Key View:

Nicaragua's real GDP will contract in 2018 due to declining private consumption, exports and investment as a result of the ongoing political crisis.

That said, the most intense period of unrest appears to have passed, suggesting that growth will begin to recover towards the latter months of 2018.

The crisis will be a long-term blow to investor confidence in Nicaragua, likely reducing the country's access to foreign capital and multilateral financing.

Forecast Changes

We forecast real GDP to contract 0.9% in 2018. This is a downward revision from our previous forecast for 3.2% growth, as the downside risks we highlighted in our last piece have played out ( see 'Protests Lead To 2018 Growth Downgrade', May 25).

In 2019 we forecast real GDP to return to growth at 3.9%, due in part to base effects.

We have revised down our long-term growth forecasts for Nicaragua, due to the impact of political unrest on investor interest in Nicaragua. We forecast average real GDP growth of 3.3% of GDP over the next decade, from 3.8% previously.

Real GDP Unlikely To Return To Pre-Crisis Trend Nicaragua - Real GDP, % y-o-y f = Fitch Solutions forecast. Source: BCN, Fitch Solutions

Nicaragua's political crisis will push the country into recession in 2018. Widespread protests, which began in April following a controversial reform of Nicaragua's social security system, ground economic activity to a halt across much of the country. Economic data from May, the first full month of protests, suggests that the economy is in the midst of a deep contraction; the IMAE economic activity index fell 4.9% y-o-y, while agricultural and manufacturing exports fell 5.9% and 6.2%, respectively. Media reports suggest that falling tourist arrivals have resulted in numerous hotel closures, while our Infrastructure team forecasts the construction sector will contract 5.8% in real terms in 2018 due to delays in project activity ( see 'Nicaragua: Unrest Leads To Downward Revision Of Construction Growth Forecast', August 6). We expect these trends continued in June and July.

Activity Trending Steeply Downwards Nicaragua - IMAE Economic Activity Index Source: BCN, Fitch Solutions

However, the country appears to have moved past the worst of the crisis. While Ortega remains highly unpopular and opposition protests continue, the most intense period of violence appears to have ended when Ortega's so-called "caravan for peace" removed barricades from roads across the country, particularly in the opposition stronghold of Masaya ( see 'Quick View: Government Victory In Monimbo A Blow To Opposition In Nicaragua', July 19). Media reports suggest that relative normalcy has returned to the country, and that many student leaders have been forced into hiding or have fled the country. Given this trend, our views assume that the worst of the unrest has ended, suggesting that growth will begin to recover by end-2018.

Risks to our forecast are weighted heavily to the downside. We acknowledge that the situation on the ground in Nicaragua is volatile, and our view that the worst has passed may prove to be incorrect. If the crisis deepens, we expect four major dynamics will further undermine economic growth:

Sanctions: Several top administration officials are under sanction from the US, and the OAS recently voted to create a working group to study the situation. However, an escalation in intensity would likely see heavier sanctions put in place, cutting the country off from private and multilateral lenders. This would be a heavy blow to the Nicaraguan government, which relies on these funds to finance investment in the economy given limited domestic resources.

Capital flight: Bank deposits declined 9.1% between the beginning of the year and end-July. If the country appears to be on the brink of a larger conflict, we expect to see an acceleration in capital flight. This would put pressure on the Banco Central de Nicaragua's ability to maintain the crawling peg of the cordoba, potentially spurring the government to put capital controls in place to stabilise the currency.

Outmigration: While the current unrest has already seen growing numbers of refugees fleeing to regional neighbours, the rate of outflows will accelerate the longer unrest drags on. This will undermine Nicaragua's labour force, particularly if migrants do not eventually return.

Outbreak of a civil war: We cannot rule out that unrest escalates into a full-blown civil war, which would see a sharp reduction in private consumption, investment, trade and tourism, and would also spark increased emigration.

The political tensions revealed by the protests will weigh on investor sentiment towards Nicaragua in the years ahead. Even if the worst of the protests have passed, it will likely take several quarters before foreign investors are willing to return to the country in earnest, given the risk that instability re-emerges. Additionally, repression of protestors and recent reports of land grabs targeting opponents of the Ortega regime will likely reduce confidence in the rule of law in the country. Most direct investment into Nicaragua is concentrated in the manufacturing sector.

We expect political risk to flare up again as the 2021 elections approach, particularly if Ortega's wife and Vice President, Rosario Murillo, elects to run, as has been rumoured. Anecdotal reports indicate that Murillo is as unpopular as her husband, if not more so, suggesting that her candidacy would provoke a strong backlash from the opposition. The likelihood of political unrest would be compounded if the legitimacy of the election were called into question, as happened during the 2016 presidential vote ( see 'Questions Over Legitimacy Will Bolster Opposition', November 7 2016).