Statement by Ramon Guzmán, Executive Director for El Salvador and Alvaro Umaña, Senior Advisor

The staff report for El Salvador’s request for a Stand-By Arrangement is examined. Fiscal consolidation led to a reduction in the public debt-to-GDP ratio, and the country has experienced the highest growth rates in a decade. Real GDP growth is projected to slow to 3.2 percent in 2008, reflecting lower growth in remittances, a tightening of external financing conditions, and a decline in investment. Exports, however, have remained buoyant despite weaker external demand. The banking system remains liquid and well capitalized, although nonperforming loans have increased and profitability is declining.

Abstract

The staff report for El Salvador’s request for a Stand-By Arrangement is examined. Fiscal consolidation led to a reduction in the public debt-to-GDP ratio, and the country has experienced the highest growth rates in a decade. Real GDP growth is projected to slow to 3.2 percent in 2008, reflecting lower growth in remittances, a tightening of external financing conditions, and a decline in investment. Exports, however, have remained buoyant despite weaker external demand. The banking system remains liquid and well capitalized, although nonperforming loans have increased and profitability is declining.

January 14, 2009

Given that the Article IV consultation for El Salvador was recently concluded, this statement can be brief. In the Summing-Up of the consultation, Directors highlighted the fact that El Salvador has strong macroeconomic fundamentals, the result of several years of sound policies, well-oriented structural reforms and a favorable external environment. However, the present international crisis (the U.S. recession in particular), and the food and fuel prices increases of 2008, have had an impact on the economy with growth slowing down to 3.2 percent last year. Inflation, which had risen in the earlier part of the year, slowed down and closed at 4.5 percent by year’s end.

The main downside risks include the difficult external environment and potential impact of inadequate financing due to the global crisis, as well as electoral uncertainty that could impact the capital account as the 2009 elections approach. All this has resulted in some tightening in domestic financial conditions, but the banking system remains resilient and well capitalized, although profitability has decreased.

The government has taken important steps to strengthen the banking system, including raising liquidity asset requirements by three percentage points to 6 percent in June 2008 (total prudential requirements—liquidity and reserves—now amount to 28 percent of deposits). Banks have also been required to submit contingency liquidity plans, including availability of external credit lines. Monitoring capabilities for key banking indicators have been upgraded and are updated daily. The central bank, with Interamerican Development Bank (IADB) resources, will purchase high quality loans to sustain credit growth in the private sector.

Linkages to global financial markets are strong since the three largest banks were acquired by foreign banks and foreign-owned banks assets are now above 90 percent, providing an additional anchor the financial system. Liquidity ratios for the banking system are about 42 percent (more than half highly liquid assets) and capital adequacy is 14.5 percent, with both indicators above prudential requirements.

The Salvadoran authorities will seek congressional approval of a Financial Sector Supervision and Regulation Law to increase the resilience of the financial sector. This law, drafted with MCM technical assistance, proposes to merge supervisory entities in the financial system, pension fund and stock market; increasing autonomy and providing legal protection for supervisor. The law also provides for cross-border consolidated supervision.

The overall public sector deficit is projected to be one percentage point higher than 2007, reaching 2.9 percent. This weaker fiscal position reflects increased social spending to shield the impact of fuel and food price increases on the poor, lower revenue growth and higher capital spending on a new hydroelectric plant. Although there have been difficulties in placing domestic debt with maturities beyond March 2009, the recent agreement to authorize loans from the World Bank and IADB, the first such authorization in three years, will improve the liquidity position of the government.

Although exports continued to increase (17 percent) in 2008 despite the U.S. recession, the global slowdown is likely to cause export growth to stagnate. Remittances growth had decelerated and is expected to remain low throughout 2009. Domestic demand is expected to decrease this yea as well. To mitigate the drop in domestic demand, the fiscal deficit target for 2009 has been revised to 2.8 percent, 0.4 percent above the earlier target. The authorities are also expected to increase revenues by 0.2 percent of GDP and to eliminate nonresidential subsidies for electricity, as well as creating additional space for social spending (0.3 percent of GDP to expand the Red Solidaria).

The main goals for the Fund SBA is to provide for stability and policy continuity in the face of electoral uncertainty, sustain investor confidence and increase the economy’s resilience to shocks. The level of access (300 percent of quota) has been clearly justified by staff using a variety of metrics. It also has one of the lowest multipliers of quota among the recent SBA’s approved by the Fund, as shown in Figure 1-B of the risk assessment Supplement 1.

The staff’s evaluation of the exceptional access criteria clearly shows that El Salvador meets three of the four criteria, namely: sustainable debt position, access to private capital markets and strong policy reform and implementation capacity. El Salvador does not presently have exceptional pressures on the capital account and it intends to treat the program as precautionary, in case that these pressures should materialize.

Given its strong economic fundamentals, location and openness of the economy, El Salvador is well positioned to renew growth once the global crisis subsides. Years of responsible policies have also resulted in a decrease in total debt, so El Salvador has a strong capacity to repay the Fund. In light of the country’s strong track record, its unique present situation and its potential needs, we request you support for the proposed SBA.

El Salvador: Request for Stand-By Arrangement: Staff Report; Staff Supplement and Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for El Salvador
Author: International Monetary Fund