UICIASSTID,

UNITED STITES UNENWIONAL DEVELOPMT COOPERATION AGENCY AGENCY FOR INTERNATIONAL DEVELOP MENT Wahington. D. C. 20523

NICARAGUA

PROJECT PAPER

ECONOMIC SUPPORT FUND (ESF)

AID/LAC/P-867 PROJECT NUMBER: 524-0333

UNCLASSIFI7D CLASSIFICATION: 1. PAAD Number 524-0333 AGENCY FOR INTERNATIONAL DEVELOPMENT 2. Courtry Nicaragua PROGRAM ASSISTANCE 3. Category APPROVAL DOCUMENT Cash Transfer (PAAD) 4. Date

5, To 6. OYB Change Number Mark Schneider, AA/LAC 8. OYB Increase

7. From Eric Zallman, LAC/DR To be taken from: Economic Support Fund (ESF)

9. Approval Requested for Commitment of 10. Appropriation Budget Plan Code S 40,000,000.00 "1. Type Funding 12. Local Currency Arrangement 13. Estimated Delivery Period 14. Transaction Eligibility Date 0 -Loan 0 Grant I E Informal E Formal El None FY94 "5. Commodities Financed

16. Permitted Source 17. Estimated Source U.S. only U.S. Limited F.W. Industrialized Countries Free World Local Cash Other

18, Smnmary Description

Economic Recovery and Development I (ERD-I) continues USG support to Nicaragua's policy reforms. The $40 million cash transfer's disbursement will be conditioned on the Government of Nicaragua's (GON's) implementation of specific reforms in the areas of: (1) resolving property disputes, (2) improving financial management of public funds, (3) dealing with fiscal and balance-of-payments deficits, and (4) expanding private participation in the financial sector. qn addition, the GON will covenant to maintain compliance with all reform conditions of earlier ESR agreements. A.I.D. will deposit the $40 million cash transfer in the Federal Reserve Bank of New York for use in financing Nicaragua's debt-service payments to multilateral organizations (approximately $13 million), and to finance or reimburse eligible private im­ ports from the United States and Central America (approximately $27 million) handled by Nicaragua's private commercial banks. Import financing and reimbursement will generate local currency, which will be deposited in the Central Bank of Nicaragua (BCN) and used: (1) to finance up to the equivalent of $5 million of the local costs of certain project activities, preferably through a new Program Trust Fund; (2) to increase by up to the equivalent of $0.5 million the GON's contribution to USAID's existing Program Trust Fund for administration, control, and audit of U.S. assistance; (3) to pay existing GON debts to the BCN; and (4) to offset accumldated foreign-exchange losses of the BCN. 19. Clearances i/ate 20. Action LAC/DR:SA1exander&JW 1, '\/j I/ LA/DPP:JStepanek _ . C / APPROVED C DISAPPROVED LAC/CE: Eckerson&KEls/If/ 4, /g ARA/ U: .Harrington ..* -gnq' Authorized? Date ARA/EN:U .chonander '_X i )oL.ca) GC/LAU:J.Melghan Title rk Schneider FA/ : Greene 8 T 1/ Assistant Administrator, LAC Bureau DAA/LAC:NLarker .LASSIFICATION.J ?I~W ~ 1 0:" APPR: MS ()

DRAFT: SA

CLEAR: NP

UNCLASSIFIED CLEAR: EZ CLEAR: JW ( ) AID/LAC/DR/CEN&CAR:SALEXANDER:CABLE2.ERD CLEAR: DE ( ) 12/16/93 647-9171 AID/AA/LAC:MSCHNEIDER CLEAR: KE ( )

DAA/LAC :NPARKER LAC/DR: EZALLMAN (DRAFT) LAC/DR:JWALL (DRAFT) LAC/CEN:DECKERSON (DRAFT) LAC/CEN:KELLIS (DRAFT) GC/LAC:RMEIGHAN (DRAFT) LAC/DPP:JSTEPANEK (DRAFT) FA/B:BGREENE (DRAFT)

IMMEDIATE MANAGUA

AIDAC

E.O. 12356: N/A

TAGS:

SUBJECT: AUTHORIZATION OF ERD-I (524-0333)

REF: STATE 352407 DATED 11/20/93

1. AA/LAC AUTHORIZED ERD-I PROGRAM '524-0333) AT A FUNDING LEVEL OF DOLS. 40 MILLION ON JANUARY 11, 1994, TO BE OBLIGATED AND DISBURSED IN ONE TRANCHE. THE CONGRESSIONAL NOTIFICATION EXPIRED ON DECEMBER 14, 1993.

2. MISSION MAY PROCEED TO OBLIGATE AND DISBURSE FUNDS UPON RECEIPT OF SEPTEL NOTIFICATION THAT AN ADVICE OF BUDGET ALLOWANCE HAS BEEN ISSUED. YY

UNCLASSIFIED UNCLASSIFIED 2

CLEARANCE PAGE FOR NICARAGUA AUTHORIZATION CABLE ERD-I (524-0333)

GC/LAC:RMEIGHAN DATE 1%L LAC/DPP:JSTEPANEK DATE j'@' FA/B:BGREENE - - DATE21 / ARA/ECP: JHARRINGTON DATE ARA/CEN: CSCHONANDERC , DATE IL

UNCLASSIFIED Table of Contents

I. Introduction and Executive Summary ...... 1

I1. Relationship to USAID's Strategy ...... 3

Ill. The Impact of BOP Assistance ...... 3

A. Macroeconomic Impact ...... 3 B. Social Im pact ...... 6

IV. Macroeconomic Developments in 1992-93 ...... 7

A. National Output and Spending ...... 7 B. Foreign Trade and the Balance of Payments ...... 10 C. Money, Finance, Inflation, and Exchange Rates ...... 12 D. Public-Sector Finances ...... 13

V. Economic Policy Reforms in 1992-93 ...... 14

A. The Productive Framework ...... 14 B. International Trade Policies ...... 16 C. Monetary and Financial Policies ...... 17 D . Fiscal Policies ...... 21

VI. The GON's Medium-Term Development Policy ...... 22

VII. ERD-l's Policy Reform Program ...... 23

A. Resolution of Property Claims ...... 24 B. Accountability in the Public Sector ...... 25 C. Macroeconomic Stabilization ...... 26 D. Financial-Sector Reform ...... 26

VIII. Dollar Uses ...... 29

A. Proposed Disbursement Plan ...... 29 B. Separate Account Criteria and Operating Procedures ...... 30

IX. Uses of Local-Currency Generations ...... 32

A. Program m ing ...... 32 B. Accountability ...... 33

Lj Appendixes

ERD-I's Policy Conditions ...... 36 Concept Paper Approval Cable ...... 38 PAAD Approval Cable ...... 40 Environmental Threshold Decision ...... 42

Statistical Appendixes National Product by Sector ...... 44 National Expenditure ...... 45 Balance of Payments ...... 46 Exports (FOB) by Major Category ...... 47 Imports (CIF) by Major Category ...... 48 Monetary Accounts of the Financial System ...... 49 Consumer Prices and Wage Rates ...... 50 Fiscal Balance: Non-Financial Public Sector ...... 51 Fiscal Balance: Total Public Sector ...... 52

Statutory Checklist ...... 53 December 1993 ERD-I PAAD 1

I. Introduction and Executive Summary

In July 1993, AID/Washington approved the Mission's Concept Paper proposing the Economic Recovery and Development Program I (ERD-I), a cash transfer of FY93 ESF, for balance-of-payments (BOP) assistance subject to conditionality relating to democratic governance, macroeconomic adjustment, financial sector reform, and natural resource management. (See the Concept Paper approval cable, page 38.) Through this PAAD, USAID/Nicaragua requests AID/Wash­ ington's authorization of the Mission's final design of this assistance at the $40 million level, which is consistent with the FY1993 ESF allocation.

ERD-I is an integral part of the Mission's multi-year assistance strategy reaf­ firmed by AID/Washington in February 1993. It contributes directly to meeting the Mission's Strategic Objectives of increased investment and increased com­ petitiveness, diversification, and participation in the economy. In addition, it contributes to the Strategic Objective of building a greater consensus on demo­ cratic values.

BOP assistance continues to be vital in Nicaragua's current circumstances. Nicaragua's import bill in Unfinanced 1992 was more than triple the size of export reve- BOP Gap nues. (See the table "Balance of Pa,ments," below Year $ ins on page 46.) While the trade imbalance was com­ pletely financed in 1992, a combination of factors, 1993 151 including reduced donor assistance and higher debt 1994 189 service payments, has resulted in a financing gap that for 1993 was estimated at $151 million as late 1995 181 as August and that is projected to continue for 1996 205 several years. U.S. BOP assistance would go a long way toward cushioning the inevitable contraction in Projections by the imports in the coming months. World Bank as of August 1993, as- The IMF projects that large BOP deficits will continue suming no U.S. to require financing through the end of the decade. BOP assistance. Too-rapid reduction in BOP assistance in this situa­ tion could jeopardize the economic and political stability that is vital to bringing private investment back to Nicaragua and to solidifying democratic institutions. Nicaragua also needs BOP assistance to attenuate the substantial human hardship that its population is already experi­ encing because of economic disruption in the 1980s. In a separate study, the Mission will evaluate the net benefits at the grass-roots level of BOP assistance in more detail.

AID should continue to support policy reforms with substantial aid resources to ensure that the GON can follow through on its commitment to maintain and 2 ERD-I PAAD December 1993

deepen economic and legal reforms. Since 1991 the GON has substantial achievements to its credit in reducing the fiscal deficit and inflation, liberalizing and privatizing the financial sector, and liberalizing foreign trade and the ex­ change-rate regime. Since mid-1 992, the GON has also revitalized its effort to reestablish property rights and security of property in Nicaragua. The policy lev­ erage of U.S. assistance has been instrumental in achieving these changes.

The reform program must continue and deepen if it is ultimately to be effective in bringing about sustainable economic growth, secure property rights, and a consolidation of democracy. In rnacroeconomic reforms, the GON needs to take concrete additional steps to further reduce the fiscal deficit, to rationalize tax ad­ ministration, to adjust the exchange rate, and to further open banking and insur­ ance to private entry and expansion. Carrying this reform effort through to frui­ tion will be a multi-year effort.

However, many reforms achieved in recent years are coming under political pressure. This is due in part to the frustration produced by continual belt-tight­ ening and the persistence of political demands for subsidies and for renewed governmental control of the economy. The United States has been a significant contributor of BOP assistance, and a change in course forced on the GON would harm U.S. interests in democracy strengthening and economic development in Nicaragua. The policy conditionality of ERD-I will demonstrate U.S. interest in the continuation of the GON's reform program. For a summary of ERD-I's policy conditionality, see page 36.

ERD-l's dollars will be disbursed to a Separate Account owned by the Central Bank of Nicaragua (BCN) in the Federal Reserve Bank of New York (the Fed) for use in paying GON debt owed to official multilateral organizations and in finan­ cing private import transactions handled by Nicaragua's private commercial banks. USAID/Nicaragua will monitor all uses of dollar funds.

The GON will deposit the local-currency equivalent of the dollars used for imports in an interest-bearing Separate Account in the BCN. This local currency will be used to finance the equivalent of $5,000,000 of the local costs of selected proj­ ect activities, preferably through a new Program Trust Fund; to increase by the equivalent of $500,000 its contribution to the Program Trust Fund established under the previous BOP grant, ESR-IV-A (524-0325A), for administration, con­ trol, and audit of U.S. assistance; to retire outstanding GON obligations to the BCN; and to reduce the BCN's outstanding stock of foreign-exchange losses.

1 Following the Concept Paper review, the Mission has decided to address natu­ ral-resource policy reform in FY1994, either through an ESF program or under the Natural Resource Management project (524-0314). USAID based this decision on the uncertainty over the availability of funding in FYI 993. December 1993 ERD-I PAAD 3

II. Relationship to USAID's Strategy

Both the Program Strategy Review Paper, submitted to AID/Washington in February 1993, and the FY1 994-95 Action Plan emphasize the continuation of policy-based, BOP assistance. ERD-I will contribute to achieving the Mission's Strategic Objective of promoting a greater consensus on democratic values in two ways. First, its conditionality relating to resolution of private property claims and election of a GON Controller General will directly improve governance. Second, BOP assistance will increase the availability of imported consumption goods and production inputs, thus helping to maintain employment levels and increasing social stability.

ERD-l's macroeconomic elements as well as property conditions support the Mis­ sion's Strategic Objectives of (1) increasing foreign and domestic investment (through improving the investment policy framework, stabilizing the economic environment, and revitalizing the banking and financial markets) and (2) increas­ ing competitiveness, diversification, and participation in the economy (through removing barriers to competition and reducing state participation in the economy).

I1. The Impact of BOP Assistance

The following section reviews important benefits generated by USAID's cash transfers in Nicaragua to address concerns about the social impact of this assis­ tance. First, macroeconomic impacts are described, followed by an explanation of the social impact of these changes.

A. Macroeconomic Impact

1. Price Stability

The GON has made a commitment to a sound monetary policy under which international reserves would back any monetary emission. Under this policy, the GON has used the reserves provided by USAID's cash transfer to support growth in the monetary base without inflation. Without this type of assistance, Nica­ ragua would not have the resources it needs to back its money supply at the levels consistent with its economic growth targets.

2. Private Credit

USAID's cash transfers have also leveraged policies that allowed credit to Nicara­ gua's private sector to increase. Expansion of the private banking system and private deposit and lending activity will give a broader group of people access to 4 ERD-I PAAD December 1993

financing for business development and investment. Development of a private financial system implies that decisions will be based on a generalized set of busi­ ness rules, not on political clout. Benefits to the public will be more widely dis­ tributed under such a system, as investment decisions are more likely to be based on economic criteria.

The financial-sector reforms that the cash transfer program supports reinforce this impact. Without the policy reforms, the public would not have viable private banks to provide financial services needed in a growing economy, and would not have the prudential norms, regulations, and supervision that the Superintendency of Banks is putting into place.

3. Imported Inputs

USAID's cash transfers have directly financed, and indirectly made possible, a significant increase in imported inputs that are essential for production and em­ ployment. Imported inputs used in Nicaraguan industry and construction were substantially greater in each of the years from 1991 to 1993 than they were in 1989 (the last full year of the previous administration). Petroleum imports, which play an important productive role in the industrial and transport sectors as well as in the generation of electric power, also rose noticeably during the 1991 to 1993 period compared to 1989. A substantial portion of these in­ creases can be attributed to the BOP support provided by USAID from 1991 to 1993.

Raw material & Intermediate Imports (% Increase from 1989 Levels)

Industry Construction Agriculture Petroleum

1991 19% 25% -31% 21% 1992 39% 47% -76% 29% 1993 28% 50% -71% 11% Average 1991-93 29% 41% -59% 20%

Note: 1993 data are based on a Central Bank projection from September 1993.

The reduction in imports of Inputs by the agricultural sector was primarily due to the collapse of cotton, which had been a heavy user of pesticides and other chemicais. December 1993 ERD-/ PAAD 5

4. Imported Capital Goods and Increased Investment

USAID's cash transfers support investment in Nicaragua by permitting greater levels of capital goods imports than otherwise would be feasible. Capital goods imports for industry were 7% higher than the 1989 levels, on average, during the period from 1991 to 1993, while capital goods imports for agriculture were 23% higher, on average, during the same period. Increases in capital goods indicate that investment is taking place, even if GDP data do not yet show the impact. Capital Goods Imports (% Increase from 1989 Levels)

Industry Agriculture

1991 -2% 15% 1992 21% 21% 1993 4% 3% Average 1991-93 7% 23%

Note: 1993 data are based on a Central Bank projection from September 1993.

5. Impact on Donor Assistance

The IMF, World Bank, and IDB returned to Nicaragua (in 1991) after the GON's arrears in payments on their previous loans were cleared. U.S. cash transfers contributed a crucial $75 million to GON repayments, without which the arrears clearing would not have been manageable. Since then, the World Bank and IDB have provided structural-adjustment loans for $110 million as well as several pro­ ject loans, and are continuing to develop their portfolios. The IMF has cooperat­ ed with the GON in an 18-month Stand-By Agreement and is now negotiating a three-year Enhanced Structural Adjustment Facility (ESAF).

Cash transfers were crucial to the GON's success in meeting the macroeconomic targets under the Stand-By Agreement. Furthermore, donors would probably have reduced aid if the stabilization targets and other economic policy-reform commitments had not been met.

6. Financial Sector

One of the most important effects of USAID's BOP assistance has been the transformation of the financial sector from a structure oriented to the needs of a planned socialist economy to that of a simple modern capitalist system. To accomplish this, USAID/Nicaragua has utilized its policy leverage to, among other

/C 6 ERD-I PAAD December 1993 things, create a new Superintendency of Banks, license private banks, force state-owned banks to compete on an even playing field with the private banks, and eliminate those activities previously undertaken by the BCN that are more appropriately the domain of commercial banks or a development bank. (See "The Efficiency of Credit Allocation" on page 18.)

7. Other Areas

USAID's BOP support has also provided policy leverage in several other critical reform areas. These include exchange rate liberalization (foreign currency tran­ sactions in Nicaragua now take place at or near market rates of exchange), trade liberalization (Nicaragua has largely abandoned the protectionist policies of the previous administration and is now an active participant in the generalized movement toward free trade that is occurring throughout Central America), and increased fiscal responsibility (the GON has sharply reduced the fiscal deficit since 1990 and it is gradually reducing the size of the public sector to a level that is consistent with the size of the economy).

B. Social Impact

1. Increased Imports and Consumption

Increases in consumption are an indication of increases in income and improve­ ment of the population's well-being. Higher consumer imports were a major source of increased consumption in Nicaragua in 1991 and 1992. While both donors and the GON intend foreign financing of such imports to be a temporary measure, such financing does allow consumption and well-being to rise in the short term, facilitating the investment that will increase output in the future.

Consumer imports, which represented 34% of total imports in 1992, include non-durable goods such as food and beverage products, pharmaceuticals, and clothing, as well as durables such as household appliances, furniture, and vehi­ cles. Cash transfers, which financed 16% of consumer imports in 1992, have increased the levels and variety of consumption of the population.

2. Employment

Cash transfers can affect employment in two ways. First, successful economic stabilization improves the business climate, leading to more job creation (particu­ larly in the longer term). Second, cash transfers finance imports of inputs, without which many firms would have to reduce employment. December 1993 ERD-I PAAD 7

3. Stabilization

Stabilization has important effects on people's daily lives. Lowering inflation is one example. Many observers regard inflation as an unfair tax, since the weal­ thy can afford to protect their assets by hedging or investing in other currencies, while the poor lose purchasing power daily.

Also, inflation increases retail pricing margins is merchants anticipate future price increases and compensate for past ones. Stabilization reduces inflationary expectatioc,- and pricing margins, and thus increases the purchasing power and consumption level of the public.

4. Public-Sector Spending

In Nicaragua, the social-sector Ministries are highly funded compared with the level and quality of services delivered. Given the realities of resource availabili­ ties, it is critical that the GON restructure expenditure policy to increase the effectiveness with which it targets and delivers services.

Health and Education are the two largest civilian ministries in the GON. Both Ministries received an increasing share of the central government budget in 1991 and 1992. For example, in response to a campaign of strikes and disorder by the Sandinista Front, the Ministry of Education's 1992 budget included a large increase for universities, thus restricting the availability of funds needed for broad-based education programs at the grass-roots level. Thus, despite claims that policy reform sacrifices the interests of the poor, policy reform is needed in Nicaragua to make sure that public spending priorities do not neglect the poor.

IV. Macroeconomic Developments in 1992-93

This section presents the overall macroeconomic results for 1992 and indications for 1993. Section V, below, discusses the GON's policy changes that contribut­ ed to these results.

A. National Output and Spending

1. Output

Aggregate economic statistics are always imprecise in countries that can afford only limited statistic gathering. However, Nicaragua's official data on GDP (national output) appear to require more than the usual caution. According tr, two independent labor-market studies commissioned by USAID and the World Bank, official data underestimate GDP by at least 10% and perhaps by as much as 100% relative to the GDP level implied by wage rates observed in the 8 ERD-I PAAD December 1993

economy. Furthermore, the GON's methods for estimating GDP rely on a narrow base of data from which the GON makes rough extrapolations to cover sectors for which it has no direct data.

Nonetheless, official data appear to confirm that the decline in GDP did essen­ tially stop after 1990, as output was down by only 0.2% in 1991 and increased by 0.4% in 1992. This occurred despite the collapse of the cotton sector, which lost its cost competitiveness in the world market. Also, with the full amount of foreign aid originally expected in 1992, output might have been two or more percentage points higher (based on calculations in USAID's 1992 PAAD for ESR- IV).

First-quarter industrial production figures and anecdotal information about retail sales in the first months of 1993 suggest that the tighter foreign-exchange sup­ ply may have contributed to a new recession. The Central Bank has continuous­ ly adjusted downward its projections for GDP in 1993, currently projecting a de­ crease of 0.7%.

Sectoral analysis of national income is highly sensitive to the data problems men­ tioned above. However, based on GON data the trends in 1992 for sectoral shares of value-added to output (equal to the shares in total resources used) are as follows. (See the table, "National Product by Sector," page 44.)

" Commerce (the value-added by retailers and wholesalers) continued to out­ perform other sectors, perhaps due to the large volume of imported commod­ ities financed by external assistance. However, its share in the economy is still much lower than it was in the 1970s.

* Manufacturing underperformed the rest of the economy, perhaps held back by its links with the troubled cotton sector, by the availability of imported consumer goods, bV the lack of confidence among investors, and by disrup­ tions related to the privatization process.

" Agriculture as a whole, including the relatively healthy cattle and fishing sub­ sectors, grew at an intermediate pace.

" The share of national resources used in the Government remained about the same as in 1991, which is lower than its peak in the late 1980s but still much higher than in the 1970s.

2. Spending

In analyzing the uses of national output, the first point to notice is that Nicara­ gua's domestic expenditures exceeded domestic production by 35% in 1992, December 1993 ERD-I PAAD 9 compared to 29% in 1991. This was due to larger net inflows of foreign aid and remittances from Nicaraguans overseas.

Despite this increase in use of goods and services in 1992, uses of goods and serv'-es by government and investment both fell in absolute terms. The trends in shares in 1992 were as follows. (See the table, "National Expenditure," page 45.)

" Consumption spending continued to boom in 1992. After rising from 67% of GDP in 1990 to 89% in 1991, it reached 98% in 1992.

* The Investment rate was lower than in the 1970s and was at a level that, while it should lead to 5-6% growth in output, was still lower than in rapidly growing low- or middle-income economies. These are discouraging findings for an economy that should be in a reconstruction phase, with a high rate of investment. (However, the likely imprecision in both GDP and investment data makes these calculations slippery.) " While falling in 1992, Government spending as a share of total spending is still much higher than in the 1970s.

3. Employment

Labor-market conditions are difficult to gauge, not only because of the shortcom­ ings of the data available but also for conceptual reasons. Self-employment is very common in low-income countries. Therefore, the fact that a person is not working for an employer is not a dependable indicator of unemployment. Also, the practice of giving low-income people what appear to be unproductive posi­ tions in the organized sectors implies that being on a payroll should not be auto­ matically accepted as "employment."

In one sense, the best indicator of "employment" is the output and income that labor generates, rather than the institutional form in which the labor-time is orga­ nized. Most workers in Nicaragua are only marginally productive compared to workers in technically advanced economies, and could therefore be considered "underemployed" in terms of productivity.

In the distributional sense, however, the institutional form of employment may be a critical determinant of the individual's entitlement to a share in the social division of income. In this sense also, it is probable that the unemployment and underemployment rates are high and perhaps even rising in 1992 and early 1993, as Nicaragua is suffering in a distributional sense from large dislocations in employment.

'9 10 ERD-I PAAD December 1993

Large numbers of former soldiers have left the military since 1990. Furthermore, under the Occupational Conversion Program the civilian employment rolls of the central government fell by over 27,000 in 1990-92, equal to over 20% of initial government workforce of 120,000, and 2% of Nicaragua's estimated total labor force of 1,400,000. However, these dislocated employees have at least had ac­ cess to support under public programs. This has not generally been the case for those affected by the contraction in labor-demand in the cotton and coffee sectors, which has been significant on the national scale, and devastating in some regions specialized in cotton (such as the western region, Le6n and Chinandega).

B. Foreign Trade and the Balance of Payments

The BCN projected in September that export revenues would rise by 9% in 1993, reversing a long trend of falling exports. (For historical data, see the table, "Balance of Payments," page 46. For World Bank projections, see the table that follows.)

Export performance in 1992 was held back notably by low prices in world mar­ kets for cotton, which was formerly one of Nicaragua's main exports. Cotton and banana export revenues each fell about $20 million in 1992, making up about 80% of ihe lost revenue in that year. Lower world prices in 1992 explain much of the decline in export revenues from these and other agricultural commodities.

Growth in exports in 1993 is based on higher expected coffee prices and in­ creased non-traditional exports. Exports to the United States, especially exports of beef, which resumed in September 1992, seem likely to rise substantially. These factors outweigh the additional drop of over $20 million in export reve­ nues from cotton expected in 1993, as low world prices in 1992 virtually elimi­ nated cotton planting in Nicaragua.

The increase in exports in 1993 reverses only a small part of the long decline of the 1980s, however. In 1977 Nicaragua's export revenues were about $1.0 bil­ lion in terms of 1992 purchasing power. By 1990, misgovernment, mismanage­ ment, war, and embargo had cut exports to $352 million. The 1991 and 1992 figures were $275 million and $224 million. These figures exhibit a compound rate of decline of 9.5% a year for fifteen years - 18.8% in 1992 alone. (Every $18 million decline equals 1% of official GDP in 1992.)

As a result, import levels are still much less than the $1.1 billion figure of 1977, despite a 40% increase in population in the intervening fifteen years. Thanks to a heavy inflow of foreign aid, however, imports (fob) rose in 1992 from $680 million to $757 million in 1992. Increases in non-durable consumer goods made up the bulk of the increase in 1992 imports, although a 25% increase in capital December 1993 ERD-I PAAD 11 goods for industry is also notable. This latter increase, more than 1 % of official GDP, is not necessarily inconsistent with the falling investment-to-GDP ratio re­ ported above, but it is another reminder of the possible inaccuracy of some data.

Obviously, the huge gap between imports and exports results from net inflows of foreign aid, although private inward transfers between relatives plays some role also. However, several disbursements of donor resources that were scheduled for the final third of 1993 appear to be in doubt.

AID/Washington staff who in June 1993 reviewed USAID's Concept Paper for ERD-I expressed concern about the possible effects of reduced assistance on

Balance of Payments Projections (Millions of Dollars)

1993 1994 1995 1996

Current Account -885 -774 -631 -696

Trade Balance -412 -385 -385 -398 Exports, f.o.b. 240 263 304 340 Imports, f.o.b. 652 -649 -689 -738

Other services & private transfers net -52 -38 -39 -41 Official interest payments due -421 -351 -207 -257

Capital Account -64 -499 -133 -24

Official -164 -529 -168 -64 Official transfers 296 200 200 200 Loan disbursements 213 240 230 200 Amortization 673 -969 -598 -464

Overall Balance -949 -1,274 -763 -720

Change in reserves (- increase) -10 -20 -20 -20 Increase in arrears 863 1,104 602 535 Payment of outstanding arrears -51 0 0 0

Financing gap -151 -189 -181 -205

Source: World Bank projections. 12 ERD-/ PAAD December 1993

Nicaragua's economic stability. The World Bank's projections in August 1993 showed a BOP financing gap for the remainder of the year of $151 million and financing gaps for the three following years of $189, $181, and $205 million, respectively. The Bank assumes no BOP assistance from the United States in these projections.

As a baseline, even if the 1993 financing gap were somehow filled (which is highly improbable, with the year already two-thirds over in August), the World Bank's scenario projects that 1993 imports would nonetheless fall to $652 mil­ lion, a sharp reduction from 1992's level.2

We can now assume that the financing gap will remain at least at $151 million. If we use this figure for the gap and assume that one-third (approximately $220 million) of the $652 million of projected imports for 1993 would occur during the last third of 1993, then imports would have to fall by a devastating 68 percent in this period, unless the $151 million gap is closed in some other way. How­ ever, at this point the only other way to close the gap would be to increase ex­ ternal debt arrearages by even more than the $863 million that the World Bank already assumes will occur during 1993. This is not a viable approach to buffer­ ing the negative impact on imports since it could easily result in a severing of re­ lations with the IFIs.

As mentioned earlier, preliminary evidence suggests that the economy is per­ forming sluggishly in the first half of 1993. In addition, USAID recently received the preliminary results of a recent FAO household survey that shows a significant decrease in caloric intake in rural areas around Managua over the period Decem­ ber 1991 to May 1993. These are exactly the kinds of economic and social re­ sults one would expect from a squeeze on import availability.

Of course, releasing U.S. BOP assistance would not by itself solve the financing gap, and eliminating the gaps in each of these years would still leave Nicaragua with sharply lower import levels for the coming years, which would tend to result in lower employment, consumption, and economic growth.

However, the absence of USG BOP assistance would make it more difficult for the GON to negotiate an ESAF, which in turn could easily lead to a chain reac­ tion of lost donor support that would produce an even sharper decline in eco­ nomic conditions.

C. Money, Finance, Inflation, and Exchange Rates

2 These World Bank projections are very similar to, but do not perfectly coincide with, the historical data provided earlier to USAID by the IMF and BCN. December 1993 ERD-I PAAD 13

By the first quarter of 1993, the GON had stabilized the monetary sector. The ratio of M1 (circulating currency plus demand deposits) to nominal GDP had settled at 10%, which is a bit below the average for the region.

However, the GON allowed a substantial gap between the official exchange rate and market exchange rate to develop in the middle of 1992, disguising the econ­ omy's inflationary potential. This gap resulted in a substantial shift in the de­ mand for money balances away from the c6rdoba and to the dollar. Dollar­ denominated deposits in the banking system rose 55% to become the largest component of M3 (currency plus all bank deposits), ahead of currency, demand deposits, and time deposits. (Ml increased by 16% in 1992 and M3 by 30%. See the table on page 49.)

The 20% devaluation of January 10, 1993 immediately raised the relative price of directly tradable goods by 20% and, through the impact it had on dollar-de­ nominated deposits, expanded the c6rdoba value of M3 by almost 7%. The re­ ported consumer price index rose by 9.3% in January and by 7.8% again in Feb­ ruary. It has stabilized since, as the GON has restrained the credit supply, in ac­ cordance with real resource availability. Since January 10, 1993, the official ex­ change rate has devalued according to a daily crawl set at a 5% annual rate. Despite this measure, though, the spread between the official exchange rate and the market exchange rate has gradually widened, from less than 1 % during the months February to May, to approximately 3% by the beginning of September.

Contrary to some fears, there has not so far been much pressure to raise nominal wage rates to keep up with the 20% devaluation and the 18% inflation in Janua­ ry-February 1993. In fact, after rising by 13% in 1992, official data show a 2.8% increase in nominal wage rates in January and a 6% increase between De­ cember 1992 and June 1993. (See the table, "Consumer Prices and Wage Rates," page 50.)

Agricultural credit in Nicaragua is under very heavy pressure to expand, but at the same time is in organizational crisis, for several reasons. The traditional financiers, the state-owned banks, remain insolvent and unprofitable despite recent attempts at restructuring. Private banks, with their modest capital base, have so far been very cautious about lending to agriculture (the problem has been exacerbated recently by the scarcity of credit available from the BCN for the private banks). This caution is due to the high risks created by recent events (including the fall in world cotton and coffee prices, poor rains in 1992, and continuing personal and property insecurity in rural areas).

D. Public-Sector Finances

An increase in the sales tax rate generated a marked increase in public-sector revenues in 1992, equal to 5% of GDP. The GON spent this gain in a doubling

'W/ 14 ERD-I PAAD December 1993

of fixed capital formation. Thus, despite the higher revenues the public-sector deficit increased, from 8% of GDP to 10%. (See the table on "Fiscal Balance: Non-Financial Public Sector," page 51.)

The GON financed this deficit with foreign grants and loans, which rose from 14% of GDP to 19%. As a result, in 1992 the GON was able for the second year in a row to retire debts owed internally in Nicaragua, in an amount equiv­ alent to 9% of GDP (compared to 5% in 1991). However, in 1992 foreign loans amounted to 13% of GDP, compared with only 1% in 1991, implying a more serious addition to the future burden of external debt-service payments. The projected decrease of n.t foreign-aid inflows will also complicate the financing of future deficits.

V. Economic Policy Reforms in 1992-93

A. The Productive Framework

1. Property Rights

The Sandinista government seized many properties that were administered privately, rather than being nationalized as government property. Shortly before ceding authority to the incoming Chamorro government in April 1990, the Sandinista administration tried to legalize the private beneficiaries' possession of these properties, in what became known as the property "piriata" (a grab-bag of gifts that shower down on children in a fiesta).

To resolve the claims of the thousands of property owners adversely affected by these 'pifiata laws" and by the Sandinistas' original confiscation decrees, the Charnorro administration established by Decree 11-90 the "National Review Commission." This Commission accepted claims from 5,400 individuals relating to approximately 17,000 properties, which it planned to resolve by administra­ tive determinations to return properties. In June 1991, however, Nicaragua's Supreme Court ruled that the Commission lacked authority to resolve cases ad­ ministratively. Because of this legal obstacle, the GON's property resolution sys­ tem remained moribund for over a year.

However, in late 1992 and early 1993 the GON developed a revised method for administrative resolution of property claims that avoided the legal problems associated with the original approach. The first step in the new process is an accelerated review of property disputes by a modified National Review Commis­ sion. The Commission's reviews can lead to the return of improperly confiscated properties to the previous owners, or to the confirmation of legal title to current occupants and compensation of previous owners. December 1993 ERD-I PAAD 15

The Ministry of Finance administratively determines the amount of compensation offered and has established an internationally accepted system of arbitration to respond to disputes relating to the valuations of properties. ERD-I's Policy Condition A.1 will help ensure that implementation of this valuation program stays on schedule. (See page 24 below.) As of August 1993, however, the property compensation system was still getting under way, as a mere 104 (of 5384 cases) property valuations had been issued by the Ministry of Finance. The GON nonetheless anticipates that the process of property valuation will accelerate dramatically in the coming months to meet the property valuation targets established in ERD-I.

Once the value of property has been established, the GON pays compensation in the form of 20-year zero-coupon bonds. The bonds are transferable and can be used to purchase shares of some of the state-owned companies that are being privatized or are in the hands of the state-owned banks. Bondholders can also cash bonds early by selling them in GON-sponsored auctions. The GON will finance its purchases in these auctions in part from the cash proceeds of privati­ zations. ERD-I's Policy Condition A.2 will help ensure that the GON uses the funds generated by privatization to support the compensation program and to help resolve the property question. (See page 24 below.)

2. Privatization

During 1992 and early 1993, the GON's holding company for nationalized indus­ try, CORNAP, continued to make steady progress in privatizing and divesting the firms under its control. From January 1992 to March 1993, 77 additional CORNAP companies were privatized, liquidated, or returned to their original owners. These additional privatizations bring to a total of 237 (of 351 original companies) that have been divested. Two prominent divestitures, with USAID technical assistance, yielded substantial cash payments: the Montelimar Pacific­ coast beach resort and the Intercontinental Hotel in Managua.

Besides the progress made with CORNAP companies, the GON has also begun to plan the privatization of major state-owned companies that are not a part of the CORNAP group, such as the state telecommunications company, TELCOR, with USAID technical assistance. Recently, however, the Sandinista deputies in the National Assembly have been debating bills that could impede this process.

3. Foreign Private Investment

The GON also took steps in 1992 to promote greater private participation in the economy by establishing laws designed to promote foreign investment in Nica­ ragua. While legal requirements and bureaucratic red tape still affect potential 16 ERD-I PAAD December 1993

foreign investors, the new Foreign Investment Law and Free Zone Law (for free trade zones) simplify and clarify the process of foreign investment.

4. Infrastructure

Large-scale electric power rationing occurred during portions of both 1992 and early 1993, reflecting:

" Inadequate maintenance of existing generating and transmission facilities.

* Inadequate investment in new generating capacity.

* The failure of the national energy company (INE) to charge electric power tar­ iffs consistent with marginal supply costs (which would have curtailed power demand and provided higher revenues to pay for more power imports).

The water utility company (INAA) also failed to recover its supply costs. Togeth­ er, INE and INAA are experiencing a growing gap between operating revenues on the one hand and operating and capital expenditures on the other. The gap rose from 0.9% of GDP in 1991 to 1.4% in 1992, and a projected 1.5% in 1993.

Among distilled petroleum products, only the price of gasoline rose faster than the CPI in 1992 and 1993. Gasoline prices rose 10% in July and an additional 12% in August 1993. Diesel, LPG, and fuel oil prices fell relative to the CPI through February 1993 and have risen at about the same rate as the CPI since then. Electricity tariffs kept up with the CPI until February, but since have fallen in real terms. Water rates have fallen continuously relative to the CPI. Lagging prices of imports such as petroleum-based products are regrettable, as the prices should be rising in relative terms to encourage conservation and to close the for­ eign-exchange gap.

B. International Trade Policies

1. Private Participation in International Trade

Following the reforms of 1991, which abolished state trading monopolies, the GON took several steps during 1992 to liberalize and clarify trade policies fur­ ther. In particular, the GON eliminated the requirement that exporters surrender foreign-exchange earnings to the BCN, as well as the requirement that importers receive prior approval from the BCN for foreign-exchange purchases. Exporters and importers can now complete these transactions entirely within the commercial banks (which, however, are technically acting only as the agents of the BCN for these purposes). December 1993 ERD-I PAAD 17

2. Tariff Protection

The GON made major reductions to its import tariff levels in 1992 and early 1993. In early 1991, the import tariff range was from 3% to 143% and ave­ raged 18%. By the end of 1991 the range was brought down to 10-50% for most products. In 1992 the range for most products was further narrowed with the imposition of a 20% ceiling on tariffs for most products. As of this writing, the GON also levies an additional selective consumption tax on many imports.

3. Import and Export Procedures

Despite significant reductions in official trade barriers, many exporters complain that exporting can be far more burdensome in practice than is apparent from the letter of the law. Although export-processing procedures have been streamlined, the so-called "one-stop" window for exports currently requires no less than ten steps. Fulfilling the required export procedures can require 1-2 weeks or more, and an additional 2-3 weeks to obtain the tariff rebates granted under the export promotion law. For exporters of perishables, which include some of Nicaragua's promising nontraditional seafood, fruit, and vegetable exports, even one week is obviously a significant delay.

Many steps required are modified versions of procedures that were initiated under the Sandinista regime to control international trade, not help it. Importers and exporters complain that they continue to encounter negative bureaucratic attitudes regarding foreign trade. However, the GON in currently developing a really streamlined "one stop window" for exporters.

4. Export Bans

Very few export bans remain. In 1992 the GON eliminated the ban on the ex­ ports of basic staples: maize, sorghum, rice, and beans. However, gold and sil­ ver exports are still subject to government control, and exports of wood products are restricted.

C. Monetary and Financial Policies

1. Controlling Aggregate Money and Credit

Due to a lack of other monetary instruments, the BCN carries out a tightly controlled monetary policy through adjusting the volume of its lending to the commercial banks. The tightness of credit is evidenced by the fact that M1 grew at a trend rate 28% slower than the Consumer Price Index from August 1992 to August 1993. This also implies that credit policy and exchange-rate policy (the 20% devaluation of the official exchange rate on January 10, 1993) together succeeded in bringing about a real devaluation in early 1993. 18 ERD-I PAAD December 1993

The BCN also took the first steps toward creating a more neutral market mechanism for controlling aggregate liquidity, when in March 1993 it authorized the emission of "Monetary Stabilization Letters" (LEMOs). LEMOs will be short­ term interest-bearing notes whose purchase and sale by the BCN in the open market will increase and decrease the volume of liquidity supplied by the BCN to the banking system, without involving the BCN in discounting commercial-bank assets. This will help disentangle the BCN's vital role in setting and implemen­ ting monetary policy from its past role in directed credit programs, which the BCN is winding down.

2. The Efficiency of Credit Allocation

A critical ongoing advancement in the efficiency of credit allocation in Nicaragua has been the continued professional development of the Superintendency of Banks and the prudential supervision of the financial sector that has resulted. This oversight of the financial system fosters the responsible use of the assets of depositors and strongly encourages financial institutions to provide credit based on the financial merits of economic activities rather than on-the political clout of borrowers.

In 1992 and early 1993 the GON also took the following additional measures to increase the efficiency of credit allocation.

* As of November 1992, the BCN ceased to provide credit directly to end­ users.

* The Ministry of Finance financially restructured the state-owned banks to reduce their dependency on Central-Bank credit. In this operation, the Ministry bought $150 million worth of the state-owned banks' worst loans. In addition, the Ministry purchased enough additional loans to allow the state-owned banks to constitute both an adequate loan-loss provision for low-grade assets remaining in their portfolios and an adequate capital base for a 'fresh start' as financially responsible commercial banks operating under the standards established by the Superintendency of Banks. (The Ministry financed this operation through the BCN, which the Ministry will compensate by assuming some of the BCN's foreign debt obligations.) Based on this restructuring, the GON established the policy that it would not provide any additional capital to the state-owned banks.

* The BCN started providing medium-term (5-year and over) resources to the private commercial banks, to broaden the new private commercial bank sector's range of activities. (ERD-I's Policy Condition D.1 will build on this progress. See page 26 below.)

p December 1993 ERD-I PAAD 19

Three new private banks were established in 1992, making a total of seven. Two more bank applications are currently pending with the Superintendency. The private banks are meeting all prudential requirements and following cautious policies.

In addition, the state-owned commercial banks have made considerable efforts to improve their performance, to complement the restructuring of their assets as described above. The largest bank, the agriculture-oriented National Develop­ ment Bank (BANADES), has been especially energetic in cutting operating expen­ ditures, reducing its staff by 61 % and the number of branch offices by 46% by the end of 1992. The other large state-owned bank, BANIC, also reduced staff, by 42%. In October 1993, the President also decreed a new Organic Law for BANADES as part of the effort to give BANADES more responsible management and a mandate to be commercially viable.

Partly because of these reforms and partly due to privatization, the private sec­ tor's share in the total credit provided by the financial system has continued to increase. From 42% after the state-owned banks restructured their portfolios in June 1992, private banks' share grew to 63% in March 1993, as credit to the private sector grew while credit to the public sector contracted.

However, the position of the state-owned banks continues to be difficult. Due to popular political demands, the GON frequently pressures the state-owned banks to make relief-oriented loans to borrowers who are in many cases unable to repay. Frequently, the borrowers have little incentive to repay, as they are aware of the well publicized governmental pressure on the banks on their behalf. Pressures are often strongest on BANADES, particularly with respect to the plight of the unemployed cotton workers, a situation heavily exploited by the Sandinista Front at the Government's (and potentially BANADES') expense.

At the beginning of the agricultural season in May 1993, political pressures forced the GON to promise that BANADES would ignore that cotton growers were defaulting on past loans and "loan" money again for production known in advance to be unprofitable. However, BANADES and the rest of the banking system are attempting to find ways to meet the spirit of the Government's promises while avoiding unsound practices. The BCN also believes that it can still respect its planned aggregate credit limits.

Nonetheless, the state-owned banks are still incurring operating losses. These imply a reduction in their capital, and, due to prudential regulations requiring min­ imum capital-adequacy levels, a reduction in the capacity to extend loans. How­ ever, due to the large volume of public deposits not indexed to the U.S. dollar, the 20% devaluation of January 10 generated extraordinary exchange-rate gains for the state-owned banks, which has strengthened their capital position. Fur­ thermore, the Ministers of Economy and Finance, from their positions on the 20 ERD-I PAAD December 1993

Board of Directors of the Superintendency, have encouraged the Superintendent to be flexible in applying prudential norms to avoid tightening credit even further.

ERD-I proposes two Policy Conditions, D.2 and D.3, that will support short- and long-term measures to reduce the GON's control over commercial banking and to make its regulatory function more professional and transparent. (See pages 27ff. below.)

3. Broadening the Financial Sector

In June 1993, the GON issued decree 33-93 containing regulations for the su­ pervision of stock markets. As of September 1993, USAID is helping the GON to frame appropriate regulatory norms for any stock exchanges that the private sector may establish, under the supervision of the Superintendency of Banks and Other Financial Institutions. At this point, it is not clear whether the stock of negotiable financial securities is large enough to generate the trading volume necessary to justify the overhead costs associated with a stock exchange. There is nonetheless increasing interest in the potential for securities trading relating to privatization, compensation for confiscated property, and implementation of monetary policy. As a result, one private business group has applied for and been granted permission to establish a stock market, which it hopes to open in January 1994.

In addition, the GON has also committed itself to making the legal reforms necessary to permit the re-entry of private firms into the insurance sector. Sev­ eral firms are interested in taking advantage of this authority when it is put in place. ERD-I Policy Condition D.4 will support implementation of this reform. (See page 28 below.)

4. Foreign Exchange

Significant changes occurred in 1992 in the policies governing the foreign-ex­ change market.

" By September 1992 all state-owned foreign-exchange houses had ceased operations, leaving the exchange houses entirely in private hands.

* Commercial banks were permitted, for the first time, to freely buy and sell foreign exchange during a business day (with the requirement that any re­ sidual foreign exchange be sold to the BCN at the end of the day).

* Starting in early 1993, commercial banks were theoretically given the right to buy and sell foreign exchange at the exchange-house (market) rate, al­ though the implementation details are not yet in place. December 1993 ERD-I PAAD 21

* In January 1993 the GON altered the exchange-rate regime by announcing that the official exchange rate would follow a continuous devaluation instead of a rigidly fixed rate. The crawl was initially set at a 5% annual rate, which was increased to 12% in November.

* In March 1993, the BCN's Board of Directors approved the issuance of for­ eign-exchange bonds ("BOMEX") by the BCN, which are currently beginning to be traded. These will eventually provide a mechanism for open-market methods of managing the availability of foreign exchange.

ERD-I's Policy Condition C.1 is designed, in part, to ensure that the GON continues to adjust its official exchange rate to meet both the short-term goal of maintaining price stability and the long-term goal of reducing the structural gap in the balance of payments. (See page 26 below.)

D. Fiscal Policies

Little progress was made in fiscal stabilization during the latter half of 1992 and the beginning of 1993. While total tax revenues of the public sector continued to increase in 1992 and 1993, largely as a result of a rate increase in the sales tax (IGV) in October 1992, public-sector expenditures rose even more sharply. The increase in expenditures was largely due to increased capital expenditures by the public utilities, which together accounted for more than 50% of the increase.

In January, the GON announced a number of fiscal measures to increase revenues: an increase in luxury taxes, an increase in stamp taxes, an increase in license fees in the transportation sector, a reduction in import tax exemptions, an increase in energy prices, and measures to improve tax administration. Simul­ taneously, however, it announced increased spending plans for the social sector. This increased spending, combined with a 1993 Central Government budget that failed to curb spending in other areas, and the slight reduction in selected taxes announced in March, resulted in a projected Central Government deficit in 1993 of approximately 8% of GDP.

Following the April 2 meeting of the Consultative Group, it became clear that external resource availability would be less than the GON had hoped for and that further reductions in the fiscal deficit would be needed. The GON therefore worked with advisors from the IMF and World Bank (in the context of developing the macroeconomic program to support an ESAF) to define the size and shape of additional fiscal cuts. IMF and World Bank advisors established the need to reduce fiscal spending by the equivalent of approximately 3% of GDP.

The GON is also attempting, with assistance coordinated by the World Bank and with financing by the IDA, to organize a debt buy-back to eliminate its debt to 22 ERD-I PAAD December 1993 foreign commercial banks (not to be confused with debt payments to official multilateral institutions). U.S. commercial banks are the principal creditors with outstanding claims. However, resources available for this purpose are severely limited, and the likely rate of repayment under a buy-back would only be ten cents on the dollar relative to the original principal amounts (or five cents on the dollar including all interest capitalized or past due).

While the GON did not adopt a comprehensive plan for cutting the fiscal deficit in 1993, it did take positive steps to address the fiscal deficit by raising taxes on petroleum products (especially gasoline) twice during the months of July and August. ERD-I's Policy Condition C.1 will ensure performance under the GON's commitment to a realistic program for reducing the fiscal deficit. (See page 26 below.) Condition B.1 will help ensure that the GON improves its internal financial management and accountability. (See page 25 below.)

VI. The GON's Medium-Term Development Policy

The GON's track record shows a commitment to stabilization, liberalization, and privatization surpassed by few countries in recent history. The GON has elimi­ nated hyperinflation, rapidly divested itself of ownership in a large number of companies, and taken vigorous steps to overcome inherited Constitutional and legal obstacles (as well as continuing political opposition from various parties) to private-sector development.

However, the GON remains dependent on external assistance for the definition and support of its reform program's details. Thus, donor technical and financial assistance has an excellent opportunity in Nicaragua to collaborate with a com­ mitted government in reversing the tragic decline in economic, social, and demo­ cratic standards that has occurred since the 1970s.

In its presentation to the Consultative Group meeting in Paris, on April 2, 1993, the GON described its plans in the following terms:

"The program puts particular emphasis on reestablishing basic macro­ economic balances ... . The Government's three-year program will aim at expanding traditional exports such as coffee, fish products and beef and developing the necessary conditions for the growth of nontraditional exports. The authorities plan to achieve this objective through a rapid resolution of the property rights issue, an improvement in external competitiveness through an adequate exchange rate policy, a tight wage policy, the adoption of measures to improve labor productivity through adequate technology, and measures to add flexibility to labor market regulations, a continuation of the process of trade liberalization, and a December 1993 ERD-I PAAD 23

substantial increase in public sector savings to finance the reconstruction of infrastructure in the productive areas."

Details within these general themes are emerging from an in-depth process of consultation between the GON and Nicaragua's r-olitical parties and between the GON and the donor community. Clear-cut directions have been slow to emerge because of the reduction in external resources available in 1993 compared to 1992. As the import level is projected to fall sharply, the GON must plan for large reductions in public-sector spending (through budgetary revisions) and pri­ vate spending (through upward revisions in the prices of tradable goods, the prices of public services, and taxation, and through limitations on aggregate credit). Obviously, it is difficult for the GON to achieve public consensus on such austerity measures, despite the ample discussions that it has undertaken.

The GON is currently negotiating an ESAF with the IMF and the World Bank that would form an essential part of a complete macroeconomic program for the medium term. An ESAF would open the way to a se, -4 IDA adjustment credit (ERC-Il), and would demonstrate to the donor community that the country's macroeconomic program is on track. ERD-I's Policy Condition C.1 will ensure that the GON makes adequate progress toward meetings the prerequisites for an ESAF before USAID disburses its BOP assistance. (See page 26 below.)

VII. ERD-l's Policy Reform Program

For balance-of-payments assistance to be justified, the recipient must take measures that will make it more self-reliant in the future. Furthermore, the BOP assistance itself must facilitate the implementation of these measures and make them more effective.

Nicaragua meets these requirements. The principal national economic challenge for the medium term is to raise production of exports and import substitutes so as to lower the excess demand for imports, which can only be met at present by large net inflows of foreign aid. In the short term, the GON needs to take ef­ ficient measures to reduce the demand for imports to the financing available.

An attempt to fully adjust in the short term to the existing shortage of external resources without BOP assistance (through devaluation) would strongly risk reig­ niting hyperinflation. This would be due to the unwillingness of firms and indi­ viduals to allow relative prices to change (e.g., unwillingness to allow real wages to fall). There is also a strong possibility that foreign-exchange shortages would lead to strong and intrusive governmental controls over the economy. Controls might include, inter alia, higher import tariffs, a lengthy process for GON licen­ sing of imports, higher reserve requirements for commercial banks, and requiring that all foreign exchange be turned over to the Central Bank. 24 ERD-I PAAD December 1993

Therefore, a broad program responding to real resource shortages is needed to avoid the risks of short-term destabilization and accelerated inflation, as well as risks of long-term stagnation in an economy dominated by government controls and protection. As described above, the GON is in the process of carrying out a wide-ranging adjustment program that contains many measures to reduce the external gap in the short and medium terms.

The measures that ERD-I will support include both measures needed for short­ term stabilization and measures that, although possibly complicating the GON's task in the short term, are needed to establish a base for long-term growth. A summary of ERD-l's policy conditionality is presented in the table on page 36.

A. Resolution of Property Claims

Condition A.1: Issuance by the Ministry of Finance's Office of Compensation Valuation (OCI) of at least 500 property valuation resolutions, of which at least 50 name U.S. citizens as claimants.

Discussion: Timely compliance with its recently announced plan to resolve outstanding disputes relating to property rights is critical to the GON's ability to reactivate economic growth and development. While the issue transcends eco­ nomics, from an economic perspective resolution of the property issue is a nec­ essary condition for major new investment to occur in Nicaragua. The overall potential claimant universe includes 5,384 individuals. Partly as a result of U.S. encouragement (and to meet the expected condition precedent in the eventual ERD-I agreement), the GON has substantially accelerated the pace of processing claims. As of mid-November 1993, the GON had issued 257 property valuation resolutions, of which 48 involved U.S. citizens.

The Mission has chosen a benchmark relating to the OCI's valuation resolutions because these resolutions are important decision points and potential bottlenecks in the claims-resolution process. The issuance of a valuation resolution shows that the GON has reviewed the rights of the property's current occupants and decided that it cannot return the property to the original owner and that there­ fore it must offer the owner compensation. Furthermore, a resolution's issuance shows that OCI has dealt with various questions relating to the inherent value of the property and other claims on it that may affect the original owner's net equity. The resolution's issuance is also a verifiable administrative action upon which USAID can base an accountable disbursement decision.

Condition A.2: Commitment by the GON to implement Decree 56-92 where it states that the net cash proceeds from privatization of the telecommunications functions of TELCOR will be applied to redemption of bonds received in compen­ sation for lost property. December 1993 ERD-I PAAD 25

Discussion: A key requirement to resolve property disputes is that the GON have liolid financial resources available to provide a backing to the compensation bonds i.jued by the GON's Treasury. In 1992, the GON issued a decree stating that it would use the net resources generated from the privatization of TELCOR's telecommunications functions to compensate bondholders. This would maintain the value of compensation bonds in the secondary market and permit a larger volume of early redemptions by the GON. Without such backing, the value of the bonds could fall to a level at which claimants could reasonably assert that the GON had not provided adequate compensation, thereby jeopardizing the suc­ cess of the entire claims-resolution process.

TELCOR's privatization process has begun, using technical assistance from USAID/Nicaragua. Unless the process is delayed by the National Assembly, it is expected that the privatization strategy will be completed and submitted to the GON in December 1993. Invitations for proposals wold then be published in February 1994, and the transaction would be completed by June 1994. ERD-l's policy condition will emphasize the importance of using funds from this privatiza­ tion for property compensation.

B. Accountability in the Public Sector

Condition B.1: Submission by the GON to the National Assembly of nominees for the position of Controller General according to the laws of Nicaragua.

Discussion: For most of the past year, the position of the GON's chief audit and financial accounting officer, the Controller General, has been vacant due to the National Assembly's politically controversial dismissal of the previous incum­ bent. To fill this position, Nicaraguan law provides that the President should nominate three candidates, of which the National Assembly would elect one. To date, however, the President has made no nominations.

The absence of a Controller General significantly reduces the transparency of financial operations in government. In order for there to be the transparency in governance that is essential to the democratic process, the Government needs to be accountable for resource use through a system of checks and balances. Furthermore, although the public sector is far smaller than it was under San­ dinista rule, it remains a major component of Nicaragua's economy in terms of national expenditure, investment, and employment. From an economic perspec­ tive, it is essential that the GON use resources as efficiently as possible, which requires that the GON have the internal capacity to monitor cash flows critically.

Through the Financial Management Reform project (524-0330) for the public sector, USAID is prepared to finance technical assistance in these areas and to help lay the groundwork for a modern system of public-sector accounting and financial management. However, this assistance will only be appropriate when 26 ERD-I PAAD December 1993 the GON has put a competent and impartial Controller General in place. ERD-I's policy condition will help ensure that the GON resolves this long-standing issue in a timely way.

C. Macroeconomic Stabilization

Condition C. 1: Evidence that the GON is taking substantial steps to deal with the fiscal and balance-of-payments deficits.

Discussion: The GON's adoption of a macroeconomic program consistent with the requirements for receiving the IMF's support through an ESAF is essen­ tial to Nicaragua's continued economic progress. A key component in the establishment of an ESAF is the development of a Policy Framewurk Paper which covers a broad spectrum of stabilization and development issues. Besides financial targets similar to those of an IMF Stand-By program, the Paper covers structural reforms in several sectors, including industry and infrastructure as well as banking and finance. Resolution of property issues will also be included.

The GON was unable to meet two major prerequisites for an ESAF agreement with the IMF in 1993: financing the balance-of-payments gap and reducing the fiscal deficit (as well as several relatively minor prerequisites). As a result, not only did macroeconomic policy continue to exacerbate the foreign-exchange shortage, but several donor financing packages were delayed. One symptom of these developments was the continuous drop in Nicaragua's net foreign-ex­ change reserves, which raised the fear of instability in the exchange rate. The situation continues to be critical during the fourth quarter.

At this point the GON needs to first revise its (informal) macroeconomic program with the IMF to include viable performance criteria for the fourth quarter of 1993, and it needs to make substantial progress toward the achievement of these targets. Compliance with these steps will indicate that the GON is well on its way to obtaining IMF Board approval of an ESAF. While in principle USAID/ Nicaragua would have preferred to insist on prior approval of an ESAF as a con­ dition for disbursing ERD-I funds, we believe that attaining approval of an ESAF is not feasible in the short term and that withholding ESF funding would actually have a substantially negative impact on the GON's chances of obtaining an ESAF in the future.

D. Financial-Sector Reform

Condition D.1: Substantial progress in continuing to raise the share of national bank credit, including medium-term credit, managed by private commercial banks, to the extent consistent with stable monetary policy. December 1993 ERD-I PAAD 27

Discussion: As a consequence of the severe economic and political pressures on the GON in mid 1993, the Central Bank has not fully implemented the medium-term bond program with the private banks. A condition in ERD-l will require the GON to demonstrate substantial progress in implementing this program in order to promote increased private sector investment. The structural development of banking in Nicaragua needs to continue to emphasize the private sector and, within the private sector, the broadening of the role of private banks into the full range of financial services appropriate for Nicaragua's economy at this time. This range includes medium-term lending as well as lending to produc­ tive sectors, which have, up to now, been served almost exclusively by state­ owned banks.

The continued availability of ample medium-term resources to the private banking sector can be a powerful incentive for this structural change to move ahead. At the same time, this tool needs to be complemented by direct measures to down­ size the state-owned sector as well as a more efficient incentive structure for the private banks to widen their sources and uses of funds. This condition will help USAID to pursue these issues in its continuing policy dialogue.

Condition D.2: A commitment by the GON to the independence of the Super­ intendency of Banks in supervising the financial system.

Discussion: To act effectively, the Superintendent of Banks must be inde­ pendent of those he supervises. Currently, the Superintendency's Board of Di­ rectors includes both the Minister of Finance, whose Ministry directs the state­ owned commercial banks that the Superintendency supervises, and (as Chair­ man) the Minister of Economy, whose Ministry supervises state-owned compa­ nies that are financed by state-owned banks.

The potential conflict of interest inherent in these relationships is clearly unheal­ thy and, in the case of private banks, is frequently prohibited by regulations con­ cerning interlocking ownership and bank lending to related companies. This con­ flict is especially critical now, as state-owned banks' capital adequacy needs to be closely monitored, while the GON is under intense political pressure to increase lending from state-owned banks.

This conflict should ultimately be resolved by divestiture of state ownership in commercial banking. Meanwhile, the independent prudential supervision of the state-owned banks by the Superintendency of Banks needs to be ensured by a commitment from the GON to refrain from direct involvement at the political level in the Superintendency's responsibilities. A formal delegation of authority from the Superintendency's Board of Directors to the Superintendent would be one possible form for this commitment. 28 ERD-I PAAD December 1993

Condition D.3: Presentation by the GON of a strategy for BANIC that is consistent with progressively increasing the private sector's share of the com­ mercial banking industry.

Discussion: In the conflict between social safety-net and stabilization objec­ tives, it has become clear that the conflict of interest inherent in the Govern­ ment's being the owner, supervisor, and client of the state-owned banks is un­ manageable. Use of the banking system for political purposes not only ultimately expands the fiscal deficit, but also wastes scarce resources. Finally, the burden of past loan failures handicaps the banking sector, by distorting current lending (e.g., the "throwing good money after bad" syndrome). The GON should then withdraw from ownership and political involvement in commercial banking.

The GON has achieved some progress in slimming down the state-owned banks. BANADES in particular has made a major effort. Its management appears to be committed to minimizing its competition with the private sector. Furthermore, given its size (the largest bank in Nicaragua) and the fact that its business is con­ centrated in agriculture, the sector that the private banks' managements have targeted least, there is at least in the short term an argument for BANADES to continue to complement the private sector.

The other major state-owned commercial bank, BANIC, is smaller and dedicated to the industrial and commercial clientele that the private sector is now in­ creasingly serving. There is a growing consensus that BANIC no longer has an appropriate role as a state-owned institution in the emerging structure of the banking system. Therefore, ERD-I will be conditioned on presentation by the GON of a plan for BANIC that over the long term will be consistent with in­ creasing the role of private banks.

This plan could conceivably involve any of a variety of possible alternative meas­ ures, such as: (1) continuing to improve BANIC's performance by cutting costs and improving loan selection and collection, (2) selling parts of BANIC's loan portfolio to private banks, (3) divesting BANIC of commercial-bank functions (de­ posit-taking, making payments, opening letters of credit) and restricting it to "development" banking dependent on budgetary allocations or donor financing, (4) privatization of BANIC's ownership, and (5) liquidation. In October 1993, the GON began to discuss with USAID the possibility of private banks' buying loan portfolio from state-owned banks. Further restructuring of BANIC is also being discussed by the GON and the World Bank in the context of the Policy Frame­ work Paper for the ESAF and ERC-Il. The GON should use these discussions to develop a plan for resolving the issues surrounding BANIC.

Condition D.4: Completion by the GON of executive-branch actions necessary for issuance of definitive legal reforms and implementing regulations allowing pri­ December 1993 ERD-I PAAD 29 vate entry into the insurance sector, without unreasonable capital requirements and on an equal footing with any state-owned firms.

Discussion: Since the private insurance industry was nationalized in 1979, insurance coverage in Nicaragua has fallen to approximately half its former value. In other countries of the region, coverage of comparable risks is three to four times higher and premiums are substantially lower.

The GON has realized that continuing the monopoly of the parastatal INISER is counterproductive. As acondition precedent to disbursement of ESR-IV-A (524­ 0325A), the GON committed itself to a plan for bringing the private sector back into the insurance industry. The President of Nicaragua will propose a bill to the National Assembly to eliminate the legislatively established monopoly of INISER and provide for a mechanism to allow private companies to enter the insurance industry. The executive branch will then make the necessary dispositions through decrees or issuance of regulations. Several groups with experience in insurance in Nicaragua, Costa Rica, and the United States are interested in starting private insurance companies.

However, there is some political resistance from unions, the National Assembly, and to some extent from INISER's management, to abolishing INISER's monopo­ ly. As of November 1993, the Presidency had not submitted the necessary leg­ islative proposals to the National Assembly. Therefore, ERD-I's policy condition­ ality, as well as technical assistance from USAID's Private Sector Support Proj­ ect (524-0317) to the Superintendency of Banks and Other Financial Institutions (which has the authority to supervise the insurance industry) will be used to en­ sure that the reforms are carried out.3

VIII. Dollar Uses

A. Proposed Disbursement Plan

USAID will disburse $40 million as a cash transfer in a single tranche upon fulfill­ ment of all conditions precedent. The GON will use the cash transfer to finance debt service payments to official multilateral organizations such as the World Bank, the IDB, the IMF, and CABEI, and to finance or reimburse imports from the United States and Central America under operating procedures similar to those etablished for USAID's previous BOP grant, ESR-IV-A (524-0325A).

3 The Concept Paper for ERD-I proposed an additional condition related to the financial sector, which was that the GON issue a decree permitting the establish­ ment of private stock exchanges. On June 21, 1993, President Chamorro signed Decree 33-93 to this effect. Therefore, such a condition is no longer necessary. 30 ERD-I PAAD December 1993

The $40 million will be divided between financing debt payments and imports in approximately the same proportions as under ESR-IV-A: approximately $13 mil­ lion for debt and $27 million for imports. The figure for debt is also consistent with estimated obligations coming due to official multilateral organizations, ac­ cording to which the estimated target of $13 million could be reached in two or, at most, three months.

To be eligible for financing, individual import transactions will be required to meet the following criteria:

* A minimum dollar amount to be established by USAID and the GON.

" For reimbursement, payment date subsequent to September 30, 1993.

* Transactions must be arranged by private Nicaraguan banks.

Pursuant to applicable environmental laws and regulations, conditions will be placed in the Program Agreement between the GON and USAID to ensure that funds will not be used under this program:

* To procure or use pesticides.

* To support activities or the procurement or use of materials and equip­ ment that could lead to significant tropical deforestation, without first re­ ceiving the LAC Bureau Environmental Officer's approval of appropriate environmental assessments.

* For activities that have a negative affect on threatened or endangered species or their critical habitats.

(For the Environment Threshold Decision regarding ERD-I, see page 42 below.)

B. Separate Account Criteria and Operating Procedures

1. Accountability

USAID's Program Economics Officer will be responsible for overall management of the program, assisted by the USAID/Nicaragua Controller in the oversight of the cash transfers. In the GON, the unit responsible for managing the cash transfers will be the International Division of the BCN.

To meet a condition precedent of the ESR-IV-A program, the BCN developed a detailed set of operational procedures governing the use of the dollar resources destined for eligible inport transactions and debt service. These procedures in­ December 1993 ERD-I PAAD 31 clude approved disbursement mechanisms, requirements for separate dollar ac­ count(s), import eligibility criteria, and reporting requirements.'

Similarly, the Agreement for ERD-I will require that the BCN propose suitable operating procedures for USAID's approval. USAID, through the Controller's Of­ fice and the resident Regional Legal Advisor, will certify that ERD-I's operating procedures are fully consistent with AID regulations and AID/Washington's auth­ orization, as a condition precedent to disbursement of funds.

The management capabilities of the BCN have been evaluated by USAID per­ sonnel, by professional management firms (Robert Nathan, Ernst &Young), and by Price Waterhouse and Peat Marwick & Mitchell under the Non-Federal Audit Program of A.I.D.'s Regional Inspector General (RIG). In addition to RIG's audit of the ESF Program in Nicaragua dated February 8, 1991 and a RIG-supervised award survey of the BCN dated May 22, 1991, several additional audits of USAID's ESF programs have been completed.

These Federal and Non-Federal audits identified several areas requiring action by the BCN related to the administration, reporting and approval of import trans­ actions under USAID's ESR programs. The Mission brought these weaknesses to the attention of the appropriate BCN officials. Mission personnel have moni­ tored actions taken by the BCN to correct the deficiencies noted by the audits and will evaluate their impact in the course of further audits of the program.

Based on the results of U.S. Government audits, the Mission has determined that the BCN has the capability and sufficient span of control to manage the cash transfer activities under the proposed ERD-I program adequately.

2. Audit

The Regional Inspector General is required to conduct regular reviews of cash transfers in Nicaragua. In performing these functions, RIG, in coordination with the Mission, oversees the overall financial management aspects of the program and schedules audits to determine compliance with the terms of The agreement and proper use of funds. RIG obtains the services of a qualified external CPA firm to assist in meeting this responsibility. USAID will use local currency from USAID's Program Trust Fund for administration, control, and audit to finance Non-Federal audits of the ERD-I program. In addition, the Office of the USAID/ Nicaragua Controller will perform periodic financial reviews to ensure that the GON properly manages and accounts for the Program's funds.

4 ESR-IV-A's Operating Procedures are available for AID/Washington's review. 32 ERD-I PAAD December 1993

IX. Uses of Local-Currency Generations

A. Programming

ERD-I will generate Host-Country-Owned Local Currency (HCOLC) on dollar funds not used for payment of debt. The HCOLC will be generated at the time USAID approves and the GON executes the use of dollars for payment or reimbursement of imports, using the highest rate of exchange not unlawful that is in effect in Nicaragua. The GON will deposit these generations into an interest-bearing Separate Account(s) in the BCN.

HCOLC will be programmed for the following purposes.

(1) To increase t!,9 GON's contribution to USAID's Program Trust Fund by the equivalent of $500,000.

USAID uses the Program Trust Fund to finance supplies, equipment, salaries, and technical assistance expenses to ensure proper administration, control, and audit of AID assistance in Nicaragua.

(2) To finance the local costs of limited project activities up to $5 million.

The Mission will make HCOLC available for high-priority local-cost activities, such as AIFLD's possible home-improvement lending program, the local costs of the activities of U.S. PVOs, and CIAV's housing activities. The Mission's pre­ ferred approach would be for the GON to contribute the equivalent of $5 million of ERD-I's HCOLC to a separate Program Trust Fund for financing projects. 1his Program Trust Fund would be managed by USAID/Nicaragua. Alternatively, the GON and USAID could jointly manage these funds using the mechanism adopted for the HCOLC generated by USAID/Nicaragua's PL-480 Title III program. 5

(3) To pay existing GON debts to the BCN and to offset accumulated foreign­ exchange losses of the BCN.

The BCN is technically insolvent because in the 1980s, under the previous government, it financed fiscal deficits and, more importantly, assumed foreign­ currency liabilities in return for local-currency assets. This currency mismatch has resulted in the BCN suffering exchange losses in each devaluation. These

5 The Memorandum of Understanding between USAID and the GON regarding the establishment of a joint Secretariat for management and audit of HCOLC generated under USAID/Nicaragua's PL-480 Title III program is available for AID/Washington's re­ view. Operating procedures for the Secretariat are being designed with the technical assistance of Price Waterhouse and will be approved by USAID/Nicaragua.

21 December 1993 ERD-I PAAD 33

accumulated losses are now several times the domestic liabilities of the Bank. Using HCOLC to offset these debts and foreign-exchange losses allows the BCN to make available a correspondingly larger volume of liquidity to the economy through the banking system.

The restrictions on uses of dollar funds relative to environmental protection, described above on page 30, will apply to HCOLC uses also.

B. Accountability

As a condition precedent to the use of HCOLC, the BCN will establish operating procedures for the HCOLC separate account(s). An Annex to the Memorandum of Understanding on local currency will detail those procedures, as well as ac­ countability and monitoring responsibilities of USAID and the GON relating to de­ posits into and disbursements from the HCOLC separate account(s).8

Immediately after the GON transfers dollar funds for the payment or reimburse­ ment of imports, the GON will deposit HCOLC in separate non-commingled ac­ counts in the BCN. These accounts will earn interest based on the highest inte­ rest rate for six-month certificates of deposit in effect in Nicaragua's commercial banks on the first day of each month.

The BCN will make the statements of HCOLC accounts, as well as records of supporting transactions, available for review and audit by AID. The Mission will include these accounts and transactions in the audit of its programs.

The Mission will be responsible for the management of the HCOLC contributed to USAID/Nicaragua's Program Trust Fund(s), using procedures equally rigorous as "'or appropriated dollars. In the event that USAID and the GON jointly manage HCOLC for project support, the model for the mechanism to be used will provide for comprehensive tracking and auditing of HCOLC used for project activities. In addition, such uses will be subject to the Mission's project implementation controls.

6 The Memorandum of Understanding and Central Bank operating procedures for HCOLC management under USAID/Nicaragua's previous cash transfer, ESR-IV-A (524­ 0325A), are available for AID/Washington's review. 34 ERD-I PAAD December 1993

51 December 1993 ERD-I PAAD 35

Appendixes

c,/C 36 ERD-I PAAD December 1993

ERD-I's Policy Conditions

ISSUE STATUS IN MID-1993 OBJECTIVE Establishment As of mid-November 1993, Issuance by the Ministry of Fi­ of Private the OCI has emitted 257 nance's Office of Compensa­ Property property valuation resolutions, tion Valuation (OCI) of at least Rights of which 48 involved U.S. cit- 500 property valuation resolu­ izens. tions, of which not less than 50 name U.S. citizens as claimants. The GON has not funded the Commitment by the GON to bonds it is emitting as com- implement Decree 56-92 pensation for confiscated where it states that the net property. cash proceeds from privatiza­ tion of the telecommunica­ tions functions of TELCOR will be applied to redemption of bonds received in compensa­ tion for lost property. Accountabil- The National Assembly dis- Submission by the GON to the ity in the missed the previous Controller National Assembly of nomi­ Public Sector General in 1992 and the Presi- nees for the position of Con­ dent has not yet proposed troller General according to new candidates for election the laws of Nicaragua. by the National Assembly. Macroecon- The GON is discussing a mac- Evidence that the GON is tak­ omic Stabi- roeconomic plan for 1994-96 ing substantial steps to deal lization with staff of the IMF and the with the fiscal and balance-of­ World Bank. payments deficits. December 1993 ERD-I PAAD 37

ISSUE STATUS IN MID-1993 OBJECTIVE Financial Sec- The Central Bank has made a Substantial progress in conti­ tor Reform small test purchase of medi- nuing to raise the share of um-term bonds from the pri- national bank credit, including vate banks, to initiate a one- medium-term credit, managed year program valued at 240 by private commercial banks, million c6rdobas (the equiva- to the extent consistent with lent of about $38 million), stable monetary policy. The relative roles of the Su- A commitment by the GON to perintendent of Banks and the the independence of the Su­ GON-appointed Board of Di- perintendency of Banks in rectors of the Superintenden- supervising the financial sys­ cy is fluid and potentially tem. open to political pressures. The two main state-owned Presentation by the GON of a banks, BANADES and BANIC, strategy for BANIC that is have been financially restruc- consistent with progressively tured but are still dependent increasing the private sector's on the Central Bank for liquidi- share of the commercial bank­ ty and are competing with the ing industry. private banks. The GON has committed itself Completion by the GON of to make the legal reforms executive-branch actions nec­ necessary to allow the private essary for issuance of defini­ sector to re-enter the insur- tive legal reforms and imple­ ance business. The Presiden- menting regulations allowing cy plans to submit a bill for private entry into the insur­ approval by the National As- ance sector, without unrea­ sembly, to be fo!lowed by sonable capital requirements additional decrees and regula- and on an equal footing with tions. any state-owned firms. 38 ERD-I PAAD December 1993

Concept Paper Approval Cable

STATE 207572 Dated July 9, 1993

TO AmEmbassy Manaqua

AIDAC Mission Director Janet Ballantyne

SUBJECT Nicaragua Economic Recovery and Development I (524-0333) Concept Paper Review

1. An Issues Meeting was held to review the proposed Dols 45 million FY 93 ESF cash transfer Economic Recovery and Development I program Concept Paper. The meeting was chaired by LAC/DR and was attended by representa­ tives of LAC/DR, LAC/CEN, LAC/DPP, LAC/TI, R&D, FA, State/ARA and Treas­ ury. USAID/Nicaragua was represented by Todd Amani (Mission Program Offi­ cer) and Joe Ryan (Mission Economist).

2. The issues raised at the meeting were resolved. The Chair concluded that a DAEC review was unnecessary and a recommendation should be made for A- AA/LAC approval of the document. Thus, the ERD I Concept Paper, with A-AA/ LAC concurrence, is hereby approved and the Mission is advised to proceed with preparation of the PAAD, which will be reviewed in AID/W.

3. The Issues Meeting participants discussed the broad context of policy reform­ conditioned balance of payments assistance to Nicaragua. Past assistance of this kind has made a strong contribution to the macroeconomic stabilization and liberalization achievements to date. However, Nicaragua is finding it increasingly difficult to obtain sufficient donor resources to finance the growing trade deficit arising from increased demand for imports and decreasing world prices for exports. If the unfinanced trade deficit becomes too large, Nicaragua may be forced to make adjustments too quickly, which could bring a return to high inflation and threaten the continuation of the economic liberalization program. Thus, in determining ESF allocations within the LAC region, State/ARA, the LAC Bureau and the Mission must assess the potential negative impact of declining balance of payments support on the U.S. foreign policy goals in Nicaragua of economic stability under market-oriented conditions and political accommodation under a democratic system.

4. Recommendations for PAAD design which were offered during the Issues Meeting are set forth below. December 1993 ERD-I PAAD 39

A. In order for State and AID to rank the priority of balance of payments support for Nicaragua against competing demands for declining ESF resources, the Mission should include an analysis of trade projections, balance of payments gaps and adjustment scenarios as part of the PAAD, along the lines suggested in para 3 above.

B. While final ESF allocations have not yet been determined, the results of the results of the most recent budget planning exercise suggest the potential for a lower FY 93 level than the amount used in the Concept Paper. At a lower ESF level, it is anticipated that the environmental earmark will be eliminated. If the overall ESF level for Nicaragua is set at a lower amount, the Mission should reexamine the proposed ERD I program to determine if negotiation of the full package of conditionality with the GON, including the forestry management reforms, remains feasible.

C. Per follow-up discussions between LAC/DR/RD and Mission representa­ tives, the Mission should review the proposed policy program in the natural resource area, with a view to balancing the legal and regulatory measures proposed in the Concept Paper with additional economic reform measures that may be needed to create the market incentives for sustainable forest manage­ ment. LAC/DR/RD can help the Mission identify forest policy advisors to assist in the effort.

D. The LAC Bureau understands that the conditions' language presented in the Concept Paper may change in order to meet targets for the timing of program disbursements, which must be linked to achievement of World Bank/IMF ESAF program targets.

E. The policy matrix in the PAAD should be expanded to include two additional columns for recording information on each of the program conditions, including the target date for compliance and a brief description of the reform progress attained under previous ESF programs, if applicable. WHARTON## 40 ERD-I PAAD December 1993

PAAD Approval Cable

STATE 352407 Dated November 20, 1993

TO AmEmbassy Managua

AIDAC

SUBJECT : Review and Authorization of USAID/Nicaragua Economic Recovery and Development Program (524-0333)

1. SUMMARY: The DAEC Review of the USAID/Nicaragua Economic Recovery and Development Program PAAD was held on October 22, 1993. A-DAA Norma Parker chaired the meeting, which was attended by representatives from LAC/ DR, LAC/DPP, LAC/CEN, R&D, GC/LAC, LPA/IEG, STATE/ARA, STATE/EB, and Treasury/OASIA. USAID/Nicaragua was represented by Mission Director Janet Ballantyne and Program Economist Joe Ryan. The Program was approved at a level of Dols 40 million, to be obligated and disbursed in one tranche. The Mis­ sion may proceed to obligate and disburse funds upon receipt from AID/W of notification that the A-AA has authorized the program at the $40 million level, the Congressional Notification (CN) has been released, and advice of Budget Allowance issues. END SUMMARY.

2. DAEC Decisions

A. Impact of BOP Assistance: Despite the difficult and uncertain situation in Nicaragua, very slow progress in achieving a political resolution, and the substan­ tial possibility that no further ESF will be allocated to support the ERD program, the Review Committee endorsed the PAAD's recommendation to provide the full $40 million. This decision reflects the importance of protecting cumulative U.S. investment in Nicaragua, as well as that of providing Nicaragua a bridge to po­ tential larger financing packages from the IFIs.

B. Relationship of BOP Assistance to Multilateral Donor Funding: The Review Committee concurred with the PAAD recommendation to proceed with disburse­ ment of funds despite uncertainty regarding IMF negotiations for a new ESAF program. The rationale for this decision rests in the GON's informal, good-faith commitment to proposed fiscal reforms and the possibility that U.S. funding would not only lessen the impact of existing fiscal reforms on the social sectors, but could also help to win Nicaraguan political support from those currently op­ posed to an IMF program. A-DAA Norma parker encouraged both A.I.D. and State to press the IMF for more rapid and reasonable negotiations with the GON. December 1993 ERD-i PAAD 41

C. Local Currency Generation and Programming: At the request of the A-DAA, USAID/Nicaragua will review its portfolio of projects which support a NicudIaguan social safety net (particularly the Title IIIprogram and the PVO Co-Financing Pro­ ject), determine how to best fill in gaps in coverage, recommend a level of ESF financing for new repeat new or additional social projects, especially targetted in the North, and report its recommendations to AID/W within two weeks of the review. A level of at least $10 million was recommended to the Mission as be­ ing appropriate. Management and monitoring implications of increased numbers of social sector projects was to be included in the Mission's analysis.

D. Conditionality on Property Rights Resolution: The condition precedent will require issuance by the Ministry of Finance's office of Compensation Valuation (OCI) of a cumulative total of property valuation resolutions which name 50 U.S. citizens as claimants. This is a new condition added at the time of the DAEC review by ARA.

E. A.I.D.'s Strategy for Consulting with Congress: The Bureau, in consultation with LEG and State, will develop an appropriate strategy for submission of the Congressional Notification and will advise the Mission accordingly. TARNOFF## 42 ERD-I PAAD December 1993

Environmental Threshold Decision

STATE 344563 Dated November 12, 1993

TO AmEmbassy Managua

AIDAC Mission Environmental Officer Ralph Conley

SUBJECT Environmental Threshold Decision for the Economic Recovery & Development Program - FY93 ESF Balance of Payments Program (524-0333)

1. LAC Acting Chief Environmental Officer, Jeffrey J. Brokaw, has reviewed, and hereby approves Mission request for a Categorical Exclusion for subject pro­ ject. A Categorical Exclusion is issued in accordance with 22 CFR 216.2 (C) (2) (VI).

2. USAID/Nicaragua is commended for placing conditions in the Program Agree­ ment with the GON to ensure that there will be no support or funds used: (1) for timber extraction of significant deforestation, including the procurement or use of equipment that could be used in deforestation activities; or (2) for the procurement or use of pesticides.

3. In addition, USAID/Nicaragua shall include a condition in the Program Agree­ ment to ensure that funds will have no negative effect on threatened or endan­ gered species or their critical habitats.

4. Mission is requested to send a copy of the relevant sections of the Grant Agreement specifying the above conditions for inclusion in LAC/DR/E files.

5. Should the grantee be unable to comply with any of these conditions, USAID/ Nicaragua shall submit an amended Initial Environmental Examination.

6. lEE number is LAC-IEE-94-01. Copy of the Environmental Threshold Decision is being sent to the Mission for inclusion in project files. CHRISTOPHER## December 1993 ERD-I PAAD 43

Statistical Appendixes 44 ERD-I PAAD December 1993

National Product by Sector (% of GDP)

prel. proj. 19771 1990 1991 1992 1993

Primary Sector 22 24 24 24 24 Agriculture 14 16 15 15 15 Livestock 6 8 8 8 8 Forestry 1 NA NA NA NA Other 1 0 0 0 0

Secondary Sector 29 26 27 26 27 Manufacturing 23 22 24 22 23 Construction 5 3 3 3 3 Mining 0 1 1 1 1

Tertiary Sector 49 50 49 50 51 Commerce 22 17 18 19 19 General Government 5 13 11 11 11 Transportation & Communication 5 5 5 5 5 Finance 3 3 3 3 3 Public Utilities 3 3 3 3 3 Housing 5 4 4 4 4 Othor Services 6 4 4 4 5

Memo Item: Real GDP Growth 8.4 -0.6 -0.2 0.8 2.1

"NA" = Data not available. Sector elements may not sum to sector totals due to rounding. Data for 1992 and 1993 do not reflect the latest revisions made availab!e to USAID/Nicaragua in the second week of September. December 1993 ERD-I PAAD 45

National Expenditure (% of GDP)

prel. proj. 1977 1990 1991 1992 1993

Net Exports -5 -18 -29 -35 -28 Exports 34 25 21 16 19 Imports 40 44 50 52 47

Consumption 70 67 89 98 89

Government Spending 10 33 20 19 18

Gross Domestic Investment 24 19 20 18 21

Data for 1992 and 1993 do not reflect the latest revisions made available to USAID/Nicaragua in the second week of September. 46 ERD-I PAAD December 1993

Balance of Payments (Millions of 1992 Dollars)

prel. 19771 1990 1991 1992

Current Account -303 -541 -936 -1,061 Excluding official interest due na -294 -484 -616

Trade Balance -107 -251 -405 -533 Exports, f.o.b. 1,003 352 275 224 Imports, f.o.b. -1,110 -603 -680 -757

Other services & private transfers net -180 -43 -79 -83 Official interest payments due na -248 -452 -445

Capital Account 317 -299 -145 -105

Offikial 244 -24 -207 -222 Official transfers 17 215 496 277 Loan disbursements 270 235 235 365 Amortization -43 -474 -938 -864

Other Capital, net errors & omissions 73 -274 63 117

Overall Balance 14 -840 -1,081 -1,166

Financing -14 840 1081 1,166

Net reserve change 14 211 -16 15 Clearance of outstandiag arrears 0 -1,850 -427 Exceptional financing 631 2,949 1,578 Consultative Group 0 326 0 Mex/Ven/Col/U.S. rescheduling 0 920 354 Paris Club rescheduling 0 626 66 Other proposed rescheduling 0 0 3 Increase in other arrears 631 1,077 1,155

Financing gap 0 0 0 0 December 1993 ERD-I PAAD 47

Exports (FOB) by Major Category (Millions of 1992 Dollars)

1990 1991 1992

Traditional 278 217 169 Coffee 76 37 45 Cotton 40 46 26 Sesame 7 7 5 Sugar 41 32 22 Molasses 2 3 5 Meat 61 38 40 Seafood 9 13 17 Bananas 29 29 10 Gold 15 10 0 Silver 0 0 0

Non-Traditional 73 65 55 Agricultural 20 18 19 Industrial 53 47 36

Total 352 282 224

Sector elements may not sum to sector totals due to rounding. 48 ERD-I PAAD December 1993

Imports (CIF) by Major Category (Millions of 1992 Dollars)

1990 1991 1992

Consumption 169 229 292 Non-durables 137 183 243 Durables 32 46 49

Petroleum 131 118 116 Petroleum 112 100 97 Derivatives 19 17 19

Raw Materials and Intermediates 169 228 234 Agriculture 37 46 18 Industry 110 153 178 Construction 21 29 38

Capital 210 196 214 Agriculture 13 14 14 Industry 84 96 120 Transportation 113 86 80

Various 0 0 1

Total 678 771 858

Elements may not sum to totals due to rounding. December 1993 ERD-I PAAD 49

Monetary Accounts of the Financial System

C$5 per US$ C$6.3 per US$ actual prel. prel. prel. Dec. Dec. Increase Dec. Aug. Increase 1991 1992 1991-92 1992 1993 1992-93

(C$ millions) (%) (C$ millions) (%)

M3 1271 1649 30% 1855 2078 12% Foreign Currency Deposits 365 564 55% 707 899 27% M2 906 1086 20% 1148 1179 3% Saving Deposits 183 245 34% 307 361 18% M1 723 841 16% 841 818 -3% Currency 398 469 18% 469 405 -14% Demand Deposits 325 372 14% 372 413 11% less Net International Reserves 630 635 1% 796 167 -79% equals Net Domestic Assets 641 1015 58% 1059 1911 80%

(Elements may not sum to totals due to rounding.)

Notes: M1 equals Currency plus Demand Deposits. M2 equals M1 plus Saving Deposits. M3 equals M2 plus Foreign Currency Deposits. Net Domestic Assets is defined as M3 less Net International Reserves. 50 ERD-I PAAD December 1993

Consumer Prices and Wage Rates

% Change from Previous Month Wage CPI Rates

Dec 91 -0.1% 1.9% Jan 92 1.1% 1.0% Feb 92 -0.7% 2.3% Mar 92 0.0% 2.0% Apr 92 0.5% 2.2% May 92 1.5% 0.4% Jun 92 -0.9% 1.6% Jul 92 -0.9% 0.7% Aug 92 -0.5% 0.5% Sept 92 -0.2% 0.3% Oct 92 1.2% 0.8% Nov 92 1.9% 0.4% Dec 92 0.4% 0.4% Jan 93 9.3% 2.8% Feb 93 7.8% 0.7% Mar 93 -0.3% 0.8% Apr 93 -0.2% 0.0% May 93 1.0% 1.5% Jun 93 0.9% 0.0% Trend (annual rate by regression) 12/91-6/93 16.7% 12.3% December 1993 ERD-I PAAD 51

Fiscal Balance: Non-Financial Public Sector (% of GDP)

prel. proj. 19771 1988 1989 1990 1991 1992 993 Total revenue 22 22 28 19 27 32 33 Tax revenue of general govt. na 21 25 16 23 27 26 Operational surplus of utilities na .0 0 1 1 2 5 Nontax revenue na 1 2 1 2 2 2 Current transfers na 0 0 0 0 0 0 Capital revenue 2 0 0 0 0 0 0

Total Expenditure 32 48 34 47 35 41 41 Current expenditure 17 41 30 46 29 30 26 Capital expenditure & net lending 15 7 4 2 6 12 15 Fixed capital formation na 4 3 1 5 10 10 Financial investment na 0 0 0 0 0 0 Capital transfers na 3 1 0 0 1 5 Net lending na 0 0 0 1 1 0

(Current account surplus or deficit) 3 -19 -2 -27 -3 2 7

Overall deficit before grants -10 -26 -6 -28 -8 -10 -8

Foreign grants 0 1 3 15 13 6 7

Overall deficit after grants -10 -26 -3 -14 5 -4 -0

Financing 10 26 3 14 -5 4 1 External financing na 1 0 0 1 13 3 Internal financing na 25 3 14 -5 -9 -3

(Elements may not sum to totals due to rounding.)

Note: The projection for 1993 does not include adjustments currently under discussion.

6p 52 ERD-I PAAD December 1993

Fiscal Balance: Total Public Sector (% of GDP - Before Grants)

prel. proj. 1988 1989 1990 1991 1992 1993 Overall balance -34 -20 -31 -9 -11 -9 Non-financial public sector -26 -6 -28 -8 -10 -8 Central government -27 -7 -29 -8 -9 -6 Rest of general government 0 1 0 1 1 1 Public Utilities 0 -1 1 -1 -3 -2 Intragovernmental transfers 0 -0 0 0 0 0 Central bank losses -8 -14 -3 -1 -1 -1

Note: The projection for 1993 does not include adjustments currently under discussion. December 1993 ERD-I PAAD 53

Statutory Checklist 54 ERD-I PAAD December 1993

ASSISTANCE CHECKLIST

Listed below are statutory criteria applicable to the assistance resources themselves, rather than to the eligibility of a country to receive assistance. This section is divided into two parts. Part A includes criteria applicable to both Development Assistance and Economic Support Fund resources. Part B includes criteria applicable only to Economic Support Funds.

CROSS REFERENCE: IS COUNTRY CHECKLIST UP TO YES DATE?

A. CRITERIA APPLICABLE TO BOTH DEVELOPMENT ASSISTANCE AND ECONOMIC SUPPORT FUNDS

1. Host Country Development Efforts (FAA Sec. Access to U.S. dollars for imports 601 (a)): Information and conclusions on whether assis- of capital goods will increase tance will encourage efforts of the country to: (a) incr- trade, foster private initiative, and ease the flow of international trade; (b) foster private will improve technicjl efficiency of initiative and competition; (c) encourage development industry, agriculture and commer­ and use of cooperatives, credit unions, and savings and ce. It will also discourage monop­ loan associations; (d) discourage monopolistic practices; olistic practices. (e) improve technical efficiency of industry, agriculture, and commerce; and (f) strengthen free labor unions.

2. U.S. Private Trade and Investment (FAA Sec. Nicaraguan importers will buy 601 (b)): Information and conclusions on how assis- cash transfer dollars to purchase tance will encourage U.S. private trade and investment commodities from US private sup­ abroad and encourage private U.S. participation in pliers, hence increasing U.S. trade foreign assistance programs (including use of private abroad. trade channels and the services of U.S. private enter­ prise).

a. General requirement (FY 1993 Appropriations Act The Congress will be notified Sec. 522; FAA Sec. 634A): If money is to be obligated through the normal Congressional for an activity not previously justified to Congress, or Notification process prior to obli­ for an amount in excess of amount previously justified gating funds for this activity. to Congress, has Congress been properly notified (unless the Appropriations Act notification requirement has been waived because of substantial risk to human health or welfare)?

b. Notice of new account obligation (FY 1993 Appropriations Act Sec. N/A 514): If funds are being obligated under an appropriation account to which they were not appropriated, has the President consulted with and provided a written justification to the House and Senate Appropriations Committees and has such obligation been subject to regular notification procedures?

c. Cash transfers and nonproject sector assistance (FY 1993 Appropri- The Congres­ ations Act Sec. 571 (b)(3)): If funds are to be made available in the form sional Notifica­ of cash transfer or nonproject sector assistance, has the Congressional tion will provide December 1993 ERD-I PAAD 55

notice included a detailed description of how the funds will be used, with this informa­ a discussion of U.S. interests to be served and a description of any tion. economic policy reforms to be promoted?

4. Engineering and Financial Plans (FAA Sec. 611(a)): Prior to an N/A obligation in excess of $500,000, will there be: (a) engineering, financial or other plans necessary to carry out the assistance; and (b) a reasonably firm estimate of the cost to the U.S. of the assistance?

5. Legislative Action (FAA Sec. 611 (a)(2)): If legislative action is required N/A within recipient country with respect to an obligation in excess of $500,000, what is the basis for a reasonable expectation that such action will be completed in time to permit orderly accomplishment of the purpose of the assistance?

6. Water Resources (FAA Sec. 611 (b); FY 1993 Appropriations Act Sec. N/A 501): If project is for water or water-related land resource construction, have benefits and costs been computed to the extent practicable in accor­ dance with the principles, standards, and procedures established pursuant to the Water Resources Planning Act (42 U.S.C. 1962, et seq.)? (See A.I.D. Handbook 3 for guidelines.)

7. Cash Transfer and Sector Assistance (FY 1993 Appropriations Act Yes Sec. 571 (b)): Will cash transfer or nonproject sector assistance be main­ tained in a separate account and not commingled with other funds (unless such requirements are waived by Congressional notice for nonproject sector assistance)?

8. Capital Assistance (FAA Sec. 611 (e)): If project is capital assistance N/A (e.a., construction), and total U.S. assistance for it will exceed $1 million, has Mission Director certified and Regional Assistant Administrator taken into consideration the country's capability to maintain and utilize the project effectively?

9. Multiple Country Objectives (FAA Sec. 601 (a)): Information and N/A (A cash conclusions on whether projects will encourage efforts of the country to: transfer is not (a) increase the flow of international trade; (b) foster private initiative and considered a competition; (c) encourage development and use of cooperatives, credit project.) unions, and savings and loan associations; (d) discourage monopolistic practices; (e) improve technical efficiency of industry, agriculture and com­ merce; and (f) strengthen free labor unions.

10. U.S. Private Trade (FAA Sec. 601(b)): Information and conclusions N/A (A cash on how project will encourage U.S. private trade and investment abroad transfer is not and encourage private U.S. participation in foreign assistance programs considered a (including use of private trade channels and the services of U.S. private project.) enterprise).

11. Local Currencies

a. Recipient Contributions (FAA Secs. 612(b), 636(h)): Describe N/A steps taken to assure that, to the maximum extent possible, the country is contributing local currencies to meet the cost of contractual and other 56 FFID-IPAAD December 1993

services, and foreign currencies owned by the U.S. are utilized in lieu of dollars.

b. U.S.-Owned Currency (FAA Sec. 612(d)): Does the U.S. own N/A excess foreign currency of the country and, if so, what arrangements have been made for its release?

c. Separate Account (FY 1993 Appropriations Act Sec. 571). If assistance is furnished to a foreign government under arrangements which result in the generation of local currencies:

(1) Has A.I.D. (a) required that local currencies be deposited in a When signed, separate account established by the recipient government, (b)entered into the Agreement an agreement with that government providing the amount of local curren- will include: cies to be generated and the terms and conditions under which the curren­ cies so deposited may be utilized, and (c) established by agreement the re- (a) Yes sponsibilities of A.I.D. and that government to monitor and account for (b) Yes deposits into and disbursements from the separate account? (c) Yes.

(2) Will such local currencies, or an equivalent amount of local Yes currencies, be used only to carry out the purposes of the DA or ESF chapters of the FAA (depending on which chapter is the source of the assistance) or for the administrative requirements of the United States Government?

(3) Has A.I.D. taken all appropriate steps to ensure that the equiva- The Agreement lent of local currencies disbursed from the separate account are used for will provide for the agreed purposes? these steps.

(4) If assistance is terminated to a country, will any unencumbered Yes balances of funds remaining in a separate account be disposed of for purposes agreed to by the recipient government and the United States Government?

12. Trade Restrictions

a. Surplus Commodities (FY 1993 Appropriations Act Sec. 520(a)): N/A If assistance is for the production of any commodity for export, is the commodity likely to be in surplus on world markets at the time the result­ ing productive capacity becomes operative, and is such assistance likely to cause substantial injury to U.S. producers of the same, similar or com­ peting commodity?

b. Textiles (Lautenberg Amendment) (FY 1993 Appropriations Act Sec. No 520(c)): Will the assistance (except for programs in Caribbean Basin Initiative countries under U.S. Tariff Schedule "Section 807," which allows reduced tariffs on articles assembled abroad from U.S.-made components) be used directly to procure feasibility studies, prefeasibility studies, or project profiles of potential investment in, or to assist the establishment of facilities specifically designed for, the manufacture for export to the United States or to third country markets in direct competition with U.S. exports, of textiles, apparel, footwear, handbags, flat goods (such as December 1993 ERD-I PAAD 57

wallets or coin purses worn on the person), work gloves or leather wearing apparel?

13. Tropical Forests (FY 1991 Appropriations Act Sec. 533(c)(3)(as No referenced in section 532(d) of the FY 1993 Appropriations Act): Will funds be used for any program, project or activity which would (a) result in any significant loss of tropical forests, or (b) involve industrial timber extraction in primary tropical forest areas?

14. PVO Assistance

a. Auditing and registration (FY 1993 Appropriations Act Sec. 536): N/A If assistance is being made available to a PVO, has that organization provided upon timely request any document, file, or record necessary to the auditing requirements of A.I.D., and is the PVO registered with A.l.D.?

b. Funding sources (FY 1993 Appropriations Act, Title II, under N/A heading "Private and Voluntary Organizations"): If assistance is to be made to a United States PVO (other than a cooperative development organization), does it obtain at least 20 percent of its total annual funding for international activities from sources other than the United States Government?

15. Project Agreement Documentation (State Authorization Sec. 139 (as This informa­ interpreted by conference report)): Has confirmation of the date of signing tion will be pro­ of the project agreement, including the amount involved, been cabled to vided once the State L/T and A.I.D. LEG within 60 days of the agreement's entry into agreement has force with respect to the United States, and has the full text of the agree- been signed. ment been pouched to those same offices? (See Handbook 3, Appendix 6G for agreements covered by this provision).

16. Metric System (Omnibus Trade and Competitiveness Act of 1988 Yes Sec. 5164, as interpreted by conference report, amending Metric Conversion Act of 1975 Sec. 2, and as implemented through A.I.D. policy): Does the assistance activity use the metric system of measure­ ment in its procurements, grants, and other business-related activities, except to the extent that such use is impractical or is likely to cause significant inefficiencies or loss of markets to United States firms? Are bulk purchases usually to be made in metric, and are components, sub­ assemblies, and semi-fabricated materials to be specified in metric units when economically available and technically adequate? Will A.I.D. specifications use metric units of measure from the earliest programmatic stages, and from the earliest documentation of the assistance processes (for example, project papers) involving quantifiable measurements (length, area, volume, capacity, mass and weight), through the implementation stage?

17. Women in Development (FY 1993 Appropriations Act, Title II, under N/A heading "Women in Development"): Will assistance be designed so that the percentage of women participants will be demonstrably increased?

18. Regional and Multilateral Assistance (FAA Sec. 209): Is assistance No more efficiently and effectively provided through regional or multilateral 58 ERD-I PAAD December 1993

organizations? If so, why is assistance not so provided? Information and conclusions on whether assistance will encourage developing countries to cooperate in regional development programs.

19. Abortions (FY 1993 Appropriations Act, Title II, under heading "Population, DA," and Sec. 524):

a. Will assistance be made available to any organization or program No which, as determined by the President, supports or participates in the management of a program of coercive abortion or involuntary sterilization?

b. Will any funds be used to lobby for abortion? No

20. Cooperatives (FAA Sec. 111): Will assistance help develop coopera- No tives, especially by technical assistance, to assist rural and urban poor to help themselves toward a better life?

21. U.S.-Owned Foreign Currencies

a. Use of currencies (FAA Secs. 612(b), 636(h); FY 1993 Appropria- N/A. No c6rdo tions Act Secs. 507, 509): Are steps being taken to assure that, to the bas are ownec maximum extent possible, foreign currencies owned by the U.S. are by the USG. utilized in lieu of dollars to meet the rost of contractual and other services?

b. Release of currencies (FAA Sec. 612(d)): Does the U.S. own No excess foreign currency of the country and, if so, what arrangements have been made for its release?

22. Procurement

a. Small business (FAA Sec. 602(a)): Are there arrangements to N/A permit U.S. small business to participate equitably in the furnishing of commodities and services financed?

b. U.S. procurement (FAA Sec. 604(a) as amended by section 597 of N/A the FY 1993 Appropriations Act): Will all procurement be from the U.S., the recipient country, or developing countries except as otherwise deter­ mined in accordance with the criteria of this section?

c. Marine insurance (FAA Sec. 604(d)): If the cooperating country N/A discriminates against marine insurance companiec authorized to do busi­ ness in the U.S., will commodities be insured in the United States against marine risk with such a company?

d. Non-U.S. agricultural procurement (FAA Sec. 604(e)): If non-U.S. N/A procurement of agricultural commodity or product thereof is to be fi­ nanced, is there provision against such procurement when the domestic price of such commodity is less than parity? (Exception where commodity financed could not reasonably be procured in U.S.)

e. Construction or engineering services (FAA Sec. 604(g)): Will N/A construction or engineering services be procured from firms of advanced December 1993 ERD-I PAAD 59

developing countries which are otherwise eligible under Code 941 and which have attained a competitive capability in international markets in one of these areas? (Exception for those countries which receive direct economic assistance under the FAA and permit United States firms to compete for construction or engineering services financed from assistance programs of these countries.)

f. Cargo preference shipping (FAA Sec. 603)): Is the shipping N/A excluded from compliance with the requirement in section 901 (b) of the Merchant Marine Act of 1936, as amended, that at least 50 percent of the gross tonnage of commodities (computed separately for dry bulk carriers, dry cargo liners, and tankers) financed shall be transported on privately owned U.S. flag commercial vessels to the extent such vessels are available at fair and reasonable rates?

g. Technical assistance (FAA Sec. 621 (a)): If technical assistance is N/A financed, will such assistance be furnished by private enterprise on a contract basis to the fullest extent private enterprise on a contract basis to the fullest extent practicable? Will the facilities and resources of other Federal agencies be utilized, when they are particularly suitable, not competitive with private enterprise, and made available without undue interference with domestic programs?

h. U.S. air carriers (International Air Transportation Fair Competitive N/A Practices Act, 1974): If air transportation of persons or property is fi­ nanced on grant basis, will U.S. carriers be used to the extent such service is available?

i. Termination for convenience of U.S. Government (FY 1993 Appropri- N/A ations Act Sec. 504): If the U.S. Government is a party to a contract for procurement, does the contract contain a provision authorizing termination of such contract for the convenience of the United States?

j. Consulting services (FY 1993 Appropriations Act Sec. 523): If N/A assistance is for consulting service through procurement contract pursuant to 5 U.S.C. 3109, are contract expenditures a matter of public record and available for public inspection (unless otherwise provided by law or Execu­ tive order)?

k. Metric conversion (Omnibus Trade and Competitiveness Act of N/A 1988, as interpreted by conference report, amending Metric Conversion Act of 1975 Sec. 2, and as implemented through A.I.D. policy): Does the assistance program use the metric system of measurement in its procure­ ments, grants, and other business-related activities, except to the extent that such use is impractical or is likely to cause significant inefficiencies or loss of markets to United States firms? Are bulk purchases usually to be made in metric, and are components, subassemblies, and semi-fabrica­ ted materials to be specified in metric units when economically available and technically adequate? Will A.I.D. specifications use metric units of measure from the earliest programmatic stages, and f'rom the earliest documentation of the assistance processes (for example, project papers) involving quantifiable measurements (length, area, volume, capacity, mass and weight), through the implementation stage? 60 ERD-I PAAD December 1993

I. Competitive Selection Procedures (FAA Sec. 601(e)): Will the N/A assistance utilize competitive selection procedures for the awarding of contracts, except where applicable procurement rules allow otherwise?

23. Construction

a. Capital project (FAA Sec. 601(d)): If capital (e.g., construction) N/A project, will U.S. engineering and professional services be used?

b. Construction contract (FAA Sec. 611 (c)): If contracts for construc- N/A tion are to be financed, will they be let on a competitive basis to maximum extent practicable?

c. Large projects, Congressional approvai (FAA Sec. 620(k)): If for N/A construction of productive enterprise, will aggregate value of assistance to be furnished by the U.S. not exceed $100 million (except for productive enterprises in Egypt that were described in the Congressional Presenta­ tion), or does assistance have the express approval of Congress?

24. U.S. Audit Rights (FAA Sec. 301 (d)): If fund is established solely by Yes U.S. contributions and administered by an international organization, does Comptroller General have audit rights?

25. Communist Assistance (FAA Sec. 620(h). Do arrangements exist to Yes insure that United States foreign aid is not used in a manner which, contrary to the best interests of the United States, promotes or assists the foreign aid projects or activities of the Communist-bloc countries?

26. Narcotics

a. Cash reimbursements (FAA Sec. 483): Will arrangements preclude N/A use of financing to make reimbursements, in the form of cash payments, to persons whose illicit drug crops are eradicated?

b. Assistance to narcotics traffickers (FAA Sec. 487): Will arrange- Yes ments take "all reasonable steps" to preclude use of financing to or through individuals or entities which we know or have reason to believe have either: (1) been convicted of a violation of any law or regulation of the United States or a foreign country relating to narcoti s (or other con­ trolled substances); or (2) been an illicit trafficker in, or otherwise involved in the illicit trafficking of, any such controlled substance?

27. Expropriation and Land Reform (FAA Sec. 620(g)): Will assistance Yes preclude use of financing to compensate owners for expropriated or nationalized property, except to compensate foreign nationals in accor­ dance with a land reform program certified by the President?

28. Police and Prisons (FAA Sec. 660): Will assistance preclude use of Yes financing to provide training, advice, or any financial support for police, prisons, or other law enforcement forces, except for narcotics programs?

29. CIA Activities (FAA Sec. 662): Will assistance preclude use of Yes financing for CIA activities? December 1993 ERD-I PAAD 61

30. Motor Vehicles (FAA Sec. 636(i)): Will assistance preclude use of Yes financing for purchase, sale, long-term lease, exchange or guaranty of the sale of motor vehicles manufactured outside United States, unless a waiver is obtained?

31. Military Personnel (FY 1993 Appropriations Act Sec. 503): Will Yes assistance preclude use of financing to pay pensions, annuities, retirement pay, or adjusted service compensation for prior or current military person­ nel?

32. Payment of U.N. Assessments (FY 1993 Appropriations Act Sec. Yes 505): Will assistance preclude use of financing to pay U.N. assessments, arrearages or dues?

33. Multilateral Organization Lending (FY 1993 Appropriations Act Sec. Yes 506): Will assistance preclude use of financing to carry out provisions of FAA section 209(d) (transfer of FAA funds to multilateral organizations for lending)?

34. Export of Nuclear Resources (FY 1993 Appropriations Act Sec. 510): Yes Will assistance preclude use of financing to finance the export of nuclear equipment, fuel, or technology?

35. Repression of Population (FY 1993 Appropriations Act Sec. 511): Yes Will assistance preclude use of financing for the purpose of aiding the ef­ forts of the government of such country to repress the leg;timate rights of the population of such country contrary to the Universal Declaration of Human Rights?

36. Publicity or Propaganda (FY 1993 Appropriations Act Sec. 516): Will No assistance be used for publicity or propaganda purposes designed to support or defeat legislation pending before Congress, to influence in any way the outcome of a political election in the United States, or for any publicity or propaganda purposes not authorized by Congress?

37. Marine Insurance (FY 1993 Appropriations Act Sec. 560): Will any N/A A.I.D. contract and solicitation, and subcontract entered into under such contract, include a clause requiring that U.S. marine insurance companies have a fair opportunity to bid for marine insurance when such insurance is necessary or appropriate?

38. Exchange for Prohibited Act (FY 1993 Appropriations Act Sec. 565): No Will any assistance be provided to any foreign government (including any instrumentality or agency thereof), foreign person, or United States person in exchange for that foreign government or person undertaking any action which is, if carried out by the United States Government, a United States official or employee, expressly prohibited by a provision of United States law?

39. Commitment of Funds (FAA Sec. 635(h)): Does a contract or agree- N/A ment entail a commitment for the expenditure of funds during a period in excess of 5 years from the date of the contract or agreement?

L-i 62 ERD-I PAAD December 1993

40. Impact on U.S. Jobs (FY 1993 Appropriations Act, Sec. 599):

(a) Will any financial incentive be provided to a business located in the No U.S. for the purpose of inducing that business to relocate outside the U.S. in a manner that would likely reduce the number of U.S. employees of that business?

(b) Will assistance be provided for the purpose of establishing or No developing an export processing zone or designated area in which the country's tax, tariff, labor, environment, and safety laws do not apply? If so, has the President determined and certified that such assistance is not likely to cause a loss of jobs within the U.S.?

(c) Will assistance be provided for a project or activity that contributes No to the violation of internationally recognized workers rights, as defined in section 502(a)(4) of the Trade Act of 1974, of workers in the recipient country?

B. CRITERIA APPLICABLE TO ECONOMIC SUPPORT FUNDS ONLY

1. Economic and Political Stability (FAA Sec. 531 (a)): Will this assistance Yes, Yes promote economic and political stability? To the maximum extent feasible, is this assistance consistent with the policy directions, purposes, and programs of Part I of the FAA?

2. Military Purposes (FAA Sec. 531 (e)): Will this assistance be used for No military or paramilitary purposes?

3. Commodity Grants/Separate Accounts (FAA Sec. 609): If commodities N/A are to be granted so that sale proceeds will accrue to the recipient coun­ try, have Special Account (counterpart) arrangements been made? (For FY 1993, this provision is superseded by the separate account require­ ments of FY 1993 Appropriations Act Sec. 571 (a), see Sec. 571 (a) (5).)

4. Generation and Use of Local Currencies 'FAA Sec. 531 (d)): Will ESF N/A. See 5.5. funds made available for commodity import programs or other program as­ sistance be used to generate local currencies? If so, will at least 50 percent of such local currencies be available to support activities consis­ tent with the objectives of FAA sections 103 through 106? (For FY 1S193, this provision is superseded by the separate account requirements of FY 1993 Appropriations Act Sec. 571 (a), see Sec. 571 (a)(5).)

5. Cash Transfer Requirements (FY 1993 Appropriations Act, Title II,under heading "Economic Support Fund," and Sec. 571 (b)). If assistance is in the form of a cash transfer:

a. Separate account: Are all such cash payments to Yes be maintained by the country in a separate account and not to be commingled with any other funds?

b. Local currencies: Will all local currencies that Yes, the agreement will specify may be generated with funds provided as a cash trans- the terms of local currency gen­ fer to such a country also be deposited in a special eration and management. account, and has A.I.D. entered into an agreement with December 1993 ERD-I PAAD 63

that government setting forth the amount of the local currencies to be generated, the terms and conditions under which they are to be used, and the responsibili­ ties of A.I.D. and that government to monitor and account for deposits and disbursements?

c. U.S. Government use of local currencies: Will all A portion of the local currency will such local currencies also be made available to the U.S. be made available to the USG for government as the U.S. determines necessary for the USG requirements and for support requirements of the U.S. Government, or to carry out to DA programs. development assistance (including DFA) or ESF purpos­ es?

d. Congressional notice: Has Congress received The Congress will be notified prior notification providing in detail how the funds will through the normal Congressional be used, including the U.S. interests that will be served Notification process prior to obli­ by the assistance, and, as appropriate, the economic gation of cash transfer funds. policy reforms that will be promoted by the cash transfer assistance?

6. Capital Projects (Jobs Through Exports Act of 1992, N/A Sec. 306, FY 1993 Appropriations Act, Sec. 595): If assistance is being provided for a capital project, will the project be developmentally-sound and sustainable, i.e., one that is (a) environmentally sustainable, (b) within the financial capacity of the government or recipient to maintain from its own resources, and (c) re­ sponsive to a significant development priority initiated by the country to which assistance is being provided. (Please note the definition of "capital project" contained in section 595 of the FY 1993 Appropriations Act.)

/, . u u aamm a m U **Ummm *a* Uhl mmESEm UNCLASSIFIED OUTGOING AGENCY FOR INT'L DEV TELEGRAM TELECOMMUNICATIONS CENTER PAGE II STATE 352407 209603Z 9267 031096 AIDI697 STATE 352407 200603Z 9267 031096 AID1697 ORIGIN AID-DO ESAF PROGRAM. THE RATIONALE FOR THIS DECISION RESTS IN ...... THE GON'S INFORMAL, GOOD-FAITH COMMITMENT TO PROPOSED ORIGIN OFFICE LAOR-03 FISCAL REFORMS AND THE POSSIBILITY THAT U.S. FUNDING WOULD INFO OL-01 LACE-O AALA-OI GC-0I GCLA-O1 FVPP-OI ES-0I PRPC-01 NOT ONLY LESSEN THE IMPACT OF EXISTING FISCAL REFORMS ON AAID-DI FHAA-D1 LADI-04 SEOP-O1 SETN-0I GEO-O1 FFP-D9 THE SOCIAL SECTORS, BUT COULD ALSO HELP TO WIN NICARAGUAN SERP-0I SECS-02 AMAD-01 FABP-02 LA[I-i LADP-04 PPCE-0I POLITICAL SUPPORT FROM THOSE CURRENTLY OPPOSED TO AN IMF LAV-DI PPOC-B1 /943 AD 20/0612Z PROGRAM. A-DAA NORMA PARKER ENCOURAGED BOTH A.I.D. AND ...... STATE TO PRESS THE IMF FOR MORE RAPID AND REASONABLE INFO LOG-D0 AGRE-00 AR-DO CIAE-00 DOOE-DO. EB-0O TRSE-00 NEGOTIATIONS WITH THE GON. 10031

DRAFTED BY: AID/LAC/UR/CEN&CAR:SALEXANDER:CABLE.ERD C. LOCAL CURRENCY GENERATION AND PROGRAMMING: AT THE APPROVED BY: AID/A-AA/LAC:NPARKER REQUEST OF THE A-DAA, USAID/NICARAGUA WILL REVIEW ITS LAC/CEN:DECKERSON (DRAFI LAC/DR/CtN&CAR:EZALLMAN (DRAFT) PORTFOLIO OF PROJECTS WHICH SUPPORT A NICARAGUAN SOCIAL LAC/DPP:JSTEPANEN (DRAFTI) LAC/DPP:MOTT (DRAFTI SAFETY NET (PARTICULARLY THE TITLE IIIPROGRAM AND THE PVO GC/LAC/RMEIGHAN WRAFT) LAC/CEN:LAYALDE (DRAFT) CO-FINANCING PROJECT), DETERMINE HOW TO BEST FILL IN GAPS LAC/CEN:HELLIS (DRAFT) IN COVERAGE, RECOMMEND A LEVEL OF ESF FINANCING FOR NEW ------075001 200604Z /36 REFEAT NEW OR ADDITIONAL SOCIAL PROJECTS, ESPECIALLY P 20060G1 NOV 93 TARGETTED INTHE NORTH, AND REPORT ITS RECOMMENDATIONS TO FM SECSTATE WASHDC AID/W WITHIN TWO WEEKS OF THE REVIEW. A LEVEL OF AT LEAST JW0AkEMBASSY MANAGUA PRIORITY SID MILLION WAS RECOMMENL:D TO THE MISSION AS BEING APPROPRIATE. MANAGEMENT AND MONITORING IMPLICATIONS OF UNCLAS STATE 352407 INCREASED NUMBER: OF SOCIAL SECTOR PROJECTS WAS TO BE INCLUDED IN THE MISSIONIS ANALYSIS. AIDAC

E.O. 12356: N/A D. CONDITIONALITY ON PROPERTY RIGHTS RESOLUTION: THE TAGS: CONDITION PRECEDENT WILL REQUIRE ISSUANCE BY THE MINISTRY SUBJECT: REVIEW AND AUTHORIZATION OF USAID/NICARAGUA OF FINANCEIS OFFICE OF COMPENSATION VALUATION lOCI)OF A ECONOMIC RECOVERY AND DEVELOPMENT PROGRAM (524-0333) CUMULATIVE TOTAL OF PROPERTY VALUATION RESOLUTIONS WHICH

I. SUMMARY: THE DAEC REVIEW OF THE USAID/NICARAGUA NAME 50 U.S. CITIZENS AS CLAIMANTS. THIS ISA NEW ECONOMIC RECOVERY AND DEVELOPMENT PROGRAM PAAD WAS HELD ON CONDITION ADDED AT THE TIME OF THE DAEC REVIEW BY ARA. OCTOBER 22, 1993. A-OAA NORMA PARKER CHAIRED THE MEETING WHICH WAS ATTENDED BY REPRESEN4TATIVES FROM LAC/DR, LAC/DPP, LAC/CEN, R&D, GC/LAC, LPA/LEG, STATE/ARA, E. A.I.D.'S STRATEGY FOR CONSULTING WITH CONGRESS: THE BUREAU, IN CONSULTATION WITH LEG AND STATE, WILL DEVELOP STATE/EB, AND TREASURY/OASIA. USAID/NICARAGUA WAS AN APPROPRIATE STRATEGY FOR SUBMISS10 OF THE REPRESENTED BY MISSION DIRECTOR JANET BALLANTYNE AND CONGRESSIONAL NOTIFICATION AND WILL ADVISE THE MISSION PROGRAM ECONOMIST JOE RYAN. THE PROGRAM WAS APPROVED AT A ACCORDINGLY. LEVEL OF DOL 40 MILLION, TO BE OBLIGATED AND DISBURSED IN TARNOFF ONE TRANCHE. THE MISSION MAY PROCEED TO OBLIGATE AND DISBURSE FUNDS UPON RECEIPT FROM AID/W OF NOTIFICATION THAT THE A-AA HAS AUTHORIZED THE PROGRAM AT THE $40 MILLION LEVEL, THE CONGRESSIONAL NOTIFICATION (CN) HAS BEEN RELEASED, AND ADVICE OF BUDGE; ALLOWANCE ISSUED. END SUMMARY.

2. DAEC DECISIONS

A. IMPACT OF BOP ASSISTANCE: DESPITE THE DIFFICULT AND UNCERTAIN SITUATION INNICARAGUA, VERY SLOW PROGRESS IN

ACHIEVING A POLITICAL RESOLUTION, AND THE SUBSTANTIAL POSSIBILITY THAT NO FURTHER ESF WILL BE ALLOCATED TO SUPPORT THE LRD PROGRAM, THE REVIEW COMMITTEE ENDORSED THE PAADIS RECOMMENDATION T0 PROVIDE THE FULL 140 MILLION. THIS DECISION REFLECTS THE IMPORTANCE OF PROTECTING CUMULATIVE U.S. INVESTMENT INNICARAGUA, AS WELL AS THAT OF PROVIDING NICARAGUA A BRIDGE TO POTENTIAL LARGER FINANCING PACKAGES FROM THE IFIS.

B. RELATIONSHIP OF BOP ASSISTANCE TO MULTILATERAL DONOR FUNDING: THE REVIEW COMMITTEE CONCURRED WITH THE PAAD RECOMMENDATION TO PROCEED WITH DISBURSEMENT OF FUNDS

DESPITE UNCERTAINTY REGARDING IMF NEGOTIATIONS FOR A NEW

UNCLASSIFIED AGECA... . PARA . U.S. AGENCY FOR INTERNATIONAL DEVELOPU'-,

ermtb. Maragua USAID Apart_& sPtstPplte C-67,U UWit 2112 Box 9 1ZP 13 APO AA 34021 - ZPI

DATE: 16 November 1993

TO: W. Stacy Rhodes, A/AAILAC FROM: Janet Ballantyne, vI./USAID Nicaragua SUBJECT: Local Currency Uses Under ERD-I Progran

zillion in PURPOSE: This memorandum proposes the use of $5.0 million ESF local currency to be derived from the FY 93 $40.0 Economic Recovery and Development Program (524-0333). the DISCUSSION: On October 22, 1993 the DAEC rGviewed PAAD for the F! 93 $40.0 mil2.ion ESF Economic USAIDijicaragua review the Recovery and Developnent (ERD) program. During x-hat suggested that the USAID/Nicaragua Mission attempt to DAEC derived from progrem a minimum of $10 million of local currency activities in aroa of high social this program for development a: and need in Nicaragua. This memorandum proposes how conflict could be p ERD-generated local currency package of $5.0 million together, pending certain details. and At tha time of the PAAD review, i s-ate6 that programming an af'ditional local currency progran of =;his ragnitude manauing ERD would be difficult during the timefraze concemplated for disbursement. My concerns covered three areas:

-- the nature and level of on-going and progra-med USAID-financed social programs; c- -- the absorptive capacity of the Gcver..ent NHicaragua (GON), appropri:a-e .in-covern-z~al organizations, and regiszered pr:vate vun: crganizations (PVO s) To effec:--vy uzi-:ze :--4-itional .ccal currency a- tis ti-e; _nZ

the -management capabi-t. of .SAIDi:aC-_- to assu-E addition.1 progran anr a -ur , r-_....- i~ V . a new local currency prcqrB- a- -.s t--= Thi-- maeor.ndiur 'il1 disc.:s a. .. : ------_5

I re li O -.n e . l n~qeflhC IO- ",I - 01. .." 05 -2 (L oC,C ' Fal ,. Lccl No. - 670502. 670503. 6705 4 674028, 67429. 674C30 BEST AVAILABLE DOCUMENT 2 1. Nature and Level of On-Going and Programmed USAID/Nicaragua financedSocial Programs. It is important to recognize that USAID/Nicaragua has significa: involvement in the social sectors and is actively addressing th, needs of the poor in Nicaragua through various-elements of the ongoing portfolio. These -programs are heavily oriented towards local institutans and PVOs.

Attachment 1 shows the level of USAID social.programs -- past, present, and planned. t.hese total nearly .$208 million from 199( when the USAID Hissici to'Nic&ragua opened, through FY 1994.

-- Of this amount, $68.0 million corresponds to programs that are currently underway in the five key areas of health, population, employment generation, education, and agricultural technology transfer. -- An additional $38.1 million is programmed in these same areas for FY 94, using both DA funds as well as local currency derived from PL 480 Title III (corresponding to FYS 93 and 94). 2. Limits on Absorptive capacity for Additional Local Currency. GON Social Programs. Since both the major social sector programs, Decentralized Health and Basic Education, are adequately funded from DA sources, the two potential GON users c additional local currency are the Social and Economic Investment Fund (FISE) and the Communal Employment Program of the Ministry of Social Action (MAS).

-- FISE. In meetings with FISE management, USAID was told that it is already "oversubscribed" by donors for Fys 94 and 95. Beside the $11.0 million in PL 480 Title III local currency that USAID intends to provide, FISE will also receive over the next two years $17.0 million from the Inter-American Development Bank, $25.0 million from the World Bank, and additional funding from both the Swedish and Carman economic assistance programs. USAID asked if there was a possibility for FISE to set up a special program of public works in Regicns I and VI (areas of high social confllict and povert and we were told tha FISE aread concentrating efforts in those areas and could not absorb additional resources unless USAID could sinultaneously ay additional FSE operating expenses, including gove!- ent salaries.

-- YS. The ,-'inistr\. of So:' Ac-ic- s recnt1V S Co:nn .....Empoymen .z " :. p vs

BEST AVAILABLE DOCUMENT 1K,/ 3

unskilled laborers approximately US$12fweek for part time work. Funds are distributed through local mayors. At this time MAS does not have an accountability structure in place that would permit the use of USAID funds. The Mission will bring in a technical assistance team later this year to work with MAS to set up such a structure so that an estimated $3-0 million in P, 480 Title III local currency can be provided to support its*programs in Regions I and VI. Tf this ic successful, this would be an additional GON institution through .which future local currency funds could be channeled, but it is unlikely that USAID will be able to make this technical judgement until mid-1994.

3. Management Capability of USAID/Nicaragua. Given the nature of the ongoing USAID programs, the Mission is tightly stretched in terms of personnel and management capability and is facing an uncertain future in terms of both FTE personnel levels and operating expenses. We have been told that instead of receiving additional. PTE positions, as requested in last year's Action Plan, that we must reduce from 26 Y-1E to 22 FTE by 1995 and we are preparing to absorb these cuts. Until the Agency'E overall "right-sizing" exercise is completed, including a review of FSN/PSCs, TCNs, and USPSCs, we will not know what the internal management capacity of USAID/Nicaragua will look like over the next year or so. On top of this there is the Operating Expense budget uncertainty. The Mission cannot plan to expand its operations in the absence of firm knowledge of what future years OE budgets will look like. A significantly expanded local currency program, using ERD funds, will simply require additional USAID personnel. Guidance fron the IG clearly indicates that the management and financial/accountability oversight responsibilities of the USAID Mission are significant. It is perhaps worthwhile to note how the inclusion of the new FY 93/94 PL 480 Title !7 local currency program has affected both GON and USAID employee needs. In order to adequately monitor this program, the GCn has set up a new Secretariat in the Ministry of Finance which will conain six additional employees. The USAID Mission will need two additional PSC positions, one in the Office of Financial Management and cne i:n the General Development Office.

PROPOSED'USES OF ERD LOCAL CURRENCY: USA'AIDi.icaracq~a tool: seriously the sugest-ion c Uj.C a -r-um 5 5iC,.0 riil. - it. local currenc. fro-. tne ERD-- prra- -c exPand- u-on social proaran..s ,in a,'ras c 1±z ccnf; c-ct icaragua.

, The zotal ER- Lcca, 'e .:.- L'7-r :.isj r

BEST AVAILABLE DOCUMENT 4 programmatic responsibility,.is approximately $5.0 million anC even this amount remains subject to receipt of actual proposals.

(1) $800,000 in local currency in order to extend the mandate oi the Atlantic Coast Zconomic Reconstruction Program (ACER) to assume responsibility for rehabilitation of the Puerto Cabezas­ Rovita-Siuna road. Currently it takes up to 15 days for land *transport from Managua to Puerto Cabezas, given the difficulties of transitting the Puerto Cabezas-Rosita-Siuna segment of the Journey. Rehabilitating this road, using high labor content techniques developed under the ACER/FISE program, :would reduce­ the transit time to three days or less, thereby contributing to. *Atlantic Coast development as well as facilitating small farmer access to markets.

NOTE: This will require a request from the Ministry of Construction and Transport (Ambassador and Ballantyne have discussed with Minister and are awaiting the Minister's response).

(2) $1.2 million in local currency to CIAV/OAS for its Self-Hel; Housing Construction Programs in areas of high social conflict. Under the agreement between the State De.artment and OAS to extend the CIAV/OAS program in Nicaragua, all USG funds ($9.2 million) are destined for programs of verification, protection, and strengthening human rights organizations. USG funds under provided this agreement cannot be used for programs of soclal welfare or reinsertion, or for administrative costs associated with these programs.

CIAV/OAS has proven its capability in the construction and supervision of low-cost self-help housing for former combatants. $1.2 million would allow CIAV to assist in the building ofover one thousand basic housing units in Regions 1 and VI. Since housing is one area where there is no an ongoing USAID program, nor is one contemplated, the Missicn believes that the CIAV self­ help housing construction program would be beneficial and additive to development efforts.

NOTE: This would also require an amendmenm to the STATE/OAS agreement to allow that agreement to finance the administrative costs for this local currency program nf CIAV/OAS to be charged to the STATE/OAS agreement (the currenz agreement does not allow this).

-3. $3.0 nillion in Jocal currency to corp!ce-.en7: the lission's on-goeng PVO CO-Financing Project.

In FY 94, L3AID expects to add an adz-i: 14. .1iicn-- zo prograns financing PV0 actvitie in- :Jc.::',:

A3EST AVAILABLE DOCUMENT 5 -- $5.1 million in DA funds, primarily to expand upon the ongoing PVO Co-Financing Project, which provides funding to U.S. PVOs working in Nicaragua;, -- $9.0 million in PL 480 Title III local currency, which will be used primarily to fund local Nicaraguan PVO and NGO programs. The Mission believes that an additional currency $3.0 million In local to meet local costs of U.S. based PVCs is both feasible and managerially possible given implementation arrangements already in place. This will also give the PVO Co-Financing program a "margin" in local currency in the event that dollar financing for future amendments Congress, to the project are held up in as well as allow for an actual increase in PVO activities. GON AND USAID MISSION MANAGEMENT: Finally, in order to program local currencies from ERD for project activities, necessary it will be to obtain Government of Nicaragua agreement to the mandate of broaden the Title III Secretariat to include ERD local currencies and build in new accounting and oversight systems for these resources. Should it not concur with GON would this approach, the have to develop a new unit to manage cash transfer local currencies. In either case the GON will have its management to increase staff. To responsibly manage ERD local currencies USAID will require an additional PSC position.

BEST AVAILABLE DOCUMENT USAID/Nicaragua Support for Social and Programs Programs that Target the Poor Obigations end Projcted Obligations

Dollar-funded Doller-funded FY 9-93 FY 00.93 Projocted FY-93 VTne III CCOMMEM) (ONGOWG) Projected FY-94 TOTAL for FY-94 Local Currency TOTAL Title III LC., FY 90-94 101.739.113"-68,070,110 13,168,628 10,000,000 15,000.000 HEALTH 207.977.761 16Z91.085 12,752,110 3.000.000 3.000.000 1.000-000 36.143.195 Immunization 2.500,000 MAINSArV0 Projects 1.000.000 1.00000 SILA/S 10,208,085 6,920,6384.831,472 2.000.000 Emergency 2_000,000 10000 10000 17.03S,5­6,500,O Supplies 3,683.000 1.3,5 8.920.638 POPULATION 3.683,000J 4.884,000 2_00,000 Profairvea 6.IW4.000 Contacptives 4.2:99,727 2000.000 584.273 Cer-al Funds EMPLOYMENT 6,299,727 584,273 3.6e3.028 29.684,000 2.584,264 5.000.000 11,000,000 51,931,292 FI-SE/Aantice Coast 27,684.000 4.000,000 7.000,000 PV0 Projects 3.663,028 ZOO000,0 MAS 2,584.264 1.000.000.1.24 1000.000 10.247.292,000 EDUCATION 3.000,000 13,900.000 IZ,500.000 3.000.000 3,000.0oo Z9.400,000 Emergency Textbooks 12.200.00o Basic Education Project 1.2o.000 12500.000 3.060.00o Vocational Education 1,700.000 12,200,000 TECHN LOGY 15.500000 TECHNOLOGY TRANSFER R/ NS ER 8.250.000 .700,000 2,584,264 2.000,000 Private 3.000,000 15.834.264 Ag Services Grants 3,000,000 PVO Projects .6,0 2.584,264 2.000.0005.250,000 3.000,00o 5,250,000 OTHER 10,584,264 SAFETY NET 67.7,785.000 Resertement Assistance 67.785,000 67.75,000 67.765,000

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