Statement by Ramón Guzmán, Alternate Executive Director for El Salvador and Alvaro Umaña, Senior Advisor to Executive Director November 19, 2007

In 2007, imports of consumer, intermediate, and capital goods grew at annual rates slightly exceeding 10 percent. Export growth lagged behind that of imports, as buoyant nontraditional exports, rising at a 16 percent annual rate, were offset by stagnant exports of the maquila sector. In particular, the discussions centered on (i) spillovers from the United States to El Salvador and the associated risks; (ii) the short-term fiscal stance and its consistency with medium-term fiscal objectives; and (iii) the internationalization of the Salvadoran banking system.

Abstract

In 2007, imports of consumer, intermediate, and capital goods grew at annual rates slightly exceeding 10 percent. Export growth lagged behind that of imports, as buoyant nontraditional exports, rising at a 16 percent annual rate, were offset by stagnant exports of the maquila sector. In particular, the discussions centered on (i) spillovers from the United States to El Salvador and the associated risks; (ii) the short-term fiscal stance and its consistency with medium-term fiscal objectives; and (iii) the internationalization of the Salvadoran banking system.

On behalf of our authorities, we would like to thank staff for their policy advice and for the constructive discussions held within the framework of the Article IV consultation. El Salvador’s authorities broadly agree with the staff appraisal.

The economic and social performance of El Salvador during the last decade has been strong, supported by prudent policy management and a solid forward-looking strategy. The process of consolidating macroeconomic stability has advanced and structural reforms in a broad array of sectors have taken place, making the country one of the reform leaders in the region while at the same time improving the country’s social conditions. Poverty reduction has been impressive. In 1991 poverty level was at 60% and dropped by almost half to 31% in 2006. The country is committed to continue reducing poverty and meet the Millennium Development Goals (MDG’s) with innovative social programs such as Red Solidaria (solidarity network), Health Fund and the 2021 Education Plan, among others.

El Salvador’s proven track record of structural reforms is paying off. The economy has strong fundamentals and the country presents a sound investment environment. In 2007, the economy is expected to grow at an annual rate above 4.5 percent, the highest rate in a decade, and my authorities expect it to remain around 5 percent in the next few years. This growth is the consequence of good governance, well-designed economic policies including negotiation and implementation of free trade agreements (with United Stated, Mexico and Chile, among others), improvement in the business environment and many other successful government programs. Economic policies in recent years have resulted in increases in the share of nontraditional exports, agriculture, tourism and services. Remittance-financed consumption and higher private and public investment levels in high-impact infrastructure projects have also played an important role. Inflation, which peaked at 5.5 percent at the beginning of 2007 and fell back to around 4 percent recently, remains the lowest in the Central American region and among the lowest in Latin America. Consequently, the real effective exchange rate has remained broadly stable, in line with its fundamentals.

El Salvador’s current account deficit remained stable at 5 percent of GDP and it is expected to fall over the next years due to continued improvements in the fiscal growth of remittances, higher foreign direct investment and grants from the Millennium Challenge Account.

Our authorities are aware of the external risks related to a slowdown in the United States economy and continued higher oil prices in the international markets. Several internal factors favor the continuous strong performance of the economy, including a record level of both, public and private sector investment levels, the strong expansion of the tourism sector, increase in agricultural production, and the strong economic growth in the neighboring countries. Several new large-scale and broad-impact infrastructure projects will begin construction in 2008 such as public hydroelectric plants, private electric plants fueled by coal and gas in the eastern part of El Salvador, the conclusion of the construction and concession of La Union Port, the implementation of the Millennium Challenge Account grant in the northern part of El Salvador, which covers nearly one third of the country, among others.

As a result of the government’s commitment to fiscal discipline, the fiscal stance has improved in the last three years. Tax revenues to GDP have increased by 2.0 percentage points of GDP since 2004, which has permitted my authorities to expand public investment, to reduce the deficit from 4.4% of GDP in 2002 to 2.2% in 2007 and to reduce the total debt of the nonfinancial public sector from 40.6% of GDP in 2004 to 38.8% in 2007. For 2008, the budget presented to Congress envisages a further reduction of the deficit to 1.9 percent of GDP, a record level of public investment, and a further reduction of nonfinancial public sector debt to 37.7% of GD, without relying on any new financing from international markets.

In the future, the authorities will remain committed to fiscal consolidation while at the same time focusing on the poor. For that matter, the tax-to-GDP ratio will further increase in the next two years, placing debt on a firmly downward trend over the medium term. Further steps to enhance tax revenues and reduce evasion include enhancing auditing capacity, tightening control over large taxpayers, and improving further cross-checking systems and customs valuation procedures.

Private sector credit expanded by 9 percent in 2006 and 2007, participation of foreign banks in the financial system increased to 95 percent as a result of the sale of the three largest domestic banks. Our authorities are committed to accelerate financial sector reform, including the approval of new financial legislation. On this line, it is expected that this week Congress will approve a new securitization law.

The authorities will continue focusing on improving competitiveness through higher power generation and reduction of transportation costs to increase the economy resilience to external shocks, sustain economic growth and continue reducing poverty. Efforts will also continue to improve the business climate by reducing transaction costs and red tape and fighting crime and delinquency, and by enhancing the quality of the labor force and investing in people through higher allocations to education and health.

El Salvador: 2007 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for El Salvador
Author: International Monetary Fund