities which can deteriorate the entire public expend' aze and civil service management systems, and may also cause the misuse of funds. The following section analyzes the current system. Legal Status 344. A Presidential Decree reairding the organization and duties of MCB (Decree Number 56-90, Article 1, dated October 30, 1990) is the mair. legal regulation governing the mechanism of external aid. This Decree sets out MCE's primary duties in general terms: obtaining, contracting, coordinating and channeling economic, technical, and iaterial external cooperation. However, it does not stipulate how these aid packages are to be handled and channeled through NCB, nor does it set out which administrative and legal measures and punishments will be enforced in the event of non-conformance. Article 3 of the Decree states, "internal organization and the other duties of NCE will be determined by regulations which will be prepared later." However, these regulations have not yet been promulgated. 345. Article 8 of the 1991 Budget Law (Law Number 121, dated December 27, 1990) sets out some principles for the handling of foreign aid. Specifically, it states that all donations from internal or external sources used for the financing of programs and projects of the institutions includee in the general budget should be channeled without except4on through MIFIN, which will authorize disbursements in accordance with previously submitted programs. 346. According to the Law of the Auditor General (Articles 49, 122, 136), when the Auditor General's office determines that official duties and responsibilities have been conducted with a lack of legal compliance, the offender would be subjected to a monetary penalty as well as -dministrative sanctions. Examples are breaking the law, by negligence or intent, or disobedience of the regulations, manuals or norms; failure to deposit all received funds; improperly signing obligations in the name of the entity for which they work; failure to administer the budgetary laws, norms and regulations; not including all resources in the entity's budget; authorizing or spending amounts over those assigned to the entity; not maintaining a system of receipt and financial administration of resources in accordance with this Law and other applicable regulations and norms. 347. In order to enforce the administrative sanctions of the Auditor General's Law, the "internal regulation" which is to be prepared as a requirement of Article 3 of the founding Decree for MCE is lacking. Until it is prepared, sanctions against legal non-conformance cannot be carried out. Manner of Receiving Aid 348. Aid enters the country in the many ways. Some aid comes in the form of commodities and is turned over to ENIMPORT, an autonomous enterprise attached to NCE, to be marketed; some aid in commodity form is received to be distributed and used in projects; and some commodity aid goes directly to the - 94 - institutions without MCE's knowledge. Aid in the form of cash can come either with or without MCE's knowledge. Budgeting, Accounting and Auditing of the Current System 349. When donor aid comes through MCS, in the agreement the purpose of the assistance and the way it is to be used is clarified. Such earmarked aid coming in through MCE or through the ENIMPORT channel is recorded by the DE of GDB in the revenue budget, on the one hand, and in the expenditure budget of the conceined ministry on the other. 350. If the aid comes in the form of equipment, and if MIFIN is advised, it is entered into the revenue budget in the same manner, by recording it in the revenue budget allocation. When the goods are turned over to the concerned ministry, the actual expenditure record is annotated. This situation is also advised to the Directorate of Government Assets and the equipment is thereby entered as a piece of government property. 351. If cash or commodity aid is not notified to MIFIN, no budgeting procedures are possible. Consequently, the real dimension of the budget being managed by the institutions and the current expenditure needs being generated by the aid-funded projects are unknown. 352. Regarding the aid which is notified to MIFIN, the Ministry keeps accounting records for incoming and outgoing entries and is subsequently audited. Aid outside of the budget is not subject to auditing. F. MEDIUM-TERM EXPENDITURE PLANNING AND FORWARD EUDGETING Macro-economic Framework for a Medium-Term Expenditure Plan (MTEP) 353. The Government of Nicaragua needs to prepare a NTEP to project expenditures systematically in order to ensure a more efficient use of limited public resources. 354. The MTEP would consist of an overall macro-economic framework for revenue forecasting for the next three years (for an example of such a framework and an example of the forecasts, see Annex G, page 118) and would design the general policy for the distribution of resources among the highest priority sectors and highest priority programs in each sector. This prioritized expenditure planning instrument would greatly facilitate the process of allocating resources, and would be a useful guide when budget cuts are needed. 355. The MTEP should be designed in a framework based on a forward budgeting model. However, due to the fact that MIFIN is now struggling with transition efforts to strengthen financial management which has regressed during the last decade, it will be inappropriate to introduce forward budgeting immediately. - 95 - Prioritization of Government Expenditures through a MTEP 356. The most important target of a MTEP would be expenditure prioritization. This will rationalize the use of limited public resources, and allow the elimination of unnecessary and lesser priority expenditures. This exercise will gradually develop the program analysis techniques of the GDB and spending institutions (ministries and others) to enable them to analyze and make decisions based on the prioritization of expenditures, rather than to using bargaining methods or annual incremental budgeting based on the previous year's figures. 357. In addition, the MTBP will include the development of procedures for integrating investment planning priorities into current budgets. It will also develop procedures to identify annually public investment priorities and to assure that those priorities receive appropriate budget allocations. 358. Program-based budgeting and program analysis for a XTEP. In order to reach the above goals, it will be necessary to develop a program-based budgeting system which will consist of both recurrent and investment expenditures, program by program, relying on sound justification and comparing costs and benefits. 359. Establishment of a link between medium-term and long-term planning. Within the framework of expenditure planning it is necessary to develop procedures for effective linkages between the development targets and the budgeting process to ensure that the Budget is in line with the national economic development priorities and to give national budgeting a medium-term horizon. 360. Such a medium-term expenditure plan should establish objectives for both recurrent and investment expenditure over a three-year horizon that is consistent with overall government policies. 361. Forecasting the recurrent cost implications of investment expenditures. It is essential to establish the necessary linkage between the annual investment program and the recurrent budget. Procedures must be synchronized so that there will be consistency between the investment and recurrent budgets by insuring that all projects in the annual investment program are included in the investment budget. Those funded by GON and external donors, and their effects on recurrent costs, are reflected in the recurrent budget. MDE will assess the progress of the projects and determine the expected recurrent implications which will occur when the investment is either partly or totally completed. 362. In conjunction with this linkage between the annual investment program, the investment budget and the recurrent budget, an effectively functioning Advance Information System should be created. This will allow awareness of the recurrent expenditures in future years which will be generated by on-going investment projects of the annual public investment program. - 96 - 363. Components of the preliminary forward budget and its implementation formats. In the first year of implementation of the Preliminary Forward Budget, it is recommended that the format remain somewhat rudimentary. On the format, in ch column for the current budget year, figures for all item lines shoulC be filled in. However, for the estimates for the following two years, the requirement for data should be limited to only group total figures at this introductory stage of forward budgeting. The recommended format is included in Annex F, page 117. G. RECOMMENDATIONS FOR ACTION 364. To strengthen the public expenditure management system, the GON should address the following tasks: Stregthen and Restructun. Budgeta Mangnent 365. The following issues need to be addressed: (a) The borderlines among the core units which deal with budgetary practices and expenditure control need to be carefully identified to preclude overlapping and ensure that all duties are performed effectively; (b) In order ta allow for the orderly and comprehensive handling of budgeting and accounting affairs, it is recommended that an accounting system (based on the Budgeting and Accounting units) be established in Nicaragua in the shortest possible time. (c) The organizational status, duties and respons4bilities of the Director Delegates to the Institutions should be redefined, the borderlines of their duties in relation to other concerned units clarified, and a work manual written; (d) The duties and responsibilities of DR of GDB, which is the core unit of the budgetary system, should be reevaluated, particularly regarding ex-post expenditure control. (e) In the future, budget ceilings should be based on technical analysis and expenditure prioritization rather than on historical figures. 366. Establishment of MIFIN Budgeting and Accounting Units. It is recommended that a Budgeting and Accounting Unit (BAU) be established in each institution, headed by an accountant, who is a representative of MIFN. This accountant be responsible for keeping the necessary records. This unit would assist in budget preparation and implementation, assume expenditure control, and prepare periodic expenditure returns and the final year-end accounts. - 97 - 367. Although the duty and functional ties to GDB and to GDT ari equal, the place of these units in the MIFIN hierarchy would be under GDE. However, from the duty and responsibility perspective, they would be responsible to the Treasury for treasury issues, and the GDT would be consulted during their assignment and transfers. 368. Specifically, the accountdnt would: i) keep the records of the allocations to the institution to which he is assigned on a program and item basis and develop a data base for accountability as well as for budget analysis; ii) examine the supporting documents of expenditures submitted by the PD of the institution and control them, from the point of view of legality of procedures, and submit them to the Vice-Minister of the concerned institution; iii) co-sign the payments documents with the FD of the institutions. This will indicate that the accountant has reviewed the documents and shares the responsibility for their veracity and legality; iv) prepare a monthly expenditure return which shows allocation released by the Budget Department for a specific month and actual expenditure and commitments disbursed in the course of that month, co-sign this w4ith the FD of the institution, and submit it to the Vice-Minister. In due course this will be submitted to GDB. 369. Under this new arrangement, more responsibility could be given to the institutions for thei. own budget preparation and execution. A further benefit wculd be the freeing of GDB and other MIFIN officials from being bogged down in a myriad of details, allowing them to perform their primary duties more efficiently. 370. Status of the Newly Assigned Director Delegates. MIFI3 started in August 1991 a new expenditure control practice by assigning DD to selected institutions. The Internal Memorandum which describes the new position of DD needs to be more precise, particularly as regards the legal status of these delegates and their specific duties. This position needs to be institutionalized, possibly following these guidelines: (a) the delegates will work as a trouble-shooting board, located in the Ministry of Finance, directly attached to the Minister or Vice- Minister, similar to a Board of Inspectors of Finance in some other countries based on.the French system; (b) the Delegates will represent the Minister of Finance in all public institutions, and conduct all manner of investigations, inspections, audits, institutional assessments and evaluations and research in both the Ministry of Finance and spending institutions on behalf of the Minister; and (c) the Delegates will rotate among the institutions according to a working program. - 98 - Establish a Government-wide Accounting System 371. The concept of a Government-wide, comprehensive accounting system under the responsibility of MIFIN needs to be adopted. The problems of ineffective, fragmented accounting can be solved with the assistance of the proposed BAU in each institution, headed by a MIFIN-appointed Accountant, to bear key responsibility, pa-ticularly for bookkeeping and preparing year-end final accounts of the institutions. Each institution must submit its year-end final accounts to the Auditor General via MIFIN for legality and veracity clearance. The Auditor General will determine if there have been any excesses or violations and apply administrative sanctions acting as a "court of account" in the event of non-compliance. Establish the Accountability of Government Institutions 372. To hold an institution accountable for the expenditure of the funds it has handled, the following procedure should be followed. Final accounts should be prepared and signed by the accountants attached to MIFIN, then given to the Vice-Minister and FD of the institution who will also sign the document, and then submitted to the Auditor General. A copy of this final account should also be submitted to MIFIN for expenditure control and preparation of the consolidated accounts. 373. In order to establish a system which fulfills the above requirements, it will be useful to put an article into the Budget Law as follows: "Each minister must prepare his year-end final account in cooperation with the "accountant" and will submit it to the Aditor General's Office within three months of the end of the fiscal year in order to ensure clearance for veracity." 374. The Auditor General of the Republic should audit all government expenditures and institutions on behalf of the National Assembly as a superior organization and officially inform that body of its findings. Lately, this function was not fulfilled and there were no expenditure controls conducted during recent years. After restructuring the overall control mechanisms and reaching an efficient working level for the other units mentioned in this Saction (Auditor General's Office, the proposed Accountants, the DD), the possibility of abolishing the internal auditor system may be considered. At present, the internal auditor's basic functions are to: (i) examine the monthly amounts allocated by GDB, (ii) check the institution's inventory list, and (iii) examine procurement quotations and choices made for procurement. 375. Due to the current reorganization upheavals, it is not clear what the ex-post veracity expenditure control function of the DE involves. The DE's most important duty should be to monitor and evaluate the quarterly returns (see paras. 14 and 15), and take necessary measures in the event of significant variances. 376. An examination similar to that made by the DE in regard to expenditures, is made by the GDT during the issuing oi payment checks. However, this control is said to be done by the DE and Auditor General's - 99 - Office as well as by the GDT. Apparently, the Treasury if basically dealing with the monitoring of the cash balance of the Government and availability of the cash funds to make payments possible. However, it appears that there are overlapping functions. These points need to be clarified and the parameters of duties elaborated. Establish a New Expenditure Control Mechanism 377. This implies, among other things: a) revitalize expenditure control by the Auditor General; b) li.niting the flexibility to make modifications among allocations; and c) extending operations of the DAE. Improve the Mechanism for Coordination and Control of External Aid 378. Regarding a better mechanism for external aid, the key question is which organizations will be responsible for external aid management and operational decisions and which will be the executing unit. The initial recommendation, is that the Ministry of the Economy (MEDE) and MIFIN should share the overall decision making on external aid, assessing initial requests froyn the institutions as well as the offers from donors' and that MCE should conduct external aid negotiations and handle the bureaucratic execution of the external aid process as a secretariat. 379. Also, the establishment of an External Aid Coordination Committee is recommended. The External Aid Coordination Committee would regulate the flow of external aid to institutions and all aid would be channelled to the institutions through this Committee. The External Aid Coordination Committee, will be composed by one representative from each Ministry involved (MCE, who would chair it, MIFIN, MEDE and the Central Bank), and would make the final decisions on distribution of aid to the institutions. The primary function of this Committee would be to regulate the aid flow, but not the assessment of needs or daily bureaucratic details of aid use. The Committee will also function as an overall consultant group to the whole system since they are in a position to oversee external aid problems. 380. The Committee's decisions will be communicated in writing to MCE, MIFIN, MEDE, the Central Bank, to the institutions which will receive the aid and the external aid donor. 381. This regulating function of the Committee will reduce the amount of aid going directly from donors to institutK- s without the knowledge of MCE, MIFIN, MEDE, and in some cases, the adminiEurators of the concerned Ministry itself. This will be possible because a documented mechanism will have to be followed and institutions which are receiving external aid will have to have a signed document to that effect. During audits, the basic issue that the auditors will examine is whether there is a written decision of the Committee or not. If there is not, administrative sanctions will be taken against the violators. 382. According to the process described above, the recommended procedures for external aid are as follows: * 100 - (a) The main authority for external aid negotiations would continue to be MCE; (b) Spending ministries and institutions would propose their external aid needs to the Aid Lommittee, the analysis of the project and their needs for current expenditurse would be done by MEDE, MIFIN would check the availability of funds, and if there is agreement on the merit of the request, it would pass on to MCE; (c) MCE would meet with donors, and to secure Lne needed aid; and (W) If the offer of external aid comes initially from donors, the line ministry would have to go through the Aid Committee and, aCter receiving clearance, MCE would finalize the aid agreement. 383. Auditing principles and procedures for external aid would be the same as the systen, ir force for normal budget revenues and expenditures. In other words, i' would be handled by the internal auditor, MIFIN (by the proposad MIFIN Accountant in each institution and the DE of GDB), and by the Auditor Ceneral. The normal expenditure control system, with the recommended improvements, would be followed. In addition, Accountants, or Financial Officers, would submit a monthly report to MIFIN (DE) and the Auditor General of external aid received and expenditures made. 384. The External Aid Coordination Committee and MIFIN would monitor the use of the aid and closely follow whether the receiving ministry or institution has acted in accordance with norms which would be written and sent to them. During this monitoring process, if it is determined that the institution has acted in non-conformance to the related laws and norms, administrative sanctions would be taken against the offender. 385. A framework law and/or a decree establishing the parameters of an external aid mechanism needs to be promulgated. This law/decree should encompass and clearly define the following points: (i) establishment of an External Aid Coordination Committee; (ii) how the aid is initially provided; (iii) turn-over to the proper ministries; (iv) the relationship between various forms of aid and the budget (how it is to be budgeted); (v) procedures for external aid; (vi) auditing and expenditure control; and (vii) administrative sanctions against those who do not conform to the rules. These rules could, alternatively, be placed in the yearly Budget Law and written into the Budget Norms. Set up a Prioritization Mechanism and Improve the Budgetary Process 386. It is very important to establish an expenditure prioritization and program analysis mechanism. It is necessary to prioritize expenditures on the basis of detailed program analyses and program assessments, rather ;han depending on general observations. On the program level, it is important to be able to decide on a rational basis which expenditure items will be given priority in a program. As a start in expenditure prioritization, it is - 101 - r6commendad that ministry profiles and program profiles be prepared as soon as possible. 387. To improve the budget process, the GON should alqo: a) improve the content and format of budget documents for current and capital expenditures; b) extend the overall budgetary practices and 6xpenditure control to the budgets of the Ministries of Defense and Police; and c) extend budqeting practices, reporting and standarC expenditure control procedures for nimprevistoe". Restructuring of the Civil Service System 388. The civil service system needs to be completely restructured and a sound salary scale established. This is a prerequisite of an effective control mechanism for personnel emoluments. To achieve this, the GON needs to: a) establish an independent CiviL Service organization; b) set up a system of establishments aid payroll lists; c) an article should be added to the Budget Law stating that no institution will be allowed to appoint staff without having a position authorized by MIFIN; and d) prepare position tables for each institution. 389. Although a Civil Service Law was promulgat 4 in 1990 aimed at establishing a civil service organizaticn attached to the President, the necessary enabling regulations have not yet been prepared and the Ministry of Finance continues to shoulder this duty. 390. System for Establishment Register and Staff Lists Monitoring. After the reforms recommended above are accomp2ished, a code number should be given to every single position. Similarly, a staff code number should be given to each government employee and that person should keep that code number starting from thq first day of his appointment until his death. It can be held in abeyance if he leaves government service and reused if he returns. 391. After completion of this first stage of giving these two types of code numbers, the two numbers should be married so that it will be relatively easy to monitor which employee holds which post and which posts are vacant. A reliable, computerized Establishment Register with compatible, codified Staff Lists are prerequisites for effective control of emoluments as well as management of the civil service -yetem. 392. The data base in the computer system has the capacity to handle such a regiater and the various pieces of data have been loaded into the computer, although in a disorganized fashion. However, it is very hard to extract any organized position table. MIFIN needs to get from the GDI the summary tables which indicate the positions, classified by grade and by position and also by institution (see format in Annex C, page 114). After preparing such tables, a summary table should be prepared which shows an overview for each institution, grade by grade and program by program and placed in each institution's budget in the Budget Document (a sample table can be found in Anr.ex D, page 115). - 102 - SAt up a Preliminary Model for Mid-Tenn Expenditure Planning 393. Althoigh MIFIN is heavily loaded presently with restructuring the budgetary system, it is necessary to start with preliminary mid-term expenditure planning using a planning modql consistent with expenditure prioritization in a framework of program budgeting, and establish linkage between medium and long-term. planning and budgeting through forward budgeting. For this purpose, a one-year preliminary action plan should kNe prepared. This action plan should identify the targets, parameters and procedures of the mid-term expenditure plannint model and also should design the proliminary formats for forward budgeting. Prepare and Implement a Technical Assistance Program 394. In order to expedite the above restructuring efforts, short- three-pronged technical assistance needs to be provided to MIFIN consisting of: (a) workshops for General Directors and above, to gain an understanding of the necessi%y for strengthening and reforming public expenditure management; training seminars for MIFIN staff on improved budget preparation, implementation and control issAes; and some academic training abroad for Budget Directoratn staff; (b) short-term technical assistance for basic budgetary issues, including formulation of the new public expenditure management framework, organizational schemes and draft outlines of duties for the main units involved (2-3 weeks); technical assistance for the formulation of an overall government accounting system, possibly by the IMF (1-2 years); several short-term consultants in ex-post expenditure control, revision of the auditing mechanism by the Auditor General, mid-term expenditure planning and forward budgeting, expenditure prioritization and program analysis for program-based budgeting; and (c) equipment to support strengthening and restructuring efforts, particularly computer facilities. - 103 - CHAPTER VI: MACROECONOMIC FRAMEWORK AND PROJECTIONS 1992-96 A INTRODUCTION 395. The objective of this chapter is to identify the resource envelope for the public sector expenditure projections, consistent with the overall projections for growth, inflation and external balance. 396. The base projections assume a positive scenario based on the good results that the Government has achieved in stopping inflation and in initiating structural adjustment. Consolidation of stabilization, the deepening of structural adjustment, the development of market institutions ane, on that basis, a satisfactory solution to the external debt overhang, are assumed to keep Nicaragua on the path of non-inflationary sustained growth. 397. Foreign aid has played a key role in achieving these results. It has played the role of helping the stabilization effort by filling the gap between absorption and production. This has meant that, in effect, Nicaragua has not achieved any adjustment in terms of import level or trade balance deficit. Consequently the overall availability of goods did not drop significantly, buffering the economic costs and social tensions of the stabilization effort. The level of external aid is therefore a key variable in determining the evolution of the program in the medium term. B. THE MACROECONOMIC FRAMEWORK UNDER STABILIZATION AND STRUCTURAL ADJUSTMENT 398. Given Nicaragua's resource endowments, the state of technology, factor prices and the international price outlook for Nicaragua's traditional exports, in the medium term, export-oriented agriculture will be the engine of growth. The potential is large as under-utilization of agricultural land because of the past war and property rights issues still persists, and the reopening of the most important natural export market, the US, is just beginning to be exploited. The Policy Agenda for Sustained Growth 399. To exploit Nicaragua's growth potential, it is necessary to: (i) consolidate stabilization, (ii) further liberalize the economy, (iii) strengthen the key institutions for the efficient functioning of a competitive market economy, and (iv) clearly establish property rights and the functioning of the legal/contractual system. 400. Both stabilization and the establishment of a market economy require changes in the level and composition of expenditures (see Chapter II). Public sector participation in the economy should be reduced, and expenditures should be better focused and more cost-effective. Both the physical infrastructure and the human resource base need to be rebuilt. - 104 - 401. Nicaragua a economic recovery and medium-term growth will crucially depend on adequate external financing. Nicaragua faces an extraordinarily large debt overhang, amounting to US$10.4 billion at the end of .'991. The Government has obtained a favorable renegotiation of its bilateral debt, both with Latin American countries and the Paris Club. However, further debt stock reductions are needed to solve its enormous debt overhang. C. BASE CASE MACROECONOMK PROJECTIONS 402. A macroeconomic model for a small open economy was used to determine the paths of fiscal and monetary policies that are consistent with the goals of resuming growth whilo maintaining price stability and reasonable progress toward the attainment of external balance. 403. The :Iechanice of Growth. Growth, assuming that stabilization is maintained, will come in 1992 and 1993 from the reduction in distortions in production, an increase in capacity utilization, and an increase in public investment in physical and social infrastructure. Thereafter, the deepening in structural adjustment and the rebuilding of market institutions, will accelerate growth to high sustained levels, as total factor productivity rises. 404. In the early projection years (1992 and 1993), public investment for reconstruction of basic physical and social infrastructure is expanded, assuming that net positive external savings remain at about their 1991 level. This necessitates a significant reduction in public consumption from 21.3% of GDP in 1991 to 17.3% in 1993, while public investment increases from 5% of GDP to about 10% in the same period. 405. In 1994 and 1995, as growth picks up, stabilization is sustained and property rights are enforced, private investment response will become the main engine of growth. Private investment stays at about 15% of GDP. This slow response in private investment is assumed because stabilization and structural adjustment policies take time to become credible and, because market institutions and the security of property rights take time to develop. The reconstruction of the private financial sector, a key complement to private sector development, will also take time to solidify. Private consumption will remain relatively stable at about 83% of GDP. 406. During the projection years, gross domestic savings (GDS) improves substantially from -S of GDP in 1991 to 2% in 1996. The adjustment in public consumption is the most important contributor to the improvement. 407. The Role of the External Sector. The resource balance deficit would be reduced from 25% of GDP in 1991 to 22% in 1996. The size of the resource gap however, would remain large after 5 years of adjustment, making the projections very sensitive to the flows of external aid and the assumptions on renegotiation of the external debt (see Figure 3). - 105 - 408. Progress in the aolution of Nicaragua's debt overhang is assumed to postpone significant payments on past arrears and on current falling due debt service and, in addition generate sufficient net external savings to finance the resource balance deficit and the resumption of growth. At the end of May 1991, Nicaragua's external debt amounted to US$10.8 billion (seven times the GDP), including US$4.0 billion in arrears. US$7.4 billion (69%) was owed to bilateral creditors, US$1.3 billion (12%) to multilaterals, US$1.8 billion (17%) to commercial banks and US$239 million to suppliers and other creditors. The country is faced with one of the highest relative levels of external debt in the world and an unsustainable annual financing gap of US$1.3 billion (76% of GDP on average) for the 1992-1996 period, which already reflects the debt rescheduling agreed with the Paris Club creditors. However., the Government is initiating negotiations with some official and private creditors to reduce the financing gap further to about US$700 million over the 1993-95 period. Half of this amount, which is scheduled service to Eastern Europe (45%) and the Central American Countries (5%), is assumed to be rescheduled annually. The remainder of the financing gap (US$350 million) would be financed by international financial institutions and bilateral cofinanciers. To date, projected new disbursements for the 1992-1996 period average about US$190 million per year, and based on a good policy implementation record, the remaining gap (approximately US$200 million) should be rapidly covered (see Table 3). 409. Under the foregoing assumptions, the following medium term scenario is drawn: a) GDP growth will turn positive in 1992 and from then on, it will grow steadily to reach stable levels (5%) by 1994 (see Figure 1); b) consumption per capita takes a longer time to recuperate, because Nicaragua needs to reduce public consumption further. Even with this growth performance, GDP per capita will not reach the 1950s levels before 2000. Table 1 shows the details of the projected macroeconomic scenario. D. FISCAL PROJECTIONS The Government's Resource Envelope 410. Government Revenues. Tax revenues are the most important source of funds for the Central Government and are projected to stay at about 19% of GDP during the projection years. This amounts to about 73% of the domestic revenues of the non-financial public sector (NFPS) and to 58% of the total sources of fund of the NFPS. 411. Public enterprise surplus in the current account is projected to grow in line with GDP growth. Public utilities revenues are assumed to grow with the expansion of the services derived from public investment in infrastructure, and public utility prices are assumed to maintain their present levels in real terms. Given the above assumptions, total revenue of the NFPS will remain between 27% and 25% of GDP for the period 1992-96. - 106 - TABLA 1 NICARAGUA KEY INDICATORS 1991 1992 1993 1994 1995 1996 SCENARIO : BASE CASE Real Growth Rates: Gross Domestic Output -0.7 4.0 4.5 5.0 5.0 5.0 GDP per capita -4.0 0.6 1.1 1.5 1.5 1.5 National Accounts (As % of GDP) Consumption 104.8 102.4 101.6 100.6 99.7 99.0 Gross Domestic Investment 19.8 25.7 24.5 24.0 24.1 23.8 Export of Goods & NFS 20.2 20.8 21.3 21.8 22.2 22.6 Import of Goods & NFS 44.8 48.8 47.3 46.4 46.0 45.4 Non Financial Public Sector (As % of GDP) Total Current Revenues 26.3 27.4 26.4 25.7 25.5 25.2 Total Current Expenditures 28.7 25.0 23.8 23.0 22.0 21.2 Total Capital Expenditures 4.9 10.7 10.5 9.4 9.1 8.8 Overall Balance -7.1 -8.1 -7.6 -6.5 -5.4 -4.6 Overall Balance .fter Grants 7.2 0.3 -1.4 -1.4 -1.8 -1.3 GDP Deflator (Z growth rate) 2769.6 30.0 10.0 7.0 4.5 4.5 Real Exchange Rate (1990=100) 108.1 99.3 103.2 109.3 108.6 107.9 GDP in US$ Millions 1580 1850 1933 1990 2184 2396 Net Reserves (US$M) 122 137 164 186 208 230 SCENARIO : LOW CASE Real Growth Rates: Gross Domestic Output -0.7 0.6 0.4 0.2 0.1 .0.1 GDP per capita -4.0 -2.7 -2.9 -3.1 -3.2 -3.4 National Accounts (As I of GDP) Consumption 104.8 109.9 100.3 100.6 100.3 99.9 Gross Domestic Investment 19.8 17.3 17.2 16.6 15.4 15.0 Export of Goods & NFS 20.2 19.8 20.2 20.6 21.2 21.9 Import of Goods & NFS 44.8 47.1 37.7 37.8 36.9 36.8 Non Financial Public Sector (As % of GDP) Total Current Revenues 26.3 25.2 24.9 24.3 23.7 23.0 Total Current Expenditures 28.7 31.6 33.1 32.7 32.7 32.5 Total Capital Expenditures 4.9 5.7 5.3 4.9 4.6 4.2 overall Balance -7.1 -11.9 -13.4 -13.1 -13.4 -13.5 Overall Balance after Grants 7.2 -4.8 -9.6 -10.1 -10.3 -10.7 CDP Deflator (% growth rate) 2769.6 104.2 368.0 381.8 398.1 433.6 Real Exchange Rate (1990=100) 108.1 82.2 98.3 84.8 94.6 90.8 GDP in US$ Millions 1580 2161 1885 2276 2117 2289 Net Reserves (USSM) 122 111 93 66 70 82 - 107 - 412. Foreign Resources. Foreign grants to the NFPS are assumed at a level of between 6-8W of GDP for the period 1992-93 and then start to decrease gradually to reach about 3% of GDP in 1996. The private sector and the financial public sector will receive twice that amount (see Tables 2 and 3). Government Expenditures 413. It is necessary to continue adjusting public expenditures and in particular, operational expenditures (i.e. current expenditures excluding interest payments) to make room for public investment in the early projection years, for private investment in the outer projection years, for interest payments and also for possible extra social security expenditures. 414. Overall NFPS expenditure is programmed to decline from 34% of GDP in 1991 to 30% in 1996, but capital expenditure is programmed to increase from 5% of GDP to 8.8W in the same period, and interest payments are also programmed to increase in the projection period from 1.5 * of GDP to some 4% of GDP. Programmed expenditure reduction occurs basically on current expenditure. In 1992, a significant reduction in the wage bill is programmed due to the 12% reduction in central government employment enacted in 1991. In the following years, further reductions in defense expenditure, goods and services and general administration expenditures are programmed. If the macroeconomic conditions required it, there is room for additional reductions in current expenditures that are not factored in our projections and are described in the Chapter II. Overall Central Government expenditure is projected to decline from 28% of GDP in 1991 to 21% in 1996, but interest payments will increase from 1.5% of GDP to 4% of GDP. FWsca Deficit and Sustainability. 415. The deficit on the current account of the NFPS turns close to equilibrium in 1991, and from then on turns to a surplus, increasing to about 4% of GDP in 1996 (see Figure 4). Adding capital expenditures, which are programmed to be substantial, the overall surplus turns into a deficit before grants that averages 6.4W during the projection period. As grants average about 5.3% during the period, there is a 1% of GDP gap to be covered (see Table 2). E. LOW CASE MACROECONOMIC PROJECTIONS 416. The balance on current account of the Central Government reaches equilibrium in 1993 and a surplus of about 0.4% of GDP on average for the projection period. Adding capital expenditures, the overall surplus turns into a deficit before grants that averages 2.7% during the projected period. Projected grants average more than this, but they will contribute to finance the overall non-financial public sector deficit. 417. Risks exist that could delay or imrede the implementation of this policy reform program. First, due to the weak human capital base and weak - 108 - NICARAGUA: REAL AND PER CAPTrA GDP NICARAGUA. INFLATION OP GDP DEFI.ATOR (Mion and units or 190 Codob) (nmal Prn tate in -.S ~e) 16000 RelGDp 1400 16000 lwow -10000 191975 GDP Per~ apia 190 19S.. -.........c - .....90 -5190 15. ......-.......i Figure 1 Figure 2 NICARAGUA.: FOB EXPORTS AND IMPORTS NICARAGUA: NON-FINANCIAL PUBUC SECTOR øfl0 US Døilhn) ~duptBlOGP Figure 3 Figure 4 - 109 - TABLA 2 NICARAGUA CONSOLIDATED OPERATIONS OF THE NONFINANCIAL PUBLIC SECTOR (As Percent of GDP) 1991 1992 1993 1994 1995 1996 TOTAL REVENUE 26.5 27.6 26.6 25.9 25.7 25.4 CURRENT REVENUE 26.3 27.4 26.4 25.7 25.5 25.2 Tax Revenue of Gral Govt 23.8 23.7 23.5 23.3 23.2 23.1 Direct Taxes 3.8 3.7 3.6 3.6 3.6 3.6 Taxes on Goods & Services 11.5 11.5 11.4 11.4 11.4 11.4 Taxes on Foreign Trade 4.0 4.4 4.3 4.2 4.1 4.0 Other 4.6 4.2 4.2 4.2 4.2 4.2 Nontax Revenue of Gral Covt 1.3 0.8 0.8 0.8 0.7 0.7 Current Acet Surplus of PE 1.2 2.9 2.1 1.6 1.5 1.4 Current Revenues 9.1 9.9 9.1 8.5 8.3 8.0 Current Expenditures 7.9 7.0 7.0 6.9 6.8 6.7 CAPITAL REVENUE 0.2 0.2 0.2 0.2 0.2 0.2 TOTAL EXPENDITURE 33.7 35.7 34.3 32.4 31.1 30.1 CURRENT EXPENDITURE 28.7 25.0 23.8 23.0 22.0 21.2 General Government 25.5 24.2 23.2 22.5 21.7 20.9 Wages & Salaries 10.0 6.3 6.0 5.7 5.5 5.2 Goods & Services 14.0 11.9 11.4 10.9 10.4 9.9 Interest Payments 1.5 3.5 3.4 3.7 3.7 3.8 Net Current Transfers 3.2 2.5 2.3 2.2 2.1 2.0 CAPITAL EXPENDITURE 4.9 10.7 10.5 9.4 9.1 8.8 Fixed Capital Formation 4.8 9.9 9.9 8.9 8.7 8.5 Capital Transfers 0.1 0.8 0.6 0.5 0.4 0.3 CURRENT ACCOUNT DEFICIT (*) -2.4 2.4 2.6 2.7 3.4 4.0 OVERALL DEFICIT BEFORE GRANTS -7.1 -8.1 -7.6 -6.5 -5.4 -4.6 FOREIGN GRANTS 14.3 8.3 6.2 5.0 3.7 3.3 DEFICIT (-) AFTER GRANTS 7.2 0.3 -1.4 -1.4 -1.8 -1.3 FINANCING -7.2 -0.3 1.4 1.4 1.8 1.3 External Financing 0.5 9.7 -0.8 -3.2 -2.4 -2.3 Internal Financing -7.7 -9.9 2.2 4.6 4.1 3.6 - 110 - TABLE 3 NICARAGUA'S FINANCING REQUIREMENTS (Millions of US Dollars) 1991 1992 1993 1994 1995 1996 Gross Financing Requirements -1823 -1789 -155Z -2038 -1623 -1636 Resource Balance -459 -504 -499 -519 -535 .545 Interest Due per BOP -451 -438 -439 -470 -464 -595 Amortization Due per BOP -913 -832 -587 -1023 -602 -474 Buildup of Reserves 0 -15 -27 -27 -22 -22 Sources 1823 1789 1552 2038 1623 1636 Factor Receipcs 15 13 25 25 25 25 Official Grants 528 403 414 427 442 456 Net Direct Investment 0 10 11 11 12 12 Private Capital and Others 1 78 85 98 .22 126 Pipeline Disbursements 283 225 107 8 3 0 New Disbursements 56 122 170 222 221 232 Financing Cap 1/ 941 939 740 1247 798 785 Rescheduling of Current Paym. 0 895 658 1053 620 527 New Financing Gap 941 44 82 194 178 258 1/ Figure for 1991 corresponds to accumulated arrears. - 111 - institutions, the implementation capacity of the Government is very weak. Second, urgent action is required in the area of defining property rights, particularly in agriculture, which is the main potential source of growth. If these problems are not solved, medium-term growth would be jeopardized because private investment will be reduced. 418. Third, given the size of Nicaragua's debt burden anti the role of external financial assistance in buffering the social costs of stabilization, a slowdown of external financial support could place additional tensiona on the fiscal adjustment program. The resource balance deficit is programmed to average 22.8% of GDP for the period 1992-1996. 419. The low case scenario assumes that all of the above risks materialize because they are all mutually interdependent. It assumes that stabilization fails, and stop and go policies to stabilize the economy delay the implementation of structural adjustment policies. Foreign external assistance is assumed to fall to half of its current level. As a consequence, the fiscal deficit grows (from 7.1% to 14% of GDP between 1991 and 1996) and total investment falls (from 19.8% to 10.6% of GDP in the same years). 420. After a small growth in 1992, GDP continually decreases. Inflation accelerates to about 70% a year in 1992 and thereafter increases continuously (see Figure 2). The real exchange rate fluctuates widely, discouraging exports and contributing to further deteriorating the external accounts. The loss in international reserves is enormous, and as external financing will not be available to allow this continuous loss in reserves, the fixed exchange rate system would be unsustainable (see Table 1). F. CONCLUSION 421. Sustained growth and specifically public investment will crucially depend on the flow oZ foreign aid and the results of the negotiation of the external debt. If foreign assistance does not materialize in the amounts expected, public ana private consumption would need to be further adjusted. Consequently, the GON should be careful to take into account the risks of the present soft-budget conditions, due to the existence of ample foreign resources, and perform the necessary expenditure adjustments to attain financial viability in the medium term. 422. The creation of substantial NFPS savings should be the goal of fiscal policy. These should be used to !und capital expenditures and for debt amortization. The long-term goal of a sound fiscal policy should be to finance all public consumption and a substantial portion of public investment with domestic revenues. The current total dependance of public investment on donors implies a subtle but real loss of control over the country's long-term development. MINISTERIO DE FINANZAS ORGANIGRAM1A 1992 DIRECCION SUPERIOR AUIA'TOR[i________ ¿.rgRIA INTERNTECNACA ASESOCRIA LEGAL ii SECRETARIA GENERAL DIR. GPAL CE DIR. ORAL DE [.P. ORAL CDE iR.RALDE DIR. ORALDE DIR.CGRAL DE [1GF:.GRAL DE (ir ¡CiNA.opc. IGRESC'S At&.ANAS PRESUPUESTO TES RC CONTT.C&iE:ERN PREEDURA INFCFR1AT tC A TEPITÚRIAL LRSO PUUBLA COTCC1O. POEDIII 1 N A P -113- Annex B GENERAL DIRECTORATE OF THE BUDGET ORGANIZATZONAL CHART Superior Director (Minister &Vice Minister) internal1 Auditor- retary General Gen Dir Gea Dir Gen Dir Gen Dir* Gen Dir Gen Dir Gen Dir Revenues Customs Budget TreasOry Governmt Procure- Informa- Account. ment tion (GDR) (GDC) (GDI) (GDT) (GDA) (GDP) (GDI) Admin Office Dir,Budget Dir,Budget Dir,Techni- Dir,Prog Dir,Autono- Execution Politics cal Budget* & Eval mous Entities (DE) (DP) (DT) (?E) (DAE) Current Expendi- Economic tures Office Office Capital Expendi- Social tures office Office Wages & Salaries . Service. Office Office Enterprises n- (Firms)Office *Please note that the GDA and Directorate of Tech. Budget of GDB are being abolished. -114- Annex C Examle of Positions Table for Each Inatz "ution Ministry of Finance List of Positions as of 31 October 199: Program Title : Grade:Number of: Position :Positions: Code Number -------- ----------------- ----- ----- - - -------- 01 Headquarters: :Secretary General: 1 : 1 : 00001 --- ----------------- --------- ----------------.. . . . :Deputy Sec Gen : 1 : 1 00002 :Administrator : 2 : 1 : 00003 :Financial Dir : 3 : 1 : 00004 ------------ :-----------------:------:---------:---------------- :Director 5 : 2 : 00005-6 -------------------- ----------------------- :Chief : 7 : 3 : 00007-9 --- . *------------ -------- :Clerk : 9 : 5 : 00010-14 --------.---------- ----- ------------------- :Messenger : 10 : 3 : 00015-17 -------- ------------------------ ---------.---------- 01 Total : : 17 02 Budget Directorate :Director General : 2 : 1 : 000018 ------------------ - ---- ------------------ :Deputy Dir Gen : 3 : 1 000019 - r 0-------0---2-----2-------- :Director :3 : 5 : 000020-24 -------- ----------------.-- ----- ------------ :Asst Director : 4 5 : 000025-29 ------------------ - ---- ------------------ :Chief : S : 10 : 000030-39 ------------------ - ---- ------------------ :Budget Analyst 6 : 5 : 000040-44 -------------------- ---------------------- 02 Total : : : 27 manam== man= ===== =mm=== === ======== mmm=m==am other programs... TOmA 135== =m==w==m===wmans===m==n==m=mmem== TOTAL 135 - 115 - Annex D Examole of Table of Positions Summary Ministry of Finance Gummary of Positions as of 31 October 1991 Grade : Program : Program Program Program Program Total 1 2 3 4 5 1 . 2 0 2 1 1 3 1 6 4 0 5 5 2 10 6 0 5 7 3 5 8 0 9 5 0 10 3 0 TOTAL: 17 37 : 135 - 116 - Annex E Authority to Make Virements The President reserves the authority to make the following modifications to the Budget during the course of the Budget rear: - Increases or decreases to the Budget motivated by war, national disasters, or donations that will finance specific projects - Transfers of budgetary credits between institutions and when using the Unforeseen Expenditures category - Adjustments to the budget in the form of economic measures that are decreed during the course of the year which result in a reduction of the national deficit - Adjustments to budgetary allocations to institutions generated by price fluctuations (Source: Budget Norms, Article 11) 'the Ministry_of Finance may approve the following types of virements: - Transfer credits to the Unforeseen Expenditures category by eliminating programs, projects, subsidies, debts and other expenditures that are discontinued * Transfer credits between programs and projects of the same organization - Transfers between these groups of expenses: Items in Group 01, Personnel Emoluments; Subgroups 021 Basic Services; 025 Rents; 073 Scholarships; 0362 Fuel and Lubricants; 0721 Social Security - Virements involving external aid and loans by substituting such monies for previously budgeted national funds. (Source: Budget Norms, Article 12) The Lgaislative. Judicial. and Electoral Powers are authorized to make virements within their own budgets under the following conditions: * transfers of allocations from one item to another and from some groups of expenditures to others in the following groups: non-personnel emolwents, materials and supplies, equipment, works and construction, and transfers (Source: Annual Budget Law for 1991, Article 4) Other Soendina Acencies are authorized per Article 13 of the Budget Norms to effect modifications to their budgets by the transfer of credits between items that are not in a) and b) above without the approval of MIFIN or the President. In other words, institutions may not change their allocations in the following items: Personnel emoluments Rents Social Security payments Fuels Scholarships Equipment Investments (Capital Expenditures) Travel abroad In addition, the Ministry of Health may make no virements in the categories of Medicine and Food. The Ministry of Education may make no virements in the category of Books. -117 - Annex F Details of Drgft Forward Recurrent Budget VOTE R25 MINISTRY OF EDUCATION : Estimates :Item: Title and Details : 1991 1992 : 1993 : 1994 :approved:Forward:Forward:Forward: -------------------------.------- --- ----- 001 Gen. Administration: :0111: Personnel Emoluments : : :0133: Compensations : : :0213: Water : :0611: Feasibility Studies : :.--- .........-- :--------. ---- ------ Program 001 Total : - 118- Annex G STEPS FOR IMPLEMENTATION OF MEDIUM TERM FINANCIAL PLANNING The Need for a Medium Term Financial Plan 1. The annual Budget is the main tool to translate the policies and strategies of the Government into actions. However, currently the Budget is still partially determined by past expenditure patterns, and its investment component is determined by sectoral and donors initiatives not necessarily consistent with the GON priorities. To be able to actively pursue its goals and rationalize the budget, and to capture the recurrent cost implications of investment, the GON needs to spell out its global and sectoral strategies and to plan the yearly budget in a medium term time frame. The tool to perform this task is Medium Term Financial Planning (MTFP). Main Comonents of the MTFP. 2. MTFP is a rolling three year statement of revenues, expenditures and financing requirements based on assumptions concerning economic conditions and GON policies. ITFP is the basis to elaborate a yearly Budget which translates GON policies into actions and is consistent with macroeconomic targets for inflation, the exchange rate and overall growth. The MTFP should be prepared early enough each year to elaborate specific budget guidelines to provide the basis for the ministries to prepare constrained budget submissions which should reflect the adopted GON policies and sectoral strategies. The main inputs to construct a MTFP are: (a) the projection of GON revenues including grants, (b) the size and sectoral and functional allocation of GON expenditures prioritized in accordance with GON policies and sectoral strategies. A very important component of Expenditures is the Public Investment Program (PIP) which should be prioritized also in accordance with GON policies and strategies. (c) the resulting financial requirements from the balance of revenues and expenditures have to be assessed for its short and medium term macroeconomic effects, in particular for its effects on monetary policy and the medium term growth. The main tool to perform this assessment is typically a model of medium term macro projections, which incorporates the public and the private sectors and their financing. Institutional Arrangements to Implement the XTFP 3. The office to perform this task should be a very small one and, should be placed in the MIFIN to translate the plan into specific budget actions (programs). To perform this task the office should be closely coordinated uith HEDE and the BCN. MEDE should provide on a timely basis each year an - 119- Annex G updated rolling three year PIP and updated sectoral strategies within the framework of the overall development plan, which are the basis to prioritize current expenditure. Tie BCN should contribute with the assessment of the macroeconomic consiste:.ncy of the MTFP and MEDE should assess its contribution to the targets of medium term growth. 4. A methodology to perform the preliminary exercise on medium term financial planning for 1992-1994 is presented below. This is intended to have its practical application in the elaboration of the 1993 budget. The BCN and MEDE already posses a medium term model of macro consistency which should be used to calibrate the MTFP's main aggregates. Methodology for the Elaboration of a Simplified MTFP for Nicaragua 5. The task is to have the best estimate of GON revenues and expenditures based on their structural determinants and on policy changes. To best perform the estimates it is appropriate to break down the revenues by type of tax and the expenditures by economic classification. Description of the relations of the Model (a) Revenues (i) Income Tax: growth proportional to nominal GDP (unit elasticity with respect to GDP). Adjustments can be made for increases in the tax base because the private sector is growing and by improvements in tax administration. (b) Consumption Taxes (i) General Value Tax: is also assumed to be proportional to GDP. (ii) Selective Consumption Taxes: a. Petroleum products, alcoholic beverages and the rest of the fiscal industries are estimated on a projected demand for these goods, and the average tax rate on each. Projections of the relevant international prices are also taken into account when setting the prices of these products; b. Other taxes: assumed proportional to nominal GDP. (c) Taxes on Imports: based on the projections of FOB imports which in turn are assumed to be linked to GDP growth. Once projected imports are calculated they are multiplied by the implicit import tax (defined as the amount of import taxes collected divided by total imports), adjustment should be made by tariff reductions which are already programmed to occur until December 1993. A World Bank program, SINTIA is specifically designed to estimate the -120 - Annex G fiscal effects of tariff changes, and staff of MIFIN and MEDE has already been trained in its use. (d) Non-tax Revenue: policy determined. (e) Grants: exogenous. Expenditures (a) The wage bill: depends on GON wages and employment. Employment: it is exogenous, policy determined. Wages: are a function of promotion policies, general wage adjustments and specific policies (like the inclusion of AFA in wages). (b) Goods and Services (i) Non-personnel services: the following categories should be projected separately based on detailed study by ministry: water, telephone, road maintenance, per diem; (ii) Supplies: Food requires a detailed estimation in MINSA. Gasoline, maintenance, parts are function of the number of vehicles. To better estimate goods and services it is advisable to break them by ministry. (c) Transfers: The proposed model assumes they are policy determined. (d) Block Assianments are not considered in the model as the two most important assignments (Defense and Police) have been itemized in the 1992 budget (although Defense is itemized with much less disaggregation). (e) Continaenciez. exogenous. (f) Capital Expenditure: information is provided by the results of the elaboration of the Public Investment Program. This information should include the recurrent cost implications of the PIP to be included in the current expenditure component of the MTFP. The rest of the General Government and Public Utilities are estimated in a similar way as for the Central Government. The details of the procedure are spelled out in the proposed model below. 6. Financial Reauirements: total expenditure minus total revenues determine the financial gap which should be checked for macro consistency and adjust expenditures until that consistency is achieved. -121- Annex C 7. The output tables and the equations of the first version of the MTFP model developed in Javelin are included in the Statistical Annex. In this exercise, the Central Government was treated as a whole, but the same structure can be applied to each Ministry and then consolidate the results. These results should then be used to produce the distribution by Ministries. This exercise would be the key instrument to plan the medium-term reallocation of resources towards those sectors that are considered priorities. Political negotiations on sector shares should be done, in advance, in the context of this exercise.