Caribbean & Central America - May 2018 (ISSN 1741-4458)

The most widespread civil unrest in decades, and the brutal response of the security forces, has exposed the Frente Sandinista de Liberación Nacional (FSLN) administration led by President Daniel Ortega to fierce international condemnation, ranging from the Vatican and the European Union (EU) to the White House. 

While Ortega quickly moved to repeal the unpopular reforms to the social security system (INSS) that ignited the discontent [see our sister publication Latin American Weekly Report for further discussion, WR-18-16] the protests have snowballed to include demands for a crackdown on corruption, democratic reform and even Ortega’s resignation. Corruption – including in the INSS itself – was a critical driver of the pent-up public anger at the government.

This could have serious implications for the government’s efforts to encourage much-needed foreign investment into the country under the banner of its low-cost, business-friendly and (to-date) stable operating environment.

Most significantly, following the robust US government response, Capitol Hill may now see fit to implement the Nicaragua Investment Conditionality Act (NICA), which would impose a damaging embargo on new multilateral lending, and could upset the externally-dependent country’s fragile financial stability.

Most observers think Ortega’s departure is unlikely at this point, albeit the situation remains volatile. He and the FSLN still wield very strong institutional control, including of the 92-member unicameral legislature, the judiciary, and the military. However, the country’s influential Catholic bishops and leading private sector chambers, including COSEP, have distanced themselves sharply from the presidential couple, signalling an unprecedented break in the longstanding working relationship between the FSLN government, the Church hierarchy, and the business sector.

As such, Ortega and the ruling FSLN now will be under intense pressure to move beyond the largely-cosmetic political reforms implemented to date – which were primarily aimed at preventing implementation of the NICA Act – towards more meaningful gestures in support of institutional change in the country.

With the protest movement emboldened, and the formal political opposition lacking space in the national assembly protracted civil unrest is now possible.

Nicaragua, Latin America’s second-poorest country in GDP per capita terms (after Haiti), has been one of the fastest growing economies in the region. Unlike his left-wing counterparts in Venezuela and Ecuador, Ortega has taken an orthodox macro-economic policy stance since returning to office in 2007, and has implemented a largely business-friendly administrative, legal and regulatory framework. The government works proactively to encourage Foreign Direct Investment (FDI).

While strategic ally Venezuela was a key economic and financing partner between 2007 and 2015/16, the Ortega government also made sure to maintain a reasonably diversified portfolio of external investors and trading partners, led by the US – traditionally the country’s main commercial partner. Annual FDI inflows have averaged US$874m since 2011, significantly up from just US$394m on average in 2005-2009.

Now that preferential cooperation from Venezuela has all but dried up, the country is heavily reliant on multilateral lending for its financing needs. Despite the drop in Venezuelan financing and cooperation, Nicaragua’s fiscal position was adjudged stable by the International Monetary Fund (IMF) in its latest review of the country in February. On the (preliminary) IMF estimates, the consolidated public-sector (CPS) deficit was stable at 2.5% of GDP in 2017. Total fiscal revenues (excluding grants) were worth around 28% of GDP, versus expenditures of almost 32%. As the Fund put it, “a continuing deterioration in the financial position of the INSS was partially mitigated by slightly lower budget deficits for the central government and the main municipality of Managua”.

Nonetheless, the Fund noted that it expected the CPS deficit to rise to 3.3% of GDP in 2018 – pressured by rising oil import costs – and with efforts to trim central government spending offset by planned capital expenditures elsewhere (largely on infrastructure and transport development, in support of the country’s bid for more foreign investment).

The national tax law was updated by the FSLN government in December 2014 to modernise and simplify the tax system, with changes to income and capital gains taxes and reforms to broaden the tax base and improve collection. Other recent adjustment measures have focused on better targeting electricity subsidies and eliminating some VAT exemptions.

The IMF noted that the authorities appeared “fully aware” of the need to create fiscal buffers for Nicaragua’s small, open and oil import-dependent economy. To this end, the aim was to trim expenditure, rationalise subsidies (largely for utilities) and – most importantly – reform the INSS.

The public-sector debt ratio was an estimated 42.6% in 2017, which, the Fund noted, is relatively high given the country’s limited debt servicing capacity. Largely comprising non-concessional lending from multilateral lenders, the IMF said it expected the ratio to remain stable, thanks to steady economic growth of about 4%, with no immediate payment risks on the horizon.

External ratings agencies agreed. In July 2017, Moody's reaffirmed its B2 rating for the sovereign, and improved its outlook to ‘positive’ from ‘stable’, citing “fiscal stability and favourable economic prospects relative to peers”, as well as “orthodox policy moves to protect against external risks”.

Yet political risk is never far away in Latin America, something the IMF and external agencies either fail to spot – or properly take account of – time and time again. And certainly, US approval of the NICA Act could result in substantial fiscal and balance of payments risk, as outlined below.

Investing in infrastructure

With significant multilateral support, Nicaragua has been investing heavily to improve its infrastructure, with a particular focus on transport. With a US decision on the NICA Act still up in the air, the Ortega government has been keen this year to quickly expedite approval of pending credits from regional and other multilaterals. On 10 April, the national assembly fast-tracked approval of a US$238m highway infrastructure loan from the Central American Bank for Economic Integration (Cabei) for instance, creating some consternation in the opposition about a lack of proper debate around the loan.

Box Deficit

As a fuel import-dependent country, Nicaragua has traditionally run a structural current account deficit of up to 10% of GDP. This, in turn, has been funded by multilateral lending and annual remittance inflows, also worth around 10% of GDP. More recently, rising FDI has also helped to finance the current account gap. Growing agricultural exports, rising tourism receipts and higher remittance earnings helped offset the impact of higher oil prices in 2017, allowing the current account deficit to decline sharply to 6.1% (from 8.6% in 2016), on IMF estimates. Growth in the maquila sector (which operate within Special Export Zones), as well as new mining developments, is also driving export growth. However, rising oil prices will weigh on import costs in 2018-2020, pushing the current account deficit back up. Thanks to its safe reputation (Nicaragua had the fourth-lowest homicide rate in Latin America in 2017), the tourism sector is going from strength-to-strength, underpinning a services account surplus. The transfers surplus, which rests on remittances, could be at risk of changes in US immigration policies. Absent these critical dollar inflows, Nicaragua would become even more dependent on international lending to finance its external deficit.

The controversial INSS changes, announced on 16 April, would have increased both worker and employer payments, lifting costs for the thousands of small and medium-sized companies (SMEs) that account for the vast majority of companies in Nicaragua, while reducing future pensions, sick pay, and maternity benefits. While the IMF has had regular access to Nicaraguan authorities and government policymakers under Ortega, it is unclear as to whether the Fund had any input into the particulars of the INSS reform in this instance. It has not commented on the latest political and social crisis in the country.

The intense public anger at the reform announcement was torch-lit by the fact that the INSS has been at the centre of extensive corruption problems since 2011, linked to the FSLN and Ortega’s cronies, resulting in a gaping black hole in the system. The proposed reform thus was not merely galling but, as it turned out, the final straw for many. Indeed, while the president was quick to retract the reform, it may yet come to be seen as a fatal political misstep by Ortega and his wife and powerful second-in-command, Vice President Rosario Murillo.

Young Nicaraguans – disillusioned and rebellious

To consolidate its fiscal position for the long term (and that of the INSS), Nicaragua will also need to better educate and gradually formalise its labour force, the IMF notes. Despite a young population and steady increases in primary and secondary education enrolment rates in recent years, vocational training and tertiary education levels remain quite low, and there are limited opportunities for new labour market entrants. While the government has sought to create employment through FDI, most positions are low skilled.

Moreover, the country’s minimum wage range is the lowest in Central America (the lowest rate in 2017 was US$123/month, for agricultural workers). Exacerbating this, the high rate of dollarisation in the country erodes real earnings.

The central bank (BCN) in October 2017 reported an official unemployment rate of just 3.8% but reported under-employment of 43.7%. And it is clear that the official youth unemployment rate of 10% would be higher but for emigration. Nicaragua’s labour informality rate is very high, at roughly 70%. According to COSEP, about 80% of businesses also operate informally.

Investors likely to steer clear

Mounting accusations of serious abuses against civilian protestors by the state security forces (and loyalist militant armed groups), almost certainly will result in legal actions at the Inter American Court of Human Rights (IACHR), risking lasting reputational damage to the government, and a curb on investor sentiment towards the country. It is also the case that any foreign businesses and investors that have signed deals with the Ortega government in recent years may also run the risk of being perceived as ‘complicit’ in unlawful or extra-judicial killings, potentially damaging their reputation in Nicaragua and elsewhere, and almost certainly deterring other investors from entering the country for now until the situation clears, and until the US position on the NICA Act is clarified.