Recent Developments

The economy is expected to grow at 2.4 percent in 2019. Results from relevant macroeconomic indicators during the first quarter point in this direction: credit to the private sector increased 6.4 percent (year-to-year), mainly driven by a strong growth of credit to enterprises which grew 10.3 percent, reflecting dynamism in many productive sectors, particularly construction. The primary fiscal surplus was 0.4 percent compared to 0.3 percent in the first quarter of 2018, and inflation remain low at 0.7 percent. Remittances increased 5.9 percent, higher than the 5.3 percent observed over the same period in 2018. The total liquidity of the economy grew 4.9 percent providing a good cushion for supporting the economic dynamism. The authorities share staff’s view on the main risks to the outlook. Weaker-than-expected global growth could have a negative impact on the economy, and debt could continue to drift upward in the absence of measures or if spending or public sector reforms are approved without identifying suitable funding sources.

Fiscal Discipline and Adjustment

The strong fiscal discipline and measures implemented allowed the primary fiscal balance to improve 1.1 percent of GDP between 2017 and 2018. Over the past year, the authorities continued efforts started in 2017 to reach political agreements aimed at moving forward with the country’s economic and social agenda. Consequently, an important number of fiscal laws were approved by the Legislative Assembly in December 2018: The Fiscal Responsibility Law (FRL) was strengthened by requiring debt to be put firmly on a declining path and by introducing an anchor for public debt of 60 percent of GDP by 2030; the budget and its financing were passed on time for the first time in three years, with a primary surplus of 0.7 percent of GDP. The Assembly also authorized external financing for US$1.3 billion, including to cover the US$800 million Eurobond payment due in December and an IADB loan to finance the program for strengthening tax administration that includes the implementation of the electronic invoicing. Because of the strong political cooperation and agreements that made possible the approval of these important fiscal laws, Standard & Poor’s upgraded the rating of El Salvador’s sovereign debt to B in December 2018 and the EMBI Global spread declined and is in line with regional peers.

The authorities agreed with the size of the recommended adjustment and considered that a more gradual pace of implementation (three years) would still be consistent with observing the Fiscal Responsibility Law (FRL). They are aware that a further fiscal adjustment of about 1.9 percent of GDP by 2021 is needed to comply with the FRL. To this end, they are preparing several measures, both on the revenue and the expenditure sides, and are also progressing in the technical preparation of tax administration reforms, including electronic invoicing, the “monotributo,” as well as the initiative to combat base erosion and profit shifting (“precios de transferencia”). They agreed with staff on the need to adopt additional structural revenue measures, such as excise taxes on luxury goods. The authorities do not see plausible an increase in the VAT in the short term, considering that this type of measure would require consensus among different sectors of the population given its potential negative impact on household’s consumption. Going forward, the authorities consider that a comprehensive fiscal reform is needed to eliminate distortions arising from temporary and ad hoc measures accumulated over the years. Harmonizing and simplifying the tax code could improve fairness, equity, competition and growth.

To improve the efficiency of public expenditure, the authorities are planning to centralize the procurement system and extend competitive bidding processes such as reverse auction mechanism to all public entities; to this end, a reform to the procurement law is in process. The authorities are also working on strengthening public debt management and have requested Fund’s technical assistance for this purpose.

Policies to Foster Higher Growth

The ease of doing business has improved in recent years and the authorities are committed to further improve the business climate and the country’s competitiveness. Policies to reduce poverty, inequality and emigration are bearing fruits and the government is committed to advance even more through strengthening programs in education, health, housing, water and sanitation, and urban and rural development. The agenda to promote growth has also been successful based on cutting red tape, implementing the development, diversification and productive transformation strategy in place since 2014, and on intensifying efforts to increase financial inclusion. In addition, actions are being taken to expedite the process to obtain the tax ID, improve the platform to register new enterprises and obtain construction permits. Completion of the Northern Triangle Customs Union with Honduras and Guatemala would allow to increase intra-regional trade and investment, thereby contributing to boosting growth. Regulatory improvements brought by the customs union, and better infrastructure at border crossing points, will significantly reduce the costs and processing time for exports.

The rehabilitation and prevention efforts through El Salvador Seguro plan launched in 2014 are contributing to substantially lower the homicide rate, as evidenced in Box 2 of the staff report, helping to improve the business climate and the country’s competitiveness. The authorities plan to advance the plan further by securing budgetary funds to expand two detention centers, implement public spaces recovery programs and strengthen youth violence prevention programs. They acknowledge that further actions should be taken to combat extortion, including by expanding technological surveillance and police presence in the country, and by continuing to foster community involvement. In this regard, the City Hall of San Salvador launched last April a “Smart City” project with support from Spain.

The authorities continue working on increasing the provision of public infrastructure as a catalyst for private investment growth; they plan to complete this year the expansion of the passenger air terminal and implement other important projects to enhance both country’s roads and ports network. They will also develop specific projects oriented at tourism such as the touristic marine coastal strip, and the productive development program, as well as continuing with customs modernization.

The authorities are confident that reducing informality and the gender gap in labor force will contribute to raise potential output. As part of the plan to recover San Salvador’s downtown, two large markets will be created in the upcoming years to give street vendors (mostly women) a safe and clean space to operate. The gender gap in the labor force participation rate (30 percent), is lower than in neighboring countries and the authorities expect to reduce it further by leveraging efforts of the recently introduced National Gender Equality Plan and the Gender Seal certification program. Over 60 units have been created in the public sector to institutionalize gender mainstreaming. The second program is implemented with support from UNDP. In addition, the authorities and experts expect that the 2017 amendment to the family code to ban child marriage and the development of a national policy to prevent teenage pregnancy will help reduce the gender gap in education attainment.

Financial Sector Stability

The banking sector remains solid and credit continued to expand during the first quarter of 2019. Banks reduced their external liabilities as global financial conditions tightened, remained well-capitalized and used the remittance-fueled surge in deposits to expand credit. Balance sheet risks remained sound as the deposit-to-loan coverage remained stable at 95 percent, and the cyclical position of credit expansion was within the norm. Non-performing loans declined below 2 percent, provisioning increased, and profitability reached a three-year high.

The authorities concurred with staff’s recommendations for enhancing financial sector stability. They agreed with the need to accelerate approval of the bank resolution law and remain committed to further strengthening cross-border cooperation, and appropriately fund the emergency lending assistance framework, which includes the creation of a liquidity fund facility in line with prior Fund’s recommendations. Banks’ efficiency in liquidity management, including the reactivation of the interbank market, cross-border cooperation and supervision, has increased, and the Superintendence has enhanced supervision and monitoring of financial flows—which are critical in preparation to rejoin the Egmont Group (group of 159 Financial Intelligence Units established to provide a platform for the secure exchange of expertise and information for AML/CT).

Financial Inclusion

The authorities are making progress in promoting financial inclusion. Bank account ownership has doubled from 14 percent in 2011 to 30 percent in 2017, driven by increases in rural accounts and female-owned accounts. A Presidential executive order in July 2018 established the National Council for Financial Inclusion, the inter-agency support group for financial inclusion and financial education program of El Salvador. Simplified bank accounts, for limited balances and transactions, were introduced in 2015 and 400 of these accounts were opened since the end of 2018. In addition, another electronic money provider, MOMO-Mobile Money, is in process to join the mobile money market.

Governance Framework

The authorities have adopted several measures to improve the governance framework. The Attorney General has significantly strengthened investigation and prosecution activities to curb the illicit use of public funds at the highest level. To support the anti-money laundering (AML/CFT) efforts, the Superintendency of the Financial System has put in place a system for high-frequency monitoring of financial flows. Independence and autonomy of the Financial Investigation Unit has been legally ensured to restore the exchange of information with a worldwide network of financial investigative agencies, and to enhance the governance and anti-corruption framework. In addition, a plan has been developed and implemented by the Presidency to increase citizen participation in the design, implementation, and monitoring of public policies at the national and local levels, and to receive direct corruption complaints. Going forward, the authorities believe it is important to continue strengthening the accountability and supervision of public funds and see space for improvement through further reforms that ensure a comprehensive audit of public accounts, such as (i) harmonizing the existing legal framework; (ii) strengthening the Audit Office by expanding its supervisory role to all public institutions; and (iii) modernizing audit processes through extensive adoption of technology.