Nicaragua—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Managua, Nicaragua
November 19, 2002

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431
U.S.A

Dear Mr. Köhler:

1. We are enclosing with this letter the Memorandum of Economic and Financial Policies (MEFP) that underpins our economic program and poverty reduction strategy during 2002-05, and sets out specific objectives and quarterly targets for December 2002-September 2003.

2. In order to permanently eradicate extreme poverty from our country we must provide a proper stable macroeconomic framework to foster rapid growth in a context of low inflation and expand job opportunities to all Nicaraguans, mainly through private sector investment, production and exports. A sustained increase in output and employment generation will be the only way our people, particularly the poor, will have access to better food, health, shelter, and living standards.

3. President Enrique Bolaños' strong determination to make the program succeed and his decisive battle against corruption, makes this program different from others.

Specifically,

• Our poverty reduction strategy provides a safety net for the poorest and increased public sector expenditures in social sectors, but the ultimate solution in the combat against poverty is sustainable economic growth and a steady and adequately remunerated employment. We want Nicaraguans to feel pride and dignity, and that they are able to provide for themselves and their families with their own efforts.
  
  
• A reduction of the public sector deficit that will promote price stability and stimulate job creation in the private sector, not in the public sector. We want our tax system to be more equitable so as to reduce the burden on the working people. We are reducing wasteful public spending while ensuring that outlays to benefit the poor are increased and better targeted.
  
  
• Development and strengthening of the financial markets will also be addressed, including activities to ensure that banks are sound and properly supervised and regulated. The hard working public must be confident that their financial savings are secure and channeled to sound productive investments.
  
  
• Reducing the high level of external and domestic debt is a key element of our program. Reaching the HIPC completion point will be essential to obtain external debt relief and release needed resources to fight poverty. However, we need concessionary financing while fiscal reform and expenditure rationalization allow our public sector to reach a sustainable position. We also need technical and financial support to reduce our domestic debt overhang.

4. To support these objectives and policies, Nicaragua hereby requests a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) in a total amount equivalent to SDR 97.5 million (75 percent of the quota). The Government of Nicaragua also requests interim assistance under the HIPC Initiative in an amount equivalent to SDR 1.888 million, which will cover 33.2 percent of principal obligations falling due to the Fund between the date of the approval of the new PRGF arrangement and September 30, 2003.

5. The Government of Nicaragua stands ready to take additional measures that maybe appropriate for the achievement of the program's objectives. We will continue consulting with the Fund on its economic and financial policies, and will provide the Fund all necessary data on a timely basis for monitoring purposes. During the program period, the government will not introduce or intensify any exchange restrictions, introduce or modify any multiple currency practices, conclude any bilateral payments agreements that are inconsistent with Article VIII of the Fund's Articles of Agreement, or introduce or intensify import restrictions for balance of payments purposes. Consistent with its intention to keep the public informed about its policies and objectives, the government will publish the MEFP and will report periodically on progress under the program.

6. We propose that the IMF carry out reviews under the program in March 2003, June 2003, September 2003 and January 2004 based on the observance, respectively, of end-December 2002, end-March 2003, end-June 2003, and end-September 2003, quantitative and structural performance criteria established in Tables 2 and 3 of the attached memorandum.

7. We are confident that all the above actions will earn us the trust of the multilateral and bilateral community, but most importantly that it will reestablish the credibility of our own people in their country and in their government.

Sincerely yours,

Memorandum of Economic and Financial Policies

I. Background

1. The new government that took office in early 2002 inherited a situation of rapidly declining growth and increasing vulnerabilities. In 2001, real GDP growth slowed to about 3 percent, from almost 6 percent in 2000. The combined public sector deficit before grants was above 21 percent of GDP in 2001, while after grants it exceeded 14 percent of GDP, almost 6 percent of GDP higher than in 2000. As a result, net international reserves (NIR) fell by US$170 million in 2001, lowering gross international reserves to about 2.3 months of imports. In addition, the central bank issued dollar-indexed domestic debt equivalent to almost 20 percent of GDP to resolve problems in the banking system.

2. Against this background, the new government moved decisively to address economic imbalances. In particular, the authorities restrained public expenditures and, in July 2002, the National Assembly (NA) reduced the 2002 budget by 1.5 percent of GDP (about 3 percent of GDP on an annual basis). In addition, at the initiative of the executive, a tax package was approved by the NA in August 2002, which contained a significant reduction of import tariff exemptions; a reduction of income tax exonerations; an increase in the corporate income tax rate; and increases in retention rates. Although new zero-rated VAT products were added to the subsistence basket by the NA, the package is expected to yield some 2.1 percent of GDP in revenues on an annual basis.

3. As a result of these measures, the combined public sector deficit (after grants) has fallen in 2002. During January-September 2002 the deficit declined to 6.7 percent of annual GDP, compared with 8.8 percent of GDP in 2001, while total primary expenditures fell to 26.0 percent of GDP, from 28.2 percent of GDP during the same period of last year. In addition, the level of NIR and the domestic debt of the central bank have remained broadly constant during the first three quarters of 2002, despite the absence of balance of payments support.

4. As part of the efforts to strengthen the financial sector, all banks are required to comply with existing prudential norms and the Superintendency of Banks (SB) has concluded a second round of on-site assisted inspections. In particular, all banks are now required to comply with provisioning requirements (including for coffee-related loans) and capital adequacy requirements. In addition, new norms on fit and proper criteria for bank managers and main shareholders, as well as on conflict of interest, have been approved, in line with international best practices. Moreover, based on an international bidding process, the central bank has selected and publicly announced the firm that will carry out recoveries of assets received from intervened banks.

II. Medium-Term Policies

5. The main objective of the government's economic program for 2002-05 is to resume sustained rapid growth in a context of low inflation, while significantly reducing poverty. The authorities remain committed to the strategy presented in the PRSP, as updated in the PRSP progress report. This strategy aims at restoring fiscal and external sustainability; increasing spending on poverty-reducing programs in line with HIPC relief; accelerating the implementation of structural reforms directed at higher efficiency of public spending; and boosting foreign and domestic private investment.

6. An important goal of the new government is to improve governance and fight corruption. Several concrete steps to this effect have already been taken, including the approval of a new probity law for public functionaries; changes to the penal code to define crimes of public servants; and an anti-corruption initiative that has already achieved tangible and internationally recognized results. Also, a commission on judicial reform, with civil society participation, has prepared recommendations to strengthen the judicial system. Along these lines, a public procurement reform program has been launched and a new criminal procedures code is being implemented.

7. The government's main medium-term economic objectives are as follows:

8. The fiscal program envisages a reduction of the combined public sector (CPS) deficit (after grants), accompanied by an increase in poverty-reducing expenditures. The CPS deficit (after grants) is projected to fall from 9.2 percent of GDP in 2002 to 3-4 percent of GDP in 2005, an amount that is consistent with a sustainable level of concessional loans. Fiscal consolidation will be the result of raising revenue from 30.8 percent of GDP to 31½ percent of GDP between 2001 and 2005, while reducing primary expenditures from 43 percent of GDP to about 34 percent of GDP over the same period. The revenue increase will take place despite the loss of over 2 percent of GDP of revenues in 2003-04 due to the partial transfer of pension administration to the private sector. Under the program, poverty-related expenditures will reach about 17 percent of GDP by 2005, 4 percent of GDP higher than in 1998 (before the exceptional and unsustainable increase in spending associated with the Hurricane Mitch reconstruction efforts). Tracking mechanisms for poverty-reducing spending have been developed, and reports on the use of HIPC relief are being prepared.

9. The fiscal position is to be strengthened at both the revenue and expenditure sides. On the revenue side, a second stage of the tax reform will be implemented by mid-2003, which is expected to generate about 1.0 percent of GDP on an annual basis, and tax administration will be strengthened with the assistance of multilateral organizations to increase revenues by 0.6 percent of GDP by 2005. On the expenditure side, restraint, increases in efficiency and transparency, and a permanent reduction in current primary spending will add over 5.0 percent of GDP to public savings by 2005. To assist in this effort, a comprehensive public sector restructuring plan will be prepared in 2003, enhancing the efficiency of government while also improving public savings (by about 0.6 percent of GDP by 2005).

10. Monetary policy will be geared toward improving the financial position of the central bank in the context of low inflation. A gradual reduction of the central bank's domestic debt is a key objective of the program, in order to lower vulnerabilities and support higher economic growth over the medium term by providing the basis for increased commercial banks lending to the private sector. To achieve such reduction, the program envisages the recoveries of assets received from intervened banks and the increase of central government deposits at the central bank as a result of privatization proceeds, balance of payments support loans, and fiscal adjustment.

11. To strengthen the financial sector, the authorities are committed to enforcing strictly the existing prudential framework, and strengthening that framework further where necessary. In particular, the SB will implement a new norm to address banks' maturity mismatches, and is working to improve supervisory practices with technical assistance from multilateral organizations. By September 2003, the government will submit to the NA necessary amendments to bring the legal framework in line with the Basel Core Principles for effective bank supervision and to remove secrecy on banking assets.

12. Other key elements of the structural reform agenda are aimed at removing constraints to growth and achieving a sustainable external position. Trade liberalization and efforts to lower trade barriers with key commercial partners, including through a free trade agreement with the United States, and a customs union with the other Central American countries, are among the government's priorities. Programs to bolster market-based credit to small enterprises and the rural areas are being implemented with World Bank and IDB assistance. The government also plans to implement a new system of privately managed pension funds, and to reform the judicial system and the civil service.

13. In the context of the enhanced HIPC Initiative, the authorities will seek bilateral debt rescheduling agreements on Cologne terms and will strictly limit all new external assistance to grants and concessional loans, as prudent debt management is key to fiscal and external sustainability. As noted above, the government will seek to substantially reduce the nonconcessional dollar-indexed and dollar-denominated domestic debt of the public sector (including the central bank). To improve debt management the government is aiming to standardize the terms of domestically issued dollar-indexed or dollar denominated debt so as to make it more attractive to investors.

14. The crawling exchange rate peg has served Nicaragua well as an anchor to maintain low inflation. The authorities will aim at lowering inflation further in the medium term, supported by appropriate monetary, exchange rate, and fiscal policies. For the longer run, the authorities will continually reassess the effectiveness of the current exchange rate regime and its contribution to the objectives of low inflation and adequate external competitiveness.

III. The Program for 2002–03

15. To foster sustained rapid growth in a low-inflation environment, the program aims at maintaining macroeconomic stability by pursuing a prudent and transparent fiscal policy, gradually reducing the stock of domestic debt, strengthening the official reserves of the central bank, and increasing poverty-related spending. Real GDP growth is projected to increase from 1 percent in 2002 to 3 percent in 2003.

16. The program targets a reduction of the combined public sector deficit (after grants) from over 14 percent of GDP in 2001 to 9.2 percent of GDP in 2002, and to 6.3 percent of GDP in 2003. At the same time, the program aims at an increase in poverty-reducing spending to 15.8 percent of GDP by 2003, compared with 14.1 percent of GDP in 2001. In addition, the poverty spending profile will be strengthened by replacing measures that are not well targeted to the poor with well-focused programs.

17. In order to achieve the fiscal objectives laid out in the program and to strengthen the poverty-reducing strategy, draft legislation for the second stage of the tax reform will be submitted to the NA by March 2003. The package will be designed to significantly increase efficiency, equity and fairness of the tax system, while generating revenues of at least 1 percent of GDP on an annual basis. The government considers that in order to achieve these objectives, it is necessary to consider reducing the number of products subject to excises, eliminating import exonerations, and replacing zero-rated and exempted VAT products-which are costly and not well targeted to the poor-with direct and better-focused support programs to help the most vulnerable groups. In this connection, the government will work with the NA to facilitate a consensus on these issues. The authorities will reach detailed understandings with the staff on the tax reform package prior to its submission to the assembly. In addition, the structural benchmarks on the submission to the national assembly (March 2003) and approval by the national assembly of a tax package yielding 1 percent of GDP on an annual basis (June 2003), will be converted into performance criteria at the first review of the program.

18. On the expenditure side, the 2003 budget submitted to the NA contains primary outlays of 35 percent of GDP, compared with the unsustainable level of 43 percent of GDP in 2001. Should revenue collections during the year fall short of the indicative targets set out in Table 2, the government stands ready to implement offsetting measures, while protecting poverty-reducing spending.

19. Monetary policy will be guided by the objective of strengthening the position of the central bank in a low-inflation context (6 percent during 2003). During 2003, the authorities intend to maintain the crawling peg of the exchange rate at an annual rate of 6 percent. In addition, the program targets an increase of NIR (US$30 million), together with a reduction in the dollar-indexed and dollar-denominated domestic debt of the central bank (US$70 million). These targets are to be achieved mainly by the envisaged fiscal adjustment, decisive implementation of the recovery plan for assets received from intervened banks, the privatization program, and balance of payments support—together expected to yield about US$185 million during 2003.

20. The government is firmly committed to the implementation of the recovery plan for the assets received by the central bank from intervened banks, which is crucial for the success of the program. The central bank has recently selected, on the basis of a competitive bidding process, a firm with international experience in asset management to carry out these recoveries. Signature of the contract with the selected firm will take place in December 2002, and the implementation of the asset recovery plan will be completed by September 2003.

21. Strengthening the banking system is high on the government's agenda. As a critical step, full compliance with capital requirements by end-2002 is a central objective of the program. By mid-2003, draft legislation to remove bank secrecy on assets will be introduced, and new prudential norms to limit risks derived from maturity mismatches between assets and liabilities will be approved. Also by mid-2003, the SB will begin implementing regular on-site inspections for all banks and a new unit will be set up at FOGADE, the public deposit insurance agency, to manage and liquidate assets in the event of bank interventions.

22. Additional elements of the structural reform program include the sale of the remaining government stake in the telephone company; the start of an action plan to strengthen the judicial system (based on the recommendations made by the Judicial Reform Commission in 2002); modernization of the Comptroller's office (with technical assistance and financial support from the IDB); beginning the operation of the new pension system based on private pension fund managers; approval by the NA of laws on public sector borrowing; strengthening decentralized real estate registries (with World Bank assistance); and extending the coverage of the central government's single account to include all receipts, expenditures and financing. Also, the authorities are committed to the implementation of the recommendations of the Fund's Stage One safeguards assessment of the BCN.

23. Efforts are continuing to improve the statistical database with technical assistance from the Fund, IDA, the IDB, and U.S. AID. The BCN has prepared revised national accounts estimates in constant 1994 prices, which include more accurate data sources and will be adopted by March 2003 as the official figures. Work is ongoing (with technical assistance from the IMF) to improve the database and sectorization of banking sector accounts. This will result in a major improvement in the consistency between the monetary and fiscal sector statistics, and in the quality of data on credit for the private sector.

IV. Program Monitoring and Implementation Capacity

24. Implementation of the first annual program supported under the PRGF arrangement (October 2002-September 2003) will be monitored through reviews based on the observance of quarterly performance criteria and benchmarks (end-December 2002, and end-March, end-June and end-September 2003). Quantitative and structural performance criteria are presented in Tables 2 and 3, and defined in the attached Technical Memorandum of Understanding. Prior actions will be implemented at least five business days before Executive Board Discussion of the authorities' request for the PRGF arrangement. Completion of the first review under the PRGF arrangement in early 2003 will be conditional on reaching detailed understandings on an appropriate tax reform package. The second review will focus inter alia on the asset recovery plan. The third review will focus on of the adequacy of the tax reform package approved by the assembly. The authorities will also transmit to Fund staff all the necessary documentation required under the Fund's safeguard rules, prior to the Executive Board discussion.

Table 3. Nicaragua: Prior Actions, Structural Performance Criteria, and Benchmarks1
Measures			Expected Date of Implementation
I.	Prior Actions for Board Consideration of a PRGF Arrangement
1.	Submission to the national assembly of a 2003 budget for the central government, which together with the estimated yield of the 2003 tax package, is consistent with a combined public sector deficit (after grants) target equal or less than 6.3 of GDP.		End-October 2002
2.	Confirmation by the authorities of compliance by all commercial banks with prudential norms, including on coffee sector loans.		End-October 2002
3.	Public announcement of the selection of a reputable firm with international experience in asset management to implement asset recovery.		End-November 2002
II.	Performance Criteria
1.	Confirmation by the authorities of compliance by all banks with existing capital adequacy requirements.		End-December 2002
2. Asset Recovery Plan
	(i)	Signature of a contract with an international firm to implement asset recoveries.	End-December 2002
	(ii)	End of the asset recovery process.	End-June 2003
	(iii)	Conclude implementation of asset recovery plan for assets received from intervened banks.	End-September 2003
3.	Approval by the national assembly of a 2003 budget for the central government, which with the projected yield of the 2003 tax package, is consistent with a combined public sector deficit (after grants) target equal or less than 6.3 of GDP.		End-December 2002
III.	Benchmarks
1.	Submission to the national assembly of the law on domestic and external indebtedness of the public sector.		End-December 2002
2.	Submission to the national assembly of an appropriate 2003 tax reform package, in line with paragraph 17 of the MEFP, yielding 1.0 percent of GDP on an annual basis.		End-March 2003
3.	Approval of prudential norms to limit risks derived from maturity mismatches between assets and liabilities.		End-March 2003
4.	Publication and official adoption by the central bank of revised national accounts for 1994-2000.		End-March 2003
5.	Approval by the national assembly of an appropriate 2003 tax reform package, in line with paragraph 17 of the MEFP, yielding 1.0 percent of GDP on an annual basis.		End-June 2003
6.	Adoption by the general directorates of customs and revenue of an action plan to strengthen tax administration during the period 2003-2005.		End-June 2003
7.	Start implementing a plan for regular on-site bank inspections, in line with recommendations of MAE 2001 mission.		End-June 2003
8.	Submission to the national assembly of necessary legal amendments in line with Basle Core Principles for effective bank supervision.		End-September 2003
9.	Divest the remaining government stake in ENITEL.		End-September 2003
1The specific requirements for the implementation of these measures are specified in the Technical Memorandum of Understanding.

Nicaragua—Technical Memorandum of Understanding

1. This technical memorandum sets out the understandings between the Nicaraguan authorities and the Fund relating to the monitoring of the first-year program (October 2002-September 2003) of the Poverty Reduction Growth Facility (PRGF) arrangement. It defines the concepts used to assess compliance with quantitative and structural performance criteria and benchmarks specified in the Memorandum of Economic and Financial Policies (MEFP). It also sets the frequency of the data to be provided to the Fund for monitoring the program.

A. Fiscal Targets

2. Coverage of fiscal accounts

(i) Nonfinancial public sector (NFPS) includes the central government, the Nicaraguan social security institute, the municipality of Managua, and two public sector enterprises: the electricity company (operations of ENTRESA only) and the water and sewerage company (ENACAL).

(ii) Savings of the combined public sector (CPS) include the savings of the NFPS and the operating result (quasi-fiscal balance) of the Central Bank of Nicaragua (BCN).

(iii) The deficit of the CPS includes the deficit of the NFPS and the operating result (quasi-fiscal balance) of the BCN.

3. Interest on the domestic debt includes interest on a due basis, except for the cost of CENIS issued for bank resolution, which are shown on accrual basis (see Table 1).

Table 1. Financial Cost of Bank Resolution1 (In millions of cordobas)
	Accrual	Due	Adjustment
2001	720	0	720
2002	1,026	299	727
2003	910	849	61
2004	357	2,299	-1,942
1Corresponds to the interest and dollar-indexation cost associated with the issuance of CENIS due to the bank resolution implemented in 2000–01.

4. Interest on the external debt is presented on a due basis before HIPC debt relief.

5. Total primary expenditure of the central government is defined as the sum of wages and salaries, other goods and services, current transfers, and capital expenditure.

6. Savings of the CPS are defined as the difference between current revenue and current expenditure of the nonfinancial public sector, plus the operating result of the BCN.

7. Adjuster: The floor of the combined public sector savings will be adjusted upwards by the amount of additional revenues associated with delays in the implementation of the privately managed pension funds, assumed to take place at end-June 2003.

8. Net Domestic financing (NDF) of the CPS comprises the operating result of the central bank, the adjustment of the cost of the bank resolution from cash to accrual, and the change from their respective stocks at the end of the previous year of the sum of (i) outstanding stock of indebtedness of the nonfinancial public sector to the domestic financial system (central bank, commercial banks, and FNI) net of deposits (including arrears that correspond to obligations considered eligible for refinancing or rescheduling, or other debt reduction mechanism) with the foreign currency part of the net debt to the banking system converted into cordobas at the program exchange rate (of C$14.3 per U.S. dollar for 2002 and C$15.1 per U.S. dollar for 2003); (ii) outstanding stock of domestically-issued public sector debt held by resident and nonresident private sector with the foreign currency part converted into cordobas at the program exchange rate (of C$14.3 per U.S. dollar for 2002 and C$15.1 per U.S. dollar for 2003); (iii) outstanding stock of supplier credits; and (iv) outstanding stock of floating debt.

9. Adjusters: The ceiling on the cumulative NDF of the combined public sector will be adjusted: (i) upwards/downwards by up to US$25 million in the event of lower/higher privatization receipts and/or lower/higher disbursements of balance of payments support than the amounts shown in Table 3; and (ii) downwards (unlimited) in the event of additional revenues associated with delays in the implementation of the privately managed pension funds, assumed to take place at end-June 2003.

10. Deficit of the CPS (before grants). Defined as the savings of the combined public sector (as given in paragraph 6) plus capital revenue less capital expenditure and net lending of the nonfinancial public sector.

11. Reporting: The BCN will send to the IMF monthly electronic information on the detailed operations of the CPS. The monthly information will be provided within four weeks of the end of each month.

12. Calculation of HIPC relief for poverty-reducing expenditure. For program purposes, the amount of budgetary resources freed by HIPC debt relief for additional poverty spending will be calculated as the difference between the annual average of debt service paid between 1992 and 1998 and debt service after HIPC on a cash basis. This amount cannot be lower than the amount of HIPC relief delivered as grants.

B. Monetary Targets

13. Net international reserves (NIR) of the central bank. For program purposes, NIR is defined as the difference between the (i) gross foreign assets of the central bank that are readily available; and (ii) central bank's short-term reserve liabilities (including purchases and credits from the IMF), plus arrears on foreign debt service, plus foreign currency reserve requirement deposits of commercial banks at the central bank.

14. Readily available foreign assets of the central bank exclude those that are pledged or otherwise encumbered, including but not limited to reserve assets used as collateral or guarantee for a third-party external liability.

15. Net repayment of the domestic debt of the central bank. For program purposes, it is defined as the difference between new placements and redemptions of CENIs, TEIs, TELs, BOMEX, standardized letras and any other central bank paper held by institutions outside the central government, net of new issuance of central government paper. It also includes all domestically placed paper held by residents and nonresidents. This amount will be converted into U.S. dollar at the program exchange rate.

16. Adjusters: The net repayment of the domestic debt of the central bank will be adjusted: (i) upwards/downwards by up to US$25 million in the event of higher/lower privatization receipts and/or disbursements of balance of payments support for all quarters; (ii) upwards (unlimited) if proceeds from asset recovery are received during the first quarter of 2003; (iii) upwards/downwards by US$30 million in the second quarter of 2003 in the event of higher/lower than programmed asset recovery receipts; and (iv) upward/downward by US$15 million in the third quarter of 2003 in the event of higher/lower than programmed asset recovery proceeds. In addition, to the extent that the NIR target is exceeded, the domestic debt target will be adjusted downwards.

17. Net domestic assets (NDA) of the central bank are defined as the difference between the change in the stock of currency issued and net international reserves (as defined in point B.1) valued at the program exchange rate of C$14.3 per U.S. dollar for 2002 and C$15.1 per U.S. dollar for 2003.

18. Reporting: The BCN will send to the IMF (i) daily electronic mail containing information of actual daily accounts of the BCN (stocks and flows) at the beginning of the next working day; (ii) monthly electronic mail with information of actual monthly accounts of the BCN, commercial banks and FNI (stocks and flows), within four weeks of the end of the month; and (iii) actual quarterly accounts of the central bank, commercial banks, and FNI (stocks and flows) within five weeks of the end of the quarter.

C. Structural Measures

19. Confirmation by the authorities of compliance by all commercial banks with prudential norms, including on coffee sector loans requires that the authorities confirm in writing that all banks classify and provision their loans according to the current regulatory framework.

20. Confirmation by the authorities of compliance by all banks with existing capital adequacy requirements requires that the authorities confirm in writing that all banks and finance companies meet the Capital Adequacy Ratio (CAR) of 10 percent or that they are implementing a normalization plan, in line with existing regulations, to reach a 10 percent CAR within 90 days.

21. The plan for regular supervision of banking institutions should ensure an effective supervision, in line with recommendations of the 2001 MAE mission. It should include (i) the undertaking of a peer review of compliance with Basel Core Principles; (ii) the application of consolidated supervision procedures; (iii) the review of the on-site technical and administrative procedures, including the inspection manual, to bring them up to full compliance with best international practices; and (iv) the application of a framework for intensifying supervisory action, penalties, and regulatory actions for noncompliance with regulatory norms.

22. The requirement of a public announcement of the firm selected to manage the asset recovery will be considered met after the BCN makes a public announcement of a firm that has a proven track record in international asset management, and that has been selected following the terms of reference of the international public bidding process and in line with the procurement law.

23. The requirement to sign the contract with an international firm to implement asset recoveries will be considered met after the signature of a contract containing the following elements (i) provide incentives conducive to the sale of all assets at market-determined prices within the timeframe of the contract; (ii) put all assets received by the BCN at the disposal of the firm, with the only exceptions of claims that have been previously verified as fraudulent (assets or debtors that do not exist, or cases of identity fraud), assets sold or credits paid before the start of operations of the firm; (iii) allow the final sale decisions to be taken by the outsourcing firm; and (iv) provide contractual assurances for the firm to make decisions independently from any government agency.

24. End of the asset recovery process is understood as the full completion by the outsourcing firm of the tasks assigned in the contract.

25. Implementation of the recovery plan for assets received from intervened banks will be considered as concluded when the firm hired for assets liquidation has fully completed all the tasks assigned in the contract, and the BCN has received the payments for all sold assets. Additionally, all assets managed by the firm should have been sold, or transferred to the ministry of finance and taken out of the BCN accounts.

26. The public sector restructuring plan will aim at increasing efficiency and at a permanent reduction in current primary spending contributing on a cumulative basis to at least 0.5 percent of GDP in 2004, and 0.6 percent of GDP in 2005.

27. The action plan to strengthen tax administration will aim at increasing revenues on a cumulative basis by at least 0.1 percent of GDP in 2003, 0.5 percent of GDP in 2004 and 0.6 percent of GDP in 2005.

28. Publication of revised national accounts will be considered in compliance after the authorities adopt the revised GDP series for 1994-2000 as the official figures.

29. The changes to the legal framework in line with Basle's Core Principles of effective banking supervision will (i) introduce legal protection for supervisors (Principle 1); (ii) give supervisors the authority to review and reject any proposals to transfer significant ownership in existing banks to other parties (Principle 4); (iii) grant supervisors the ability to do supervision on a consolidated basis (Principle 20); and, (iv) grant supervisors adequate supervisory measures to bring about timely corrective action when, among other reasons, banks fail to meet prudential requirement (Principle 22). In addition, the revised legal framework will eliminate the Superintendency of Banks' restrictions on sharing information with similar institutions in other countries; and remove secrecy on bank assets.

30. To address weaknesses identified during the stage one safeguards assessment of the CBN, the authorities proposed the following timetable for the implementation of Fund's Treasurer's Department (TRE) recommendation during the first year of the program:

Table 2. Nicaragua: Safeguard Assessment-Timetable for the Implementation of Treasurer's Department Recommendations
Measures		Expected Date of Implementation
1.	Disclose the differences between International Accounting Standards (IAS) and the BCN reporting standards.	July 2003
2.	Internal Audit Department of the BCN reviews the process of reconciliation of the international reserves data on a quarterly basis.	December 2002
3.	Write off outstanding loans to central government agencies, which are long overdue or implement an action plan to recover these loans.	March 2003
4.	Submit amendment of the BCN Law to the National Assembly to enhance the specificity of existing provisions for the removal of BCN Board members from office.	September 2003

D. External Sector Targets

31. Borrowing on nonconcessional terms. For the purpose of the ceiling on the contracting of nonconcesional external debt of the NFPS and the BCN, external debt limits apply to the contracting or guaranteeing of nonconcessional external debt by the public sector¹ and the BCN or any other agencies on their behalf. This limit applies not only to debt as defined in Point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted by the IMF on August 24, 2000 (see Appendix) but also to commitments contracted or guaranteed for which value has not been received. External debt includes all current liabilities with a nonresident party, which are created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, at some future point(s) in time to discharge the principal and/or interest liabilities under the contract. This definition includes loans, suppliers' credits, and leases (operational and financial leases). The ceiling on contracting of nonconcessional external debt applies both to medium-and long-term debt defined as debt with maturity of one year or longer, as well as to short-term debt, defined as debt with maturity of less than one year. For program purposes, central bank instruments placed in the domestic market held by nonresidents, will be excluded from the ceiling on the contracting of nonconcessional external debt and included in the net repayment of the domestic debt of the central bank target.

32. Excluded from the ceiling on debt with a maturity of less than one year are import-related credits and central bank reserve liabilities. Borrowing from the Fund is excluded from the ceiling (maturities up to one year).

33. Concessionality will be based on a currency-specific discount rate based on the 10-year average of the OECD's commercial interest reference rates CIRR for loans or leases with maturities greater than 15 years and on the 6-month average CIRR for loans or leases maturing in less than 15 years. Maturity will be determined on the basis of the original loan contract. Under this definition of concessionality, only debt with a grant element equivalent to 35 percent or more will be excluded from the debt limits.

34. Reporting: A loan-by-loan accounting of all new loans contracted or guaranteed by the public sector, including detailed information on the amounts, currencies, and terms and conditions, as well as relevant supporting materials, will be transmitted on a quarterly basis within four weeks of the end of each quarter by the BCN.

35. External payments arrears. External debt-service arrears are defined as overdue debt service arising in respect of obligations incurred directly or guaranteed by the public sector, except on debt subject to rescheduling or restructuring.

36. Reporting: The accounting of nonreschedulable external arrears by creditor (if any), with detailed explanations, will be transmitted by the BCN on a monthly basis within four weeks of the end of each month.

E. Other Definitions

37. Privatization receipts are defined as payments received by the government in connection with the sale of state assets net of any fee. Privatization revenues in foreign exchange are those recorded as such in the balance of payments.

38. Balance of payments support. Official external untied financial assistance is defined as loans provided by foreign official entities that are received by the budget, excluding project/tied loans. The amounts assumed in the program consistent with this definition are shown in Table 3 attached.

39. Accounting of HIPC assistance. Interim HIPC assistance from multilateral creditors is identified as grants and shown in the public sector operations under grant revenues, and in the balance of payments table under current transfers. Interim HIPC debt relief from bilateral creditors is presented as exceptional financing in the public sector and in the balance of payments' tables.

Table 3. Nicaragua: Cumulative Program Financing (In millions U.S. dollars)
	Privatization	BOP Support	Asset Recovery
2002
Q4	15	43	4
2003
Q1	15	83	4
Q2	16	83	49
Q3	46	98	49
Sources: Fund staff estimates and projections.