El Salvador
2008 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for El Salvador

El Salvador’s 2008 Article IV Consultation examines the country's economic developments and policies. In 2007, the fiscal position improved, the public debt-to-GDP ratio declined, and economic growth reached its highest level in a decade. The rise in global commodity prices has also generated substantial inflation pressures. The stock of bank deposits has stagnated relative to end-2007, while deposit rates have increased slightly. Interbank repo rates have also risen recently, reflecting tighter funding conditions, and banks have increased their external borrowing, in part to build up liquidity.

Abstract

El Salvador’s 2008 Article IV Consultation examines the country's economic developments and policies. In 2007, the fiscal position improved, the public debt-to-GDP ratio declined, and economic growth reached its highest level in a decade. The rise in global commodity prices has also generated substantial inflation pressures. The stock of bank deposits has stagnated relative to end-2007, while deposit rates have increased slightly. Interbank repo rates have also risen recently, reflecting tighter funding conditions, and banks have increased their external borrowing, in part to build up liquidity.

I. Recent Developments

1. As a result of sustained economic reforms, El Salvador’s macroeconomic fundamentals are relatively solid. In 2007, the fiscal position improved, the public debt-to-GDP ratio declined, and economic growth reached its highest level in a decade.

2. Like in other Central American countries, however, economic growth has decelerated in recent months on the back of the U.S. slowdown and still high commodity prices. Growth in the monthly economic activity indicator has slowed to 3.6 percent in the 12 months to July. Demand has been squeezed by the increase in food and fuel prices. The impact of the U.S. slowdown has also started to show: remittance growth has fallen to 4.4 percent in the 12 months to August and, while export growth (particularly from coffee, maquila, and nontraditional sectors) has shown a marked upturn this year (accelerating to 16 percent y/y in August), it has started to falter in q/q terms. Moreover, imports have also grown fast (16 percent in the year to August), driven by oil prices. The external current account deficit widened to 5.5 percent of GDP in 2007, and reached 6 percent of 2008 GDP in the 12 months to June 2008.

3. The rise in global commodity prices has also generated substantial inflationary pressures. Headline inflation increased from 4.9 percent (y/y) in December 2007 to 8.7 percent in September. The main contributor was food inflation, which rose from 6.5 percent to 14.3 percent during the same period. Rising food prices are also considered to have been a major factor behind the 4 percentage point increase in the poverty rate in 2007 (to 35 percent), a development likely to have worsened in 2008. Several alternative measures of core inflation are trending up, suggesting some transmission of external price shocks to domestic prices, though there is no clear sign of overheating or cyclical demand pressures, in contrast to other countries in the region.

El Salvador: Consumer Price Inflation Measures

(In percent, last 12 months)

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Sources: Central bank of El Salvador; and Fund staff estimates.

Excludes items with inflation in the 10-percent tails of the distribution.

4. Political uncertainty and polarization have intensified in the run-up to the 2009 elections. Since the advent of democracy in the early 1990s, Salvadoran politics have remained polarized between the two main parties—the governing ARENA and the FMLN. Over the past few years, a split congress and a difficult political dialogue between the two parties have effectively prevented passage of legislation requiring a two-thirds majority, including on long-term domestic and external financing. With congressional and presidential elections scheduled for January and March 2009, respectively, the political focus has shifted to the elections. Even though the FMLN candidate has been ahead in the polls since the start of the campaign, most analysts expect the outcome of the presidential elections to be close.

5. The global financial turmoil, and possibly, electoral uncertainty, have led to some tightening in domestic financial conditions. The stock of bank deposits has stagnated relative to end-2007, while deposit rates have increased slightly. Interbank repo rates have also risen recently, reflecting tighter funding conditions, and banks have increased their external borrowing, in part to build up liquidity. Credit growth has slowed down. The central government has found it difficult to place its short-term debt instruments (especially those with maturities beyond the presidential election) in local markets, despite the relatively solid fiscal position. In mid-September, Standard & Poor’s revised down the outlook on El Salvador’s sovereign debt rating from stable to negative (the rating itself was maintained at BB+), based on the adverse impact of external shocks on growth, inflation, and the fiscal deficit, as well as political uncertainty. However, sovereign spreads (after rising considerably in July) have recently fluctuated in line with those of other Latin American emerging markets.

6. The banking system—mainly foreign-owned—remains well-capitalized and liquid, and has so far shown resilience to the global financial turmoil. Over the last two years, the three largest banks were acquired by foreign banks; about 95 percent of bank assets in El Salvador are now foreign owned. The banking system shows capital adequacy above the regulatory minima of 12 and is relatively liquid (with net liquid assets to short-term liabilities of 34.4 percent). Much of this liquidity is held at the central bank, which in turn invests it conservatively. However, with a rising share of consumer and housing loans in total credit, nonperforming loans (NPLs) have been on an upward trend since 2006. The impact of high commodity prices and slower remittance growth on borrowers’ income may also have played a role. Profitability levels fell in 2007, mainly on account of acquisition-related restructuring costs, and remain subdued due to rising NPLs.

Selected Financial Soundness Indicators for the Banking Sector, 2003–08

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Source: Superintendencia del Sistema Financiero

Data for 2008 correspond to August 2008.

7. The fiscal position improved substantially in 2007, but is being undermined in 2008 by the impact of high fuel prices on energy subsidies:

  • At 1.9 percent of GDP, the 2007 fiscal deficit was 0.3 percent of GDP better than the budget target, on account of continued strong revenue growth and some expenditure restraint. The 2007 primary balance, estimated at ½ percent of GDP, improved by 1 percent of GDP relative to 2006, leading to a further decline in public debt.

  • The public sector fiscal deficit for the seven months to July 2008 increased relative to the same period a year earlier, driven by higher spending on energy subsidies and government actions to mitigate the impact of food prices (see below). Strong revenue performance, particularly regarding income tax and VAT receipts, cuts in nonpriority spending, and some government measures to rationalize energy subsidies, have partly offset the deterioration in the operating surplus of public enterprises and the rapid increase in spending (see Box 1).

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Source: Ministry of Finance of El Salvador.

Public Sector Operations: January–July

(In million of dollars)

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Sources: Central Reserve Bank; and Ministry of Finance.

8. The government has actively responded to high commodity prices. Key measures include expanding Red Solidaria (a well-targeted conditional cash transfer program), increasing allowances for a tax credit program for middle-income families, eliminating import tariffs on wheat and agricultural inputs, delivering seeds and fertilizers for agricultural production, and granting a selective increase in wages of low-income public servants, with an estimated impact of about 0.2 percent of GDP in 2008. The cost of these measures and of energy subsidies has been met mainly through expenditure cuts on nonpriority spending and continued tax administration improvements. Additional measures were introduced in July; namely, a tax amnesty (with an estimated one-off fiscal impact of about 0.15 percent of GDP this year); a new tax on incoming international phone calls (which would yield about 0.2 percent of GDP per year); and the gradual elimination, in three steps starting in August 2008 and finishing in October 2009, of the electricity subsidy for the corporate sector, expected to improve the operational surplus of the public electricity company (CEL) by 0.2 percent of GDP in 2009 and 0.4 percent of GDP per year thereafter.

Energy Subsidies in El Salvador

Rising oil prices have led the cost of energy subsidies to almost double since end-2007 to an estimated 2½ percent of GDP in 2008.

Energy subsidies are funded mainly by profits of the state-owned electricity company (CEL) and the general budget. About half of the energy subsidies are associated with electricity consumption, one-third with liquid gas, and the rest with public transport:

  • Lack of adjustment of electricity tariffs has provided a subsidy to final consumers, funded by CEL. The tariff is currently US$91 MWH, compared to a market price of US$141 MWH. Since half of the electricity generation is fuel-based, the profits of CEL have been quickly eroding with rising oil prices.

  • Basic residential electricity consumption is also subsidized by the central government. For consumption below 99 KWH per month the central government’s budget covers 70 percent of the electricity bill. This subsidy is relatively inexpensive.

  • An administered price for liquid gas (LPG) by the government is in place for residential consumers. Though recently increased to US$0.491 per gallon, the market price is US$1.50 per gallon. Fund staff has estimated that only one-fifth of this subsidy goes to low-income households, and there are concerns about undue use of this subsidy by businesses and smuggling to neighboring countries.

  • Ceilings on tariffs for public transport are also established. To cover the difference between operating costs and bus fares, the government grants a subsidy to bus owners, which was doubled in June 2008 to US$800 per bus and US$400 per microbus per month. To partially fund this increase, the government passed a new tax on incoming international phone calls.

Initially, the government committed to maintaining energy subsidies until the March 2009 elections, but their increasing cost prompted the adoption of offsetting measures.

  • It increased the price of liquid gas by 23 percent last April, the first increase in 13 years.

  • It announced in July that the electricity subsidy for the nonresidential sector would be gradually phased out by October 2009.

A comprehensive reform strategy for energy subsidies, however, is needed to improve their efficiency and targeting. Such a strategy should eliminate the residential electricity subsidy beyond the basic consumption threshold and improve the targeting of LPG and public transport subsidies. This could lead to savings of about 0.8 percent of GDP.

II. Short-Term Outlook and Risks

9. Despite relatively solid macroeconomic fundamentals, the outlook for 2008–09 is clouded by a combination of external and domestic shocks.

  • The external environment is likely to remain difficult. Continued global financial turmoil is leading to tighter external financing conditions for banks and corporations1, which could further constrain domestic investment and consumption. The continued U.S. slowdown projected throughout 2009 (and with serious downside risks in light of the worsening financial crisis), will negatively impact growth, given strong linkages between the two economies through exports, remittances, and financial flows.2 Global fuel and basic grain prices are projected to stabilize above their 2007 average levels, resulting in a deterioration in the terms of trade. These shocks might lead to further increases in banks’ NPLs, yet another channel for slowing credit and domestic economic activity.

  • On the domestic front, the main concern is political uncertainty, which could trigger financial volatility (such as a slowdown in capital flows, deposit withdrawals, and an increase in interest rates) as the elections draw closer.3

10. The near-term outlook will be marked by adjustment to these shocks. In this officially dollarized economy, the balance of payments is self-stabilizing: if the supply of foreign currency falls, the adjustment will be borne through squeezed purchasing power and higher interest rates. Real GDP growth would slow down to about 3 percent in 2008 and 2.6 percent in 2009. While official dollarization serves as a strong nominal anchor for price expectations, inflation is projected to increase in 2008 on account of the shocks, before subsiding in 2009, as the impact of commodity prices dissipates.4 The fiscal deficit—driven by higher spending on subsidies and wages—would rise to 2.3 percent of GDP in 2008, but improve slightly in 2009, reflecting the recent elimination of the electricity subsidy for the corporate sector. The widening of the current account deficit in 2008—financed by FDI inflows (likely to halve after their 2007 peak) and commercial banks’ net foreign assets—would begin to reverse in 2009 as commodity prices stabilize and the public and private sectors adjust their savings accordingly.

Near-term Macroeconomic Outlook

(In percent of GDP, unless otherwise noted)

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Source: Country authorities; and Fund staff estimates.

11. A key risk to the short-term outlook is a domestic liquidity crisis triggered by a deteriorating external environment and growing political uncertainty. These shocks could hamper the public sector’s ability to meet its short-term financing needs, which competes with banks for an increasingly tight pool of liquidity. The central government has to roll over or place a total of about US$250 million of debt (including from public trust funds) by end-2008. In the absence of legislative approval for long-term financing, the government has increased its reliance on short-term debt instruments (LETES). However, it could face significant difficulties in placing LETES at maturities that go beyond the presidential election. Political uncertainty coupled with the external financial turbulence could also lead to a sustained loss of bank deposits, a cut-off of external credit for banks, and systemic liquidity shortages. Given the prominent local presence of international financial institutions such as HSBC, Scotiabank, and Citibank, stress in a parent bank could also have an adverse impact on deposits or reduce the availability of external credit for the local subsidiaries.

III. External Stability and Medium-Term Outlook

12. Under current policies, GDP growth would recover slowly to reach 4 percent and public debt would stabilize at about 40 percent of GDP through 2013. The absence of further fiscal consolidation would erode growth via higher interest rates and lower productivity-enhancing spending. Based on the strong nominal anchor provided by official dollarization, inflation would gradually fall to about 3 percent by 2010. The current account deficit would narrow slowly, leading to a mild reduction in external debt. Given the absence of structural fiscal and financial reforms, the economy would be more vulnerable to negative shocks, the room for policy action would be more limited, and the risk of a financial crisis would be higher.

13. In the baseline scenario, premised on the policy recommendations described in section IV, growth would reach 4½ percent and public debt decline to about 30 percent of GDP by 2013.5 On account of a subdued domestic demand, but stronger net exports than in recent years, growth is projected to converge to its potential rate of 4½ percent. This rate is underpinned by structural reforms adopted during the last decade, further integration of the Salvadoran economy into the global economy, continued output diversification, and an increase in public spending on infrastructure. Inflation is expected to fall to 3 percent, as the inflationary impact of commodity prices subsides and domestic demand adjusts to restore external equilibrium.6 The public sector primary surplus would gradually improve to 1.9 percent of GDP by 2013 and public debt would fall to about 30 percent of GDP, mostly driven by revenue efforts.7 8

Key Macroeconomic Indicators under Baseline Scenario

(In percent of GDP, unless otherwise noted)

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Source: Fund staff estimates, based on data from country authorities.

GDP Contributions by Demand Component

(In percent of GDP unless otherwise stated)

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Sources: Salvadoran authorities; and Fund staff estimates.

14. In the absence of a crisis scenario, the medium-term external position of El Salvador remains sustainable.

  • A continued strengthening of public and private savings will lead to a gradual narrowing of the current account deficit to about 4 percent of GDP by 2013. This level is, according to staff research, broadly in line with the underlying deficit consistent with structural current account determinants. This would allow total external debt to fall to 41 percent in 2013.9

  • The real effective exchange rate (REER) appears broadly in line with fundamentals.10 The REER depreciated from early 2007 to the first quarter of 2008, as the continued weakening of the U.S. dollar vis-à-vis the weighted average of El Salvador’s trading partners’ currencies offset the increase in local inflation during the period (though this trend reversed more recently given a stronger dollar and higher domestic inflation) (see Box 2). Despite this REER depreciation, higher GDP growth and strong remittance and FDI inflows more than offset a worsening of the terms of trade in 2007, leading to both an appreciation of the equilibrium REER and a widening of the current account deficit.

  • Standard competitiveness indicators suggest that the export sector remains competitive (see Box 2). The solid export performance in recent months confirms that the sector is well positioned to contribute to the external adjustment process.

Savings-Investment Balance under Baseline Scenario

(In percent of GDP)

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Sources: Salvadoran authorities and Fund staff estimates.

External Competitiveness

Dollar weakness favored price competitiveness up to the first quarter of 2008, but the spike in local inflation has reversed the trend since. The pick-up in domestic inflation in El Salvador triggered a real appreciation vis-à-vis the U.S. However, the fall of the dollar vis-à-vis the currencies of other trading partners pushed down the nominal and real effective exchange rates up to March 2008. The REER has appreciated thereafter on the back of continued high local inflation, but it is still below its level 12 months before.

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Percentage point deviation of the RER from the Jan-01 - July-08 period average

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Export performance has been very strong in 2008. Several years of modest export growth, mainly as a result of the rise of China and a decline in the maquila sector, led to a loss of share in the U.S. and world markets. However, maquila export growth bottomed out in 2006 and reached positive territory by the end of last year. Traditional (mainly coffee) and nontraditional exports have also had a strong rebound this year. As a result, exports have been growing at over 16 percent in the year to August.

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Trade Shares

(Exports of goods to the U.S. and the world in percent of U.S. and world imports of goods)

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Sources: WEO; and country authorities.
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Exports by type

(Annual average rate of growth)

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Sources: Country authorities

El Salvador compares well with Central American countries in competitiveness rankings, but continues to be affected by crime. It ranks second in the region in the World Bank’s Doing Business Report, which focuses on regulatory costs for starting and operating a business, and third in the Global Competitiveness Index, which considers a broader set of factors. The country does well in infrastructure, goods and factors market efficiency, and macro stability, but is hindered by low human capital (health and education), poor technological sophistication and innovation, and high and rising crime.

Competitiveness Rankings

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Sources: World Bank, Doing Business Report 2007–08; and World Economic Forum, Global Competitiveness Report 2007–08.

15. The main risks to the medium-term outlook are associated with the global financial turmoil as well as with the level of commitment of the new administration to macro stability and structural reforms. If the global financial turmoil were to persist beyond 2009, leading the global growth slowdown to be more protracted than currently projected, the Salvadoran economic performance would be affected through exports, remittances, and the flows of foreign finance. Risks could also arise from a major change in policies by the next administration or lower-than-projected remittance inflows (which account for about 18 percent of GDP).

IV. Policy Discussions

16. Discussions focused on fiscal and financial policies to prepare for potential risks associated with the external shocks and election-related uncertainty, and address key medium-term macroeconomic and social challenges. In particular, the discussions centered on:

  • Government policies in the run-up to the 2009 elections to smooth adjustments to external shocks and political uncertainty.

  • The roadmap of policies and reforms that the next administration would need to adopt to enhance the resilience of the macroeconomy and the financial sector to shocks, and create the conditions for higher growth and a faster reduction in poverty.

A. Short-Term Policies to Address Global Shocks and Political Uncertainty

17. For the short term, the focus of discussions was on policies to support macro stability and contain potential risks from external and domestic shocks:

  • Design contingency measures to reduce risks in the run-up to the elections:

    • Enhance financial sector crisis preparedness. In line with previous staff recommendations, the authorities introduced in July a temporary 3 percent liquid asset requirement on banks, to buttress liquidity levels ahead of the elections. They are also negotiating external credit lines for the central bank, and are drawing up action plans on how to deal with situations of stress in the banking system. There was agreement on the need to closely monitor banks (e.g., their short-term borrowing, deposits, and liquidity levels) and cooperate more closely with their home supervisors.

    • Improve the access to, and the profile of, budget financing. There was agreement on the need to allow for higher interest rates on short-term debt instruments (LETES) to lengthen their maturity beyond the elections and the changeover in government. Staff noted that the reliance on LETES has worsened the term structure of public debt and increased vulnerabilities. There was agreement on the urgent need to reach a political agreement with the opposition to restore government’s access to long-term finance (which requires approval by a 2/3 majority in congress), including financing by multilateral development banks (MDBs). The government is working to reach such an agreement, and has secured a credit line with a regional development bank (CABEI).

  • Maintain fiscal restraint. The mission commended the authorities for the strong fiscal performance in 2007, and agreed with them on the need to maintain fiscal restraint, while expanding social programs to mitigate the impact of high commodity prices on the poor. Maintaining fiscal restraint is particularly important in light of the tightness of liquidity.11 Therefore, staff recommended that increases in well-targeted social programs (such as Red Solidaria) be accommodated within a public sector deficit target of 2.3 percent of GDP for 2008.12 This would require further improvements in tax administration and cutting nonpriority primary expenditure, including through enhanced controls of energy subsidies, specifically in the cases of gas and public transport. To reduce the risk of a wage-price spiral, the mission noted the need to limit public wage increases. There was agreement that the 2009 budget should target a deficit of 2.2 percent of GDP: higher spending in 2009 due to the impact of increases in public wages and the transportation subsidy would be offset by the newly adopted tax on incoming international calls, grants from the Millennium Challenge Corporation, and savings that will kick in from the recent reform of electricity subsidies.

18. The authorities expressed their willingness to continue adopting administrative measures ahead of the elections. These would include measures on the fiscal revenue and spending sides to provide additional room for expanding well-targeted programs and reduce the cost of subsidy abuse.13

B. Medium-Term Policies to Enhance the Economy’s Resilience and Growth Potential

19. The key policy challenges for El Salvador over the medium term are: to build up the economy’s resilience to shocks and create the conditions for counter-cyclical policies; and to boost the trend growth rate of real GDP. Staff suggested, and the authorities agreed, that the medium-term issues be discussed in a seminar with the new economic team and the IFIs following the elections.

Fiscal policy

20. There was agreement that medium-term fiscal policy be geared toward creating the fiscal space necessary to respond to shocks and address priority spending needs. A stronger medium-term fiscal position will increase the ability of fiscal policy (the main policy lever under official dollarization) to react in cases of external or domestic shocks (including natural disasters) and adopt counter-cyclical policies. It was agreed that continued fiscal consolidation should be achieved while enabling higher spending on well-targeted social programs and productivity-enhancing public infrastructure.

21. A fiscal strategy anchored on reducing public debt to about 30 percent of GDP by 2013 would help achieve these objectives.14 The strategy would imply an improvement of about 1¾ percent of GDP in the public sector primary surplus between 2009 and 2013.15 Much of this improvement (1 percent of GDP) would be achieved through tax revenue measures, and the rest through reductions in spending.

22. To ensure the success of this strategy, staff recommended:

  • Strengthening tax policy and administration, with the aim of raising the tax-to-GDP ratio by 1 percent of GDP to 15 percent by 2013. This would require additional efforts to improve the administration’s auditing capacity, cross-checking information systems and customs valuation procedures. It may also require a streamlining of tax incentives and, possibly, an increase in the VAT rate.16 The authorities requested Fund TA to assess the potential yield of measures other than raising tax rates.

  • Improving the efficiency and targeting of public spending. Eliminating the electricity subsidy for the nonresidential sector should yield about 0.4 percent of GDP per year. To build up on this achievement, staff recommended to (i) limit the electricity subsidy to low-income groups (which would save a further 0.2 percent of GDP per year); and (ii) improve the targeting and the pricing of public transport and gas subsidies, with an estimated yield of 0.6 percent of GDP per year. The government could redirect these savings toward well-targeted social programs (0.4 percent of GDP) and public investment (0.2 percent of GDP), while the public electricity company (CEL) would also be able to expand its investment program (0.3 percent of GDP).

  • Reducing other current spending by about ½ percent of GDP by 2013, mainly through restraint on wages and purchases of goods and services (0.5 percent of GDP) and the envisaged pension reform (0.1 percent of GDP), discussed below.17

  • Further reforming the pension system. Staff stressed the need for further parametric reforms to the pension system (such as reducing replacement rates and increasing the retirement age) with a view to reducing the still-high transition costs (from the pay-as-you-go system to privately managed individual accounts) and minimizing contingent liabilities.18 The authorities are opposed to implementing a parametric pension reform.

Medium-term Fiscal Framework under Baseline Scenario

(In percent of GDP)

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Sources: Central reserve bank; Ministry of Finance; and Fund staff estimates.

Financial sector

23. The authorities and staff agreed that the internationalization of the banking system entails benefits as well as challenges for macro-financial stability. The increased presence of large international banks should help deepen financial intermediation, introduce superior risk management and corporate governance practices, and provide easier access to international capital markets. However, it also exposes the local economy to events from abroad, could introduce more volatility in capital inflows, and poses a challenge for domestic supervision.

24. The mission welcomed the financial sector reforms undertaken since the last Article IV Consultation. In particular, it noted the internal restructuring of the financial system superintendency, intended to underpin the move toward risk-based supervision; the ongoing contacts with the home supervisors of foreign-owned banks; and the passage of a bill that provides a legal framework for the securitization of financial assets. On this latter issue, staff recommended strict regulations to prevent asset originators from fully passing on credit risks to third parties.

25. There was consensus on the need to implement key structural reforms in the financial sector. These include: (i) passage of the bill to strengthen financial supervision; (ii) strengthening the central bank’s liquidity management and lender-of-last-resort functions, including through a recapitalization by the treasury, a reform enabling it to pool commercial bank reserves to transfer liquidity to banks in distress (at present, an individual bank can only access its own reserves); (iii) bolstering the deposit insurance fund to 5 percent of total deposits (from the current 1 percent) by increasing the premium paid by banks; and (iv) approving the existing bill to enhance the legal basis for mutual funds.

V. Staff Appraisal

26. Economic fundamentals are solid, but the economy is entering a downturn and there are significant risks to the near-term outlook. As a result of sustained economic reforms over the last few years, the fiscal position improved, the public debt-to-GDP ratio declined, and, in 2007, economic growth reached its highest level in a decade. However, the current turmoil in world financial markets, a global growth slowdown, and electoral uncertainty entail considerable risks to the outlook.

27. Against the background of these developments, crisis preparedness and contingency measures are paramount. In the financial sector, these include monitoring banks’ liquidity and their short-term borrowing closely, drawing up concrete action plans to deal with stress in the banking system, and negotiating contingent credit lines. Staff welcomes the steps the authorities have already taken, including the introduction of a temporary 3 percent liquid asset requirement on banks, but continued efforts are necessary. In the public sector, the authorities should allow for higher interest rates to lengthen the maturity of short-term debt beyond the election and seek a political agreement to access long-term financing from MDB’s.

28. Faced with increased risks, the authorities’ main challenge is to maintain macroeconomic stability. A critical component is the need to exercise fiscal restraint. Staff recommends a public sector deficit target of 2.3 percent of GDP in 2008; increases in well-targeted social programs should be accommodated within this envelope. Also, staff welcomes the authorities’ 2009 budget deficit target of 2.2 percent of GDP, which reflects increases in public wages and transportation subsidies as well as the impact of the recent reform of electricity subsidies and a newly adopted tax on international calls.

29. The authorities and staff agree on the need to move structural reforms in the financial sector forward. These include passage of the bill to strengthen financial supervision, improvements in the central bank’s liquidity and its ability to act as lender-of-last-resort, bolstering the deposit insurance fund to 5 percent of total deposits, and passage of a bill to enhance the legal basis for mutual funds.

30. In the medium term, the authorities need to continue reforms aimed at enhancing the economy’s resilience and growth potential. Priorities include: reducing public debt to about 30 percent of GDP through tax revenue measures and cuts in nonpriority spending, improving the efficiency and targeting of subsidies, and implementing a parametric reform of the pension system.

31. Staff analysis indicates that the REER is broadly in line with fundamentals. Solid export performance in 2008 and standard competitiveness indicators suggest that the export sector remains competitive.

32. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

Figure 1.
Figure 1.

El Salvador: Real Sector

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Sources: Central Bank of El Salvador; International Financial Statistics; and Fund staff estimates.
Figure 2.
Figure 2.

El Salvador: External Sector

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Sources: Central Bank of El Salvador; International Financial Statistics; J.P. Morgan; Bank for International Settlements; and Fund staff estimates.
Figure 3.
Figure 3.

El Salvador: Fiscal Sector

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Sources: Salvadoran authorities; and Fund staff calculations.
Figure 4.
Figure 4.

El Salvador: Financial Sector Developments

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Sources: Salvadoran authorities; and Fund staff calculations.1/ Final datapoint is for March 2008.
Figure 5.
Figure 5.

El alvador: Social Indicators

Citation: IMF Staff Country Reports 2009, 035; 10.5089/9781451834789.002.A001

Sources: UNDP Human Development Report; ECLAC; World Economic Outlook; World Development Indicators; and Fund staff calculations.1/ Rank in 2004. Out of 177 countries.2/ Simple (unweighted) average.
Table 1.

El Salvador: Selected Economic and Social Indicators

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Sources: Central Reserve Bank of El Salvador; Ministry of Finance; and Fund staff estimates.

The figure for 2008 shows the average spread through October 5.

For 2008, the interest rate shows the average through June.

Includes reconstruction outlays after the earthquakes in 2001 and tropical storm Stan in 2005.

Table 2.

El Salvador: Balance of Payments

(In US$ millions)

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Sources: Central Reserve Bank of El Salvador; and Fund staff estimates.

Expressed in terms of following year’s imports

Table 3.

El Salvador: Operations of the Consolidated Public Sector

(In percent of GDP)

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Sources: Central Reserve Bank; Ministry of Finance; and Fund staff estimates.

Projections prepared by the staff

Table 4.

El Salvador: Summary Accounts of the Financial System

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Sources: Central Reserve Bank of El Salvador; and Fund staff estimates.
Table 5.

El Salvador: Selected Vulnerability Indicators

(In percent of GDP, unless otherwise indicated)

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Sources: Central Bank of El Salvador; Ministry of Finance; and Fund staff estimates and projections.

As of August 2008.

Based on past-due loans.

Refers to total external debt. Maturity less than one year, defined on a residual maturity basis.