El Salvador - International University of Japan...El Salvador 5 Country Report June 2006 ' The Economist Intelligence Unit Limited 2006 Economic structure Annual indicators 2001a 2002a

Country Report

El Salvador

June 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

El Salvador at a glance: 2006-07

OVERVIEW The president, Antonio Saca, will continue to rely on negotiations and compromise to implement his policy programme, as no party has a simple majority in Congress. However, given his popularity and good negotiating skills, the Economist Intelligence Unit does not expect this to hamper governability unduly in the forecast period. Economic prospects are improving, driven by higher consumption and investment, and by exports on the back of the implementation of the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA) with the US and the gradual easing of customs procedures in Central America. However, strengthening domestic demand will stimulate strong import growth, which will limit GDP growth to an annual average of just over 3% in 2006-07. Inflation will average 4.5-5% in 2006-07. The current-account deficit will widen to 5% of GDP or above in the forecast period, but this will mostly be financed by foreign direct investment (FDI) and long-term debt inflows.

Key changes from last month

Political outlook • It remains to be seen whether constitutional reforms and foreign loans

approved by the outgoing legislature in April will be re-approved by the new legislature, where the government will struggle to muster a 56-vote majority. With 32 seats, the opposition FMLN has made its support conditional on Arena backing a proposal to raise the minimum pension to the level of the minimum wage and to enter into a fuller discussion of the government�s debt policy.

Economic policy outlook • The appointment of new Minister of Finance, a businessman,

William Handal, could stall the tax-reform process. His predecessor oversaw a series of largely administrative reforms to the tax system in 2005 and was reported to have favoured continuing with the reform process.

Economic forecast • Following an upward revision in the Economist Intelligence Unit!s oil price

forecast to an average of US$70/b in 2006 and US$66/b in 2007, we have revised our inflation forecast up to 5% at the end of 2006 (from 4.5%) and 4.5% at the end of 2007 (from 4%).

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El Salvador 1

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006

Contents

El Salvador

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2006-07 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

14 Economic policy

16 The domestic economy 16 Economic trends 18 Agriculture 19 Manufacturing 20 Infrastructure

20 Foreign trade and payments

List of tables 9 International assumptions summary 11 Forecast summary 12 National Assembly, balance of power 15 Tax revenue 15 Non-financial public-sector accounts 16 Gross domestic product growth 17 Consumer prices 18 Interest rates 21 Merchandise trade balance 22 Curren-account balance 23 Workers� remittances 23 Net international reserves

List of figures 12 Gross domestic product 12 Consumer price inflation

El Salvador 3


El Salvador June 2006

Summary

The president, Antonio Saca, will continue to rely on negotiations and compromise to implement his policy programme, as no party has a simple majority in Congress. However, given his popularity and good negotiating skills, the Economist Intelligence Unit does not expect this to hamper governability unduly in the forecast period. Economic prospects are improving, driven by higher consumption and investment, and by exports on the back of the implementation of the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA) with the US and the gradual easing of customs procedures in Central America. However, strengthening domestic demand will stimulate strong import growth, which will limit GDP growth to an annual average of just over 3% in 2006-07. Inflation will average 4.5-5% in 2006-07. The current-account deficit will widen to 5% of GDP or above in the forecast period, but this will mostly be financed by foreign direct investment (FDI) and long-term debt inflows.

In April the outgoing legislature managed to approve some constitutional reforms including the foreign financing requirement without the Frente Farabundo Martí para la Liberación Nacional (FMLN). However, their approval by the incoming legislature was uncertain as the FMLN had the votes to block their final passage. El Salvador and Honduras settled their border dispute.

Mr Saca appointed a new Minister of Finance in April, raising press speculation over cabinet resistance to further fiscal reform. Tax revenue rose sharply in the first quarter, but a doubling on capital spending to deal with reconstruction in the wake of Tropical Storm Stan in October 2005 meant that the overall fiscal deficit widened sharply.

At 2.8%, GDP growth in 2005 was the highest for five years. Preliminary data for early 2006 suggests that the economy has continued to strengthen. In April inflation had risen above 4% again.

Despite a rise in exports, driven by non-traditional export earnings, the trade deficit rose further, owing to higher import spending. This, together with a worsening of the income deficit, caused an expansion in the current-account deficit. FDI rose to US$424m according to the Central Bank, with 75% of the investment going to industry. The government issued US$400m in Eurobonds at favourable terms in April.

Editors: Ondine Smulders (editor); Emily Morris (consulting editor) Editorial closing date: May 26th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Outlook for 2006-07

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 El Salvador


Political structure

Republic of El Salvador

Unitary republic

US-style Supreme Court system

Unicameral Legislative Assembly, comprising 64 locally and 20 nationally elected deputies, elected every three years

Universal adult suffrage

March 2004 (presidential), March 2006 (legislative and municipal); next election due in March 2009 (presidential)

President elected for a single term of five years

The president, Antonio Saca, governs with the support of Arena, which holds 34 seats in the legislature; he appoints and presides over a Council of Ministers

Government: Alianza Republicana Nacionalista (Arena)

Opposition: Frente Farabundo Martí para la Liberación Nacional (FMLN); Partido de Conciliación Nacional (PCN); Partido Demócrata Cristiano (PDC); Centro Democrático Unido (CDU)

President Elías Antonio Saca González Vice-president Ana Vilma Alvárez de Escobar

Agriculture Mario Salaverría Nolasco Defence General Otto Romero Orellana Economy Yolanda Mayora de Gavidia Education Darlyn Meza Environment Hugo César Barrera Finance William Handal Foreign relations Francisco Laínez Rivas Health José Guillermo Maza Brizuela Interior René Figueroa Figueroa Labour José Roberto Espinal Escobar Public works David Gutiérrez Tourism Luis Cardenal Debayle

Luz María Serpas de Portillo

Official name

Form of state

Legal system

National legislature

Electoral system

National elections

Head of state

National government

Main political organisations

Key ministers

Central Bank president

El Salvador 5


Economic structure

Annual indicators

2001a 2002a 2003 a 2004 a 2005b

GDP at market prices (c bn) 13.8 14.3 14.9 15.8 17.2

GDP (US$ bn) 13.8 14.3 14.9 15.8 17.2

Real GDP growth (%) 1.8 2.2 1.8 1.5 b 2.8

Consumer price inflation (av; %) 3.8 1.8 2.1 4.5 4.7a

Population (m) 6.4 6.5 6.6 6.8 6.9

Exports of goods fob (US$ m) 2,891.6 3,019.7 3,152.6 3,329.6 3,419.7

Imports of goods fob (US$ m) 4,824.1 4,884.7 5,428.0 5,948.8 6,368.2

Current-account balance (US$ m) -150.3 -405.2 -764.0 -611.6 -778.1

Foreign-exchange reserves excl gold (US$ m) 1,593.7 1,472.8 1,792.3 1,754.0 1,722.8a

Total external debt (US$ bn) 5.3 6.0 7.1 7.6 b 8.1

Debt-service ratio, paid (%) 6.8 7.7 8.7 9.1 b 9.7

Exchange rate (av) c:US$ 8.75 8.75 8.75 8.75 8.75a

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2003 % of total Components of gross domestic product 2004 % of total

Agriculture, forestry & fishing 9.5 Private consumption 90.9

Industry 31.2 Government consumption 10.5

Services 59.3 Fixed investment 15.6

Exports of goods & services 27.2

Imports of goods & services -44.2

Principal exports 2005 US$ m Principal imports cif 2005 US$ m

Maquilaa 1,726 Intermediate goods 2,343

Non-traditional goods 1,425 Consumer goods 2,022

Coffee 163 Maquilaa inputs 1,331

Capital goods 1015

Main destinations of exports 2005 % of total Main origins of imports 2005 % of total

US 60.6 US 42.7

Guatemala 12.1 Guatemala 8.3

Honduras 7.4 Mexico 7.9

Costa Rica 3.2 Japan 1.9

a Offshore assembly for re-export.

6 El Salvador


Quarterly indicators 2004 2005 2006 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 QtrNon�financial public sector balance (US$ m) Revenue & grants 686 552 753 614 777 637 758 735Expenditure & net lending 570 667 828 610 686 731 940 780Balance 111 -115 -74 4 91 -94 -182 -45Output GDP at constant 1990 prices (US$ m) Agriculture 232 234 237 250 246 247 251 n/aIndustry 483 493 495 480 494 501 499 n/aServices 1,121 1,132 1,142 1,131 1,149 1,159 1,172 n/aTotal 2,028 2,053 2,072 2,063 2,089 2,109 2,129 n/aTotal (% change, year on year) 1.8 1.8 1.9 2.5 3.0 2.7 2.8 n/a

Prices Consumer prices (2000=100) 112.6 113.6 114.4 116.2 117.5 118.4 120.0 120.5Consumer prices (% change, year on year) 4.5 5.3 5.4 5.3 4.4 4.2 4.9 3.7Producer prices (Jan 1998=100) 117.3 120.8 126.0 123.6 127.2 133.8 135.9 134.4Producer prices (% change, year on year) 5.8 7.5 13.9 9.3 8.4 10.7 7.8 8.7Coffee price (US cents/lb)a 77.4 76.0 90.6 121.3 125.0 105.0 106.0 118.4Financial indicators Exchange rate c:US$ (av) 8.75 8.75 8.75 8.75 8.75 8.75 8.75 8.75Exchange rate c:US$ (end-period) 8.75 8.75 8.75 8.75 8.75 8.75 8.75 8.75Deposit rate (av; %) 3.43 3.26 3.27 3.24 3.42 3.40 3.69 4.06Lending rate (av; %) 6.21 6.28 6.12 6.86 6.77 6.88 6.95 7.58Money market rate (av; %) 4.01 3.86 n/a n/a 5.75 4.50 5.30 n/aM1 (US$ m) 1,173.9 1,163.8 1,255.8 1,303.0 1,196.6 1,244.6 1,356.1 n/aM1 (% change, year on year) 19.1 9.1 4.8 5.6 1.9 6.9 8.0 n/aM2 (US$ m) 6,203.3 6,272.1 6,346.5 6,309.2 6,248.2 6,316.6 6,516.3 n/aM2 (% change, year on year) 1.9 3.8 1.6 0.5 0.7 0.7 2.7 n/aForeign trade (US$ m) Exports fob 807 1,165 506 821 919 1,130 513 909 Maquilab 436 667 276 422 462 592 250 415Imports cif -1,542 -2,097 -1,166 -1,542 -1,742 -2,298 -1,130 -1,777 Maquilab 332 506 -210 325 362 454 190 311Trade balance -735 -932 -661 -721 -823 -1,168 -616 -868Balance of payments (US$ m) Merchandise trade balance fob-fob -662 -578 -800 -636 -734 -795 -843 n/aServices balance -17 9 -91 -100 36 0 -9 n/aIncome balancec 557 520 610 544 623 489 638 n/aCurrent-account balance -122 -49 -281 -192 -74 -306 -214 n/aReserves excl gold (end-period) 1,688.6 1,767.6 1,754.0 1,587.2 1,927.5 1,643.4 1722.8 1,680.7

a ICO Indicator. b Offshore assembly for re-export. c Including current transfers balance.

Sources: IMF, International Financial Statistics; Banco Central de Reserva de El Salvador.

El Salvador 7


Outlook for 2006-07

Political outlook

In legislative elections held on March 12th 2006 the ruling right-wing Alianza Republicana Nacionalista (Arena) and the opposition left-wing Frente Farabundo Martí para la Liberación Nacional (FMLN) showed themselves to be the main political powers in El Salvador, at the expense of the smaller parties. Neither party gained a majority, with Arena winning 34 of the 84 seats, two more seats than the FMLN. This election result ends a trend of recent legislative elections, in which Arena lost ground in the legislature to the FMLN. Arena�s fortunes were boosted by its remarkably popular president, Antonio Saca, and by the FMLN�s internal divisions. With the elections out of the way, the government has returned to its policy agenda, but without a majority in the legislature, Arena will have to continue building alliances with other parties to pass legislation, indicating that policymaking will remain slow at times.

The big losers in the mid-term elections were the small parties. The right-wing Partido de Conciliación Nacional (PCN), which had in past elections made inroads among Arena voters, slipped from 14 to 10 seats. The centre-left Centro Democrático Unido (CDU) lost three of its five seats, but the centre-right Partido Demócrata Cristiano (PDC) held onto its six seats. On the assumption that El Salvador�s small political parties remain open to negotiating with the government, the Saca administration will continue to be able to pass legislation requiring a simple majority quite easily. However, on legislation requiring a two-thirds majority, the government will need the support of the FMLN. Its radical faction was securely confirmed in control of the party by the election results. The failure of the more moderate FMLN dissidents to gain a single seat in the legislature has undermined their chances of launching a comeback to challenge for the party leadership, whose radical faction does not seem to have been diminished by the death of Shafik Handal, the FMLN�s hardline leader, in January.

The strength of the radicals within the FMLN will complicate coalition building for Mr Saca, who will find it difficult to convince the FMLN to vote along with some of its legislative initiatives that require a two-thirds majority, such as the foreign financing section of the annual budget. The president�s strong negotiating skills and popularity will help coalition-building. Since assuming office in mid-2004, Mr Saca has galvanised cross-party support for reforms to the criminal justice system and set up a multiparty discussion forum to analyse other aspects of his reform agenda, which has helped smooth the passage of legislation.

El Salvador will remain one of the US�s staunchest allies in the region. It is the only country in the region that still has troops in Iraq, and in February Mr Saca sent a sixth contingent of troops to the country. Although this is an unpopular position at home, it has so far carried a negligible political cost. In return for his support for the Iraq war, Mr Saca received an extension of the Temporary Protection Status (TPS), which allows an estimated 220,000 Salvadorans in the

Domestic politics

International relations

8 El Salvador


US to work, until September 2007. He is also seeking US support for fighting maras (violent street gangs), some of which are led by deportees from the US. The integration of the C4 countries (El Salvador, Guatemala, Nicaragua and Honduras) is expected to accelerate in the forecast period. The coming-into-effect of the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA) with the US in March (with Nicaragua and Honduras joining in April) will strengthen regional ties.

Economic policy outlook

Mr Saca�s economic platform largely mirrors that of previous Arena admini-strations, but his social policies, including an overhaul of the education and healthcare sectors, go further. Mr Saca�s education programme, known as Plan 2021, is addressing educational deficiencies. Mr Saca�s government remains committed to maintaining tight fiscal policies, a necessity after the introduction of dollarisation in 2001. He is also committed to free trade, the promotion of foreign investment in important industries such as maquila (offshore assembly, mainly of textiles, for re-export), and the maintenance of a tax regime that promotes corporate investment. Some of the government�s greatest challenges are in the public finances, and include the rising transitional cost of pension reform, a large debt burden (the total public-sector debt is 47% of GDP, up from 35% in 2001), and the low tax take. Despite improvements in raising tax revenue in recent years (from 10% of GDP in 2001 to more than 12% of GDP in 2005), without further fiscal progress and strong economic growth, the debt ratios will not improve substantially. Apart from promoting foreign direct investment (FDI) through free trade, the government is preparing a plan to revitalise the manufacturing sector, whose performance has been lacklustre, and to develop emerging services sectors, such as tourism.

First-quarter fiscal data for the non-financial public sector (NFPS) showed strong revenue growth (up by 20%). Nevertheless, the fiscal balance before grants deteriorated to US$55m from US$3m, owing to a sharp rise (up by 116%) in capital spending. This reflects in part the exceptional costs of reconstruction following damage caused by Tropical Storm Stan and the eruption of the Ilamatepec volcano, both in October 2005. According to initial assessments, the cost of the storm damage could run up to 2.5% of GDP. Although election spending will diminish for the rest of the year and Mr Saca is set to tighten spending for the remainder of the forecast period, significant reconstruction spending in 2006 means that the NFPS deficit is likely to continue to widen in 2006, to 1.6% of GDP (up from 1.1% in 2005). Reconstruction costs will keep the fiscal deficit at 1.2% of GDP in 2007. The Economist Intelligence Unit expects the deficit will be financed primarily through external borrowing.

El Salvador relinquished control of monetary policy at the start of 2001 by adopting the US dollar as legal tender at a fixed exchange rate of c8.75:US$1. Since then, all prices have been quoted in US dollars (a legal requirement), and government and financial-sector transactions have been conducted in the US currency. The beneficial effects of dollarisation"reduced inflationary pressures

Policy trends

Monetary policy

Fiscal policy

El Salvador 9


and the convergence of interest rates towards those in the US"have already been felt and should continue in the forecast period. This will help to offset a loss of policy flexibility and the potential loss of export competitiveness. Interest rates will continue to rise in line with US rates during the forecast period, but will remain below historical levels. At the end of 2005 the average lending rate rose to 7% (from 6.4% at the end of 2004); it had risen further, to 7.4%, in April. We expect it to reach 8.5% by the end of 2006, before easing to 8% in 2007. If US rates were to rise more steeply than our forecasts suggest, Salvadoran rates would follow suit.

Economic forecast

International assumptions summary (% unless otherwise indicated)

2004 2005 2006 2007

Real GDP growth World 5.6 4.9 4.9 4.3

US 4.2 3.5 3.1 2.4

EU25 2.4 1.7 2.3 2.1

Exchange rates ¥:US$ 108.1 110.1 109.2 98.5

US$:� 1.244 1.245 1.296 1.390

SDR:US$ 0.675 0.677 0.665 0.635

Financial indicators ¥ 2-month private bill rate 0.00 0.00 0.25 0.58

US$ 3-month commercial paper rate 1.48 3.49 5.24 4.88

Commodity prices Oil (Brent; US$/b) 38.5 54.7 70.0 66.0

Coffee (Arabica; US cents/lb) 80.5 114.9 115.1 107.5

Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.5 4.0 -4.2

Industrial raw materials (% change in US$ terms) 21.0 10.5 20.0 -17.9

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

Stable, if slower, US growth in the forecast period will help to underpin El Salvador�s economy, which is closely tied to conditions in the US and to regional trade prospects. The implementation of DR-CAFTA in March 2006 will provide new growth opportunities through increased trade with, and investment from, the US. However, rising global interest rates will reduce international liquidity, putting pressure on emerging economies that have large financing needs, including El Salvador. Moreover, global imbalances raise the risk that there will be a more rapid than anticipated deceleration in 2006-07. Robust prices for some of El Salvador�s exports will benefit export earnings, but the gains are likely to be offset by the continued high cost of oil imports. We have revised our oil price forecast for the Brent-blend up to US$70/barrel (from US$66/b) in 2006. Prices will fall only slightly in 2007, to an average of US$66/b (revised up from US$55/b). The upward revision was necessary as new oil supply is not coming on stream fast enough, although demand remains robust.

GDP growth accelerated from 1.5% in 2004 to 2.8% in 2005. We expect that growth will rise further, to over 3% in the forecast period, driven by investment

International assumptions

Economic growth

10 El Salvador


in the public and private sectors. The former will be underpinned by reconstruction projects in the wake of Tropical Storm Stan and the Ilamatepec eruption, whereas the latter will be spurred by the implementation of DR-CAFTA since March. The treaty will stimulate strong import growth, along with investment, and as a result net trade will become negative in 2007, as import growth starts to outpace export growth. However, by then investment in export capacity should help to offset some of the loss of competitiveness of Salvadoran exports in the US market and help to accelerate exports. Exports of the maquila industry will be held back in the forecast period by increased competition from China in the US market, but faster growth of non-traditional exports will compensate to some extent. Private consumption growth will remain above 3%, supported by remittances from Salvadorans working abroad. On the supply side, construction, a large employer, should surge as reconstruction activity gathers pace. The services sector (especially transport, utilities and financial services) should also grow briskly, but manufacturing will continue to underperform.

After spiking to 5.9% in October as a result of food supply shortages caused by Tropical Storm Stan, inflation moderated at the end of 2005, and into 2006. However by April, 12-month inflation stood at 4.2%, as transport costs rose by 3% year on year as a result of still-high oil prices. Despite dipping below the year-end rate of 2005 (4.3%) and 2004 (5.4%), we expect that the rising cost of reconstruction-related imported inputs will keep price pressures high in the first half of 2006. Inflation will also be fuelled by higher transport costs, largely as a result of still-high oil prices. We expect inflation to end 2006 at 5%, and to moderate slightly to 4.5% at end-2007. This is slightly above our previous estimates (of 4.5% and 4% respectively) and the result of our upward revision of oil prices in the forecast period.

Under the Ley de Integración Monetaria (the Monetary Integration Law), which took effect in January 2001, the exchange rate was fixed at c8.75:US$1 and the US dollar became legal tender. El Salvador�s trade-weighted real exchange rate initially rose sharply in 2000-02, but has since depreciated to a neutral position. This is primarily owing to low domestic inflation, but also in part to the dollar�s recent depreciation against regional and European currencies. Based on our global assumptions, we expect that the real exchange rate will remain neutral in 2006-07. Nevertheless, there are some concerns over the competitiveness of Salvadoran goods in the US market, given that inflation has been rising at a faster rate than in the US and by the lack of significant productivity gains in the economy. Further strains on dollarisation would stem from a deterioration of the public finances in the forecast period owing to reconstruction costs of the tropical storm damage. That said, the fiscal imbalance has been reduced since Mr Saca assumed power and there is little risk that the dollarisation system will come under severe threat in the forecast period.

After widening in 2005 to around 4.5% of GDP, the current-account deficit will widen further in the forecast period, to an annual average of 5.5% of GDP. The trade deficit will widen, reflecting a sharp rise in import spending on investment related to DR-CAFTA, reconstruction-related imports, more

External sector

Inflation

Exchange rates

El Salvador 11


expensive oil imports and consumer goods. An increase in the income deficit as a result of the public sector�s higher indebtedness, combined with rising interest rates, will also contribute to the larger current-account deficit. However, a rise in services credits (owing to higher tourism receipts and insurance claim payouts following the October volcanic eruption and storm-related damage) and an increase in the current transfers surplus (on the back of still-strong workers� remittances) will help to stem the deterioration in the current account in the forecast period. Workers� remittances will continue to grow, albeit at a slower pace than in recent years"in 2005 they rose by 11%, to US$2.8bn (an estimated 16.5% of GDP). The recent extension of the TPS for Salvadorans in the US by 12 months (previously it was set to run until September 2006) will fuel these inflows, as will the continued flow of migrants, both legal and illegal, to the US, despite US efforts to tighten up its southern borders.

Rising principal repayments on the external debt in 2006-07, combined with a higher current-account deficit, will drive the financing requirement higher. As this is set to coincide with a decline in net long-term debt inflows and stable FDI inflows averaging around US$470m, El Salvador will need to attract around US$330m in short-term capital or else risk an erosion of international reserves below the levels that we are currently forecasting (around US$1.9bn).

Forecast summary (% unless otherwise indicated)

2004 a 2005 b 2006c 2007c

Real GDP growth 1.5 b 2.8 3.2 3.1

Industrial production growth 0.5 1.5 2.0 2.3

Gross agricultural production growth 3.0 b 5.9 2.0 2.7

Unemployment rate (av) 6.3 b 6.5 6.0 6.0

Consumer price inflation (av) 4.5 4.7 a 3.9 4.8

Consumer price inflation (year-end) 5.4 4.3 a 5.0 4.5

Short-term interbank rate 6.3 6.9 a 8.5 8.0

NFPS balance (% of GDP) -0.7 -1.1 -1.6 -1.2

Exports of goods fob (US$ bn) 3.3 3.4 3.8 4.2

Imports of goods fob (US$ bn) 5.9 6.4 7.4 7.7

Current-account balance (US$ bn) -0.6 -0.8 -1.1 -1.0

Current-account balance (% of GDP) -3.9 -4.5 -6.0 -5.0

External debt (year-end; US$ bn) 7.6 b 8.1 8.7 9.0

Exchange rate c:US$ (av) 8.75 8.75 a 8.75 8.75

Exchange rate c:¥100 (av) 8.09 7.95 a 8.01 8.88

Exchange rate c:� (year-end) 11.85 10.32 a 11.99 11.99

Exchange rate c:SDR (year-end) 13.59 12.51 a 13.62 13.72

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

12 El Salvador


El Salvador Latin America

Gross domestic product(% change, year on year)

El Salvador Latin America

Consumer price inflation(av; %)

-1

0

1

2

3

4

5

6

2001 02 03 04 05 06 07

0

2

4

6

8

10

12

2001 02 03 04 05 06 07

The political scene

The president, Antonio Saca of the ruling Alianza Republicana Nacionalista (Arena), opened a new three-year session of the unicameral Asamblea Legislativa (the legislature) on May 1st with a call on the opposition parties to enter into a dialogue. Mr Saca hopes to repeat his success early on in his presidency in 2004 when he garnered all-party support for approval of the 2005 budget, as well as a series of reforms to the criminal justice system. An early sign of consensus came with the election of a new directive board of the legislature, with the presidency taken up by Ruben Orellana, thus remaining in the hands of the right-wing Partido de Conciliación Nacional (PCN). In return for their support for the PCN candidate, Arena secured the presidency of six legislative commissions, the same as the FMLN. This will allow each party to maintain influence over different parts of the legislative agenda. It has worked well in the past, permitting cross-party negotiations and co-operation between politicians.

National Assembly, balance of power (no of seats; Mar)

2003 2006Arena 27 34

FMLN 31 32PCN 16 10PDC 5 6

CD 5 2Total 84 84

Source: Tribunal Supreme Electoral.

In the final results of the March 12th mid-term elections, Arena regained its position as the largest party in the legislature with 34 out of 84 seats. The FMLN won 32 seats, one more seat than three years earlier, but the largest change came among the three small parties. The PCN lost six seats in the final count (not four as the Economist Intelligence Unit reported in our March report, see the Political scene March 2006) and the Partido Demócrata

A new legislature is sworn in

El Salvador 13


Cristiano (PDC) gained one seat. This will give these two parties, natural allies of Arena that have co-operated at times, the power of veto. However, during the early part of the 2003-06 legislature, the PCN voted tactically alongside the FMLN to thwart several bills proposed by then-president, Francisco Flores (1999-2004). PCN leaders, however, have ruled out the possibility of entering into a de facto alliance of that nature again. The centre-left Cambio Democratico, CD, which is the FMLN�s natural ally, has two seats.

Violeta Menjívar, the daughter of a former mayor of the northern town of Arcatao, has become the highest woman office-holder for the FMLN, and the first female mayor of San Salvador, the capital. She beat Arena�s candidate, Rodrigo Samayoa, by a handful of votes (see March 2006, The political scene). She is a staunch member of the radical faction of the FMLN, which controls the party. She has promised to help combat crime in the city, to create more jobs and to build a new park in the capital. However, with limited powers (the mayor has no control over the police force, for instance), and scant resources, her ability to make changes may be restricted to cleaning up the streets of an already over-crowded and insecure city. The job will, however, increase her profile on the national scene, and as such, could provide her with a launch pad for a possible candidacy for the presidential election in 2009.

In late April, before the closing session of the outgoing legislative assembly, Arena, the PCN, PDC and the G-13 parties (a centre-left coalition that included seven dissidents from the FMLN) approved a series of constitutional amendments, including a ban on gay marriages, an extension from three to five-years for the term of office for mayors and deputies, authorisation of telecommunications eavesdropping by the state, and reforming the requirement that the foreign financing element in the budget be approved with a two-thirds legislative majority. The FMLN was also unable to block the appointment by the outgoing legislature, by a clear two-thirds majority (59 votes in favour), of five new magistrates to the Corte Suprema (the Supreme Court). The court is made up of 15 magistrates, five of whom are elected by the legislature every three years. As on previous occasions, the election was preceded by intense negotiations between the political parties, seeking to influence the final selection. Members of the G-13 voted with Arena to carry the election after the governing party agreed to withdraw two of its candidates, Carlos Alfredo Méndez Flores, a relative of the head of the Consejo Nacional de la Judicatura (the nacional judicial council), which oversees the judiciary, and the former attorney-general, Belisario Artiga. However, according to local press reports, of the five elected magistrates, all serving judges, two are close to Arena, one to the PCN and a fourth to the Frente Democrático Revolucionario (FDR, party made up of FMLN dissidents).

The opposition parties, with the exception of the FMLN, also voted alongside Arena in approving US$357.4m in foreign loans. These included US$55.4m from the Inter-American Development Bank (IDB) for rebuilding rural roads, and two loans from the World Bank for US$85m (for the Ministry of Education) and US$40.2m (for the national register).

The FMLN is isolated in final votes in outgoing legislature

First woman mayor of San Salvador takes office

14 El Salvador


To pass into law, however, the constitutional changes as well as the foreign loans will have to be approved by a 56-vote majority of the incoming legislative assembly. With 32 seats in the new legislature, the FMLN can block these reforms. It has made its support conditional on Arena backing a proposal to raise the minimum pension (currently US$114/month) to the same level as the minimum wage (US$154/month), and to enter into a fuller discussion of the government�s debt policy.

In mid-April, presidents Saca and Manuel Zelaya of Honduras ended an age-old border dispute that led to a brief war between the two countries in 1969 known as the �soccer war�. Under the auspices of the Organisation of American States (OAS), both leaders attended a ceremony at the El Poy frontier crossing, signalling the conclusion of the demarcation of 375 km of border, which had been ordered by the International Court of Justice in The Hague in September 1992. The Court had ruled that 69% of the disputed territories should lie within Honduras and the remainder in El Salvador. Despite some initial tensions surrounding the ruling, the establishment of common customs crossing points has facilitated the movement of both goods and people across their joint borders.

Mr Saca has welcomed the vote taken in late May by the US Senate approving a bill that sets out how those living illegally in the US could gain citizenship. He stated that up to 250,000 Salvadorans could benefit in the short term from the new scheme, if it eventually becomes law. These are people who are already covered by Temporary Protection Status (TPS), a programme that originally gave special status to Salvadorans after the 2001 earthquakes, but was subsequently extended. However, the US Senate bill still has to be reconciled with the more punitive measures approved by the House of Representatives at the end of 2004. There are an estimated 2.5m Salvadorans living and working in the US, many of whom have been there for more than two decades and are already citizens, but many others are living there illegally. Last year, US$2.83bn was sent back to El Salvador by the ex-patriots in the form of workers� remittances. Anecdotal evidence suggests that hundreds of Salvadorans still head for the US illegally each month. Toughening the border controls, one of the measures contained in the changes approved by the Senate, is unlikely to stop the flow of migrants.

Economic policy

Guillermo López Suarez resigned as Minister of Finance in late April. No explanation was given, although reports in the national press suggested that Mr López Suarez, who had been in the post since June 2004, faced opposition within the cabinet over his plans to continue with the fiscal reforms that he began in 2005, including a series of largely administrative reforms to the tax system. Mr Saca replaced him with William Handal, a former vice-president of Transportes Aéreos del Continente Americano (Taca, the national airline). Mr López Suarez was put in charge of the Secretaria Internacional para

Mr Saca appoints a new finance minister

Salvadorans welcome US immigration law reforms

El Salvador and Honduras settle their border dispute

FMLN regains initiative in new legislature

El Salvador 15


Asuntos Comerciales (the international trade secretariat), an office within the presidency that focuses on promoting trade agreements created in April 2006.

Mr Saca has denied that there are any inter-government disagreements over policy and Mr Handal has stated there will be no changes to the tax system, despite press speculation. The government is working instead to raise tax revenue by making its collection service more efficient and bringing more employees of the informal service sector into the tax net. Following the March 12th legislative elections, Mr Saca has less than two years (before campaigning for the presidential election in 2009 starts) to consider taking any politically sensitive decisions, including raising tax rates.

Preliminary figures from the Banco Central de Reserva de El Salvador (the Central Bank), for the first quarter of 2006 show that total tax revenue rose by 23% year on year, largely owing to the 2005 reforms (see March 2005), but also owing to higher GDP growth. Revenue from income tax rose by 23%, owing to a simplification of the tax return system, while VAT returns rose by 24%. More detailed data from the Central Bank for January 2006 indicates that customs duties rose by 7.4%, buoyed by extra consumer purchases over the festive period, after a year-end fall of almost 9%.

Tax revenue (US$ m; Jan-March)

2005 2006 % changeValue-added tax 261 325 24Income tax 143 176 23

Customs duty 38 44 16Excise duties 20 25 28

Property tax 4.3 4 -8Other taxes 17 18 4Total 483 592 23

Source: Banco Central de Reserva de El Salvador.

Despite the buoyant first-quarter tax take, the fiscal balance shifted from a small surplus to a deficit. This does not include the payments into the old pension system, which reached US$83m in the first three months of this year, up from US$67m. The deterioration in the fiscal accounts was entirely owing to the increase in capital spending. Rebuilding following Tropical Storm Stan and the eruption of the Illamatepec volcano both required increased public-sector outlays. The sharp increase in current spending, which entirely absorbed the rise in current revenue, was owing to increased outlay in fees and goods and services, as well as higher transfers associated with the Education Ministry�s school bonds.

Non-financial public-sector accounts (US$ m unless otherwise indicated; Jan-Mar)

2005 2006 % changeCurrent revenue 605 725 19.8Current expenditure 545 664 21.8Current balance 60 61 2.4

First-quarter fiscal deficit widens, despite revenue rise

Tax revenue rises sharply in the first quarter

16 El Salvador


Non-financial public-sector accounts (US$ m unless otherwise indicated; Jan-Mar)

2005 2006 % changeCapital revenue 0 0 n/aCapital expenditure 63 116 85.5Balance before grants -3 -55 1,979

Grants 9 9 4.4Overall balance 6 -45 n/a

Source: Banco Central de Reserva de El Salvador

The domestic economy

Economic trends

GDP growth accelerated to 2.8% in 2005, the highest growth rates in five years and a significant recovery from 1.5% in 2004 and 2003. The recovery was driven by strong consumer demand fuelled by an 11% yearly rise in workers� remittances, an increase in public-sector spending and a rise in foreign direct investment (FDI). Most sectors performed well in the latter part of the year. Agriculture, forestry and fishing grew by 5.8% in 2005, after expanding by 3% in 2004, as farmers continued to benefit from high world prices for their produce. After a disastrous 2004 (when it contracted by 11.4%), the construction sector grew by 3.4% last year stimulated by rising demand following the destruction of roads and buildings in many part of the country, including the capital, San Salvador, as a result of tropical storm Stan in October 2005. Industry recovered slightly in 2005 after stagnating in 2004 owing to a fall in US demand owing to increased competition from Chinese exports.

Gross domestic product growth (% change, year on year)

2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr YearAgriculture 3.9 2.8 2.7 2.6 3.0 5.8 5.9 5.5 5.8 5.8Industry 0.6 0.2 0.6 0.8 0.5 1.2 2.2 1.7 0.8 1.5

Construction -8.4 -11.3 -14.3 -11.6 -11.4 3.0 3.8 3.4 3.4 3.4Services 2.6 3 2.9 2.9 2.9 2.3 2.6 2.4 2.6 2.5

Government services 1.3 1.6 1.4 1.9 1.5 1.3 1.2 1.1 1.2 1.2GDP 1.9 1.8 1.8 1.9 1.8 2.5 3.0 2.7 2.8 2.8


The Indíce de Volumen de Actividad Económica (IVAE, a volume index of economic activity) of the Banco Central de Reserva de El Salvador (the Central Bank) posted a year-on-year rise of 5.5% in February 2006, indicating a continuation of the recovery process for most economic sectors. Agriculture expanded by 8.6% year on year in February 2006, construction by 7.7%, banking and finance by 11.6% and the utilities sector by 15.7%. The retail, restaurants and hotels segment grew by 5.3%, in line with overall performance, despite a 20% year-on-year increase in revenue reported by the tourism sector in the first quarter of 2006. Industrial manufacturing, however,

GDP growth in 2005 was the highest in five years

February�s IVAE suggests that the economy is strengthening

El Salvador 17


posted a 1.1% contraction, suggesting that the sector is still being squeezed by competition.

Following contractions in November and December 2005 and relatively subdued increases in the first quarter, inflation appeared to have picked up in April when prices rose by 0.7% month on month. Twelve-month inflation stood at 4.2% in April 2006, the highest so far this year, but below the year-earlier period when it reached 4.4% and the end of 2005, when it stood at 4.3%. Part of the April increase was caused by higher transport costs, up by 3%, which in turn has a direct effect on the costs of basic food in the markets. It also drove prices in hotels and restaurant up by 1.1%.

Consumer prices (% change)

2005 2006 May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar AprMonth on month 0.7 0.0 0.2 0.3 0.4 1.9 -1.3 -0.1 0.5 0.5 0.4 0.7Year to date 2.9 2.9 3.1 3.3 3.8 5.7 4.4 4.3 0.5 1.0 1.4 2.1

Year on year 4.4 4.3 4.1 4.2 4.4 5.9 4.6 4.3 3.3 3.8 4.0 4.2

Source:Banco Central de Reserva de El Salvador.

Since July 2005 a government subsidy has been in place of 50 US cents per gallon of diesel for buses and 15 US cents/gallon for minibuses. This was the result of prolonged negotiations between the Ministry of Public Works and representatives of the bus owners aimed at avoiding any increase in fares last year. The subsidy runs out at the end of June 2006 and the bus operators want the ministry to sanction a minimum rise of 10 US dollars in the flat fare for city buses (currently 20 US dollars), as well as a 36% rise for intercity fares. A powerful and combative lobbying group, the bus operators have in the past attempted to force the government�s hand by de facto fare increases on some bus routes until a settlement has been reached. Any change in bus fares immediately causes a knock-on effect on other transportation costs, and in turn means prices of basic foodstuffs are raised in the shops and markets. Meanwhile, the government has decided to maintain a subsidy on the price of liquid gas, which the majority of households use for cooking. The president, Antonio Saca, has said that the annual subsidy of US$70m will remain in place, despite calls from some private-sector groups for its elimination.

The BCR reports that private-sector demand for credit rose 10.5% year on year in March 2006, driven mainly by an increase in demand from the non-agricultural productive and services sectors. The Superintendencia del Sistema Financiero (SSF, the financial system watchdog) reported an 18% year-on-year increase in January-February 2006 in loans to the transport sector, a 7.4% rise in credit to the retail sector and a 6.6% yearly rise in the services sector. There was also strong demand for personal loans and mortgages, as domestic borrowing rates remain low historically. Many banks have also made it easier to apply for loans, reducing both the time and paperwork involved.

Inflation rises above 4% again

A bus-fare rise would create more inflationary pressure

Demand for credit has been strong

18 El Salvador


Interest rates (%)

2005 2006 May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar AprSavings rate (over 180 days) 3.38 3.44 3.40 3.38 3.42 3.41 3.65 4.02 4.08 3.97 4.12 4.02Lending rate (up to one year) 6.80 6.98 6.90 7.03 6.72 6.87 6.94 7.03 7.79 7.53 7.43 7.35

Spread 3.42 3.54 3.50 3.65 3.30 3.46 3.29 3.01 3.71 3.56 3.31 3.33


Short-term borrowing rates (for loans of up to one year) rose from 7.03% in December 2005 to 7.79% in January 2006, in line with US interest rates increases. Since then, short-term rates have dropped slightly to 7.35% in April 2006, but this is still high compared with a year ago, when the average rate was 6.53%. Despite the easing of short-term lending rates, long-term lending rates (more than one year) have steadily risen in 2006, from 8.87% in January to 9.02% in April of this year. Spreads between lending and savings rates peaked in January at 3.71 percentage points, but had fallen back to 3.33 percentage points by April.

Agriculture

Agricultural GDP accelerated in 2005 to 5.8% from 3% in 2004. This trend appears to have continued in the early months of 2006, according to the IVAE, which showed yearly growth in February of 8.6%, against a 2.1% contraction in the year-earlier period. The prices fetched for El Salvador�s traditional export produce, such as coffee and sugar, have continued to offset the fall in output from these sectors. Coffee revenue, for instance, rose by 20% year on year in January 2006, even though in volume terms sales fell by 8% year on year. The average price paid for a quintal (qq; 1 quintal=46 kg), of Salvadoran coffee rose from US$84.29 per quintal in January 2005 to US$109.93/quintal in January 2006, an annual rise of 30.4%.

According to the Consejo Salvadoreño del Café (CSC, the Salvadoran coffee council) coffee sales in volume terms fell by 15% between October 2005 and April 2006 to 872,000qq from 1.2mqq quintales in the year-earlier period. However, sales in value terms rose by 4.5% year-on-year during that period. Production has been negatively affected during the 2005-06 harvest by the eruption of the Ilamatepec volcano in October 2005. According to the Fundación Salvadoreña para Investigaciones del Café (Procafé, the Salvadoran coffee research foundation), an estimated 46,000qq of coffee was lost owing to volcano damage. Of more than 500 coffee farms investigated by Procafé, 52 reported damage to their plantations, all of them in the western Santa Ana region.

Despite the strong prices, the coffee growers have been complaining about under-investment in the sector. During the period before the start of a new harvest in October-November, the plantations need to be cleaned and the trees prepared for the next season. The growers complain that these pre-season works are not carried out because of a lack of funding for the growers

High prices are helping to maintain growth

Long-term lending rates rise steadily

Coffee output affected by volcanic eruption

El Salvador 19


from the commercial banks. Figures from the SSF show that loans to the farming sector grew by just 0.5% year on year in the first two months of 2006. A government-funded scheme introduced under the then president, Francisco Flores (1999-2004), the Programa de Garantias (Progara), was designed to provide a US$40m guarantee fund to enable the banks to offer cheaper loans to the coffee growers in the pre-harvest period. The government has also stated that it will try to argue the coffee-growers� case with the commercial banks. Many coffee plantations, facing a lack of seasonal workers owing to increased rural migration to the US, have been recruiting extra workers from neighbouring Honduras and Nicaragua.

The Ministry of Agriculture imposed a month-long suspension on shrimp fishing between mid-April and mid-May to allow for a recuperation of stocks during the reproductive cycle of the shrimps. Although implementation has proved difficult in the past, the ban was supported by the threat of fines of up to US$8,000. This was an annual suspension, and under a government scheme, the fishing cooperatives on the Pacific coast can apply for subsidised basic foods for their members during the downtime. Shrimp exports have fallen sharply over the past years from US$20m in 2001, to barely US$3m in 2005, mainly owing to falling stocks.

Manufacturing

Industrial GDP growth expanded by 1.5% in 2005. Although this was better than in 2004, when it barely expanded at 0.5%, the performance remained lacklustre at best. According to the Central Bank�s Indíce de Volumen de Producción Industrial (IVOPI, the volume index of industrial activity), first-quarter production fell by 0.7% year on year. This was borne out by the latest IVAE for February 2006, which showed an annual drop of 1.1% for industrial activity. The underlying poor performance is linked to the difficulties faced by the maquila (offshore assembly, mainly of textiles, for re-export) industry, where exports dropped by 5.1% in 2005. In the first quarter of 2006, maquila sales continued their contraction, falling by 6.6% year on year. El Salvador�s principal export market for maquila output is the US, where competition has increased from cheaper Chinese textile imports following the end of the Multi-Fibre Agreement in January 2005. The Central Bank reports that demand from the US for Salvadoran textiles fell by an annual rate of 3.8% in January-February 2006.

Unlike other Central American countries, many of El Salvador�s maquiladoras have traditionally produced unfinished garments and underwear, which require less raw materials and can be assembled more cheaply, for the US market. This strategy has left the sector more vulnerable to competition from East Asia. Under the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA) with the US, Salvadoran maquiladoras will have to use more expensive thread from the region or from the US (rather than from Asia as it did previously) in products aimed at the US market. By way of concession, however, Salvadoran factories will be allowed to export duty-free to the US baby clothes, as well as coats and suits for women. The Agencia de

Manufacturing recovery remains elusive

One-month shrimp fishing ban imposed

20 El Salvador


Promoción e Inversión de El Salvador (Proesa, the government export agency) reported in May that, following the formal coming-into-effect of DR-CAFTA in March 2006, four new textile firms have set up in El Salvador, although no further details were available.

Infrastructure

Around 20% of the construction work has so far been completed for building the new port complex at La Union, in the east of the country, according to the Comisión Ejecutiva Portuaria Autónoma (CEPA, the state port authority). The old port structures of Cutuco have been totally demolished and part of the Golfo de Fonseca that will be in use for the port docking facilities has been secured. CEPA aims to begin construction of the terminal buildings by the end of the year. The project, awarded to the Japanese-Belgian consortium, TOA/Jan de Nul, began in May 2005. Funding is coming from the Japanese International Cooperation Bank (US$90.8m) and the Central American Bank for Economic Integration (US$25m). A final date for the completion of the new port, which is an important part of the development of the eastern part of El Salvador, has yet to be made public.

Analysts at the Fundación Salvadoreña para el Desarrollo Económico y Social (Fusades, a private-sector think tank) have warned that, on current trends, demand for electricity will outstrip supply capacity within the next four years, causing a power deficit from 2010. Owing to problems at the main 15 de Septiembre hydroelectric plant, where one of the machines has been out of action since 2004, El Salvador is increasingly resorting to imported electricity from neighbouring Guatemala, which at peak times has been providing up to 9% of total supply. Around 48% of El Salvador�s electricity is produced with fossil fuels, which, according to Fusades, makes the country�s generating capacity especially vulnerable to rising world oil prices. Over the past 20 years, El Salvador�s fossil-fuel-based generation has risen by 18%, while production of hydroelectric and geothermal energy has risen by 1.5% and 5.3% respectively. Bidding is currently under way for the construction of a fifth hydroelectric plant, El Chaparral, and building is due to start this year at a new thermal plant at Colón, in the southern La Libertad province. Fusades warns, however, that, of 11 development projects either under way or in the pipeline, only two will be in a position to increase the supply capacity within the next two years, whereas the others will not be ready until 2010 at least.

Foreign trade and payments

After annual growth of just 2.8% in 2005, export earnings rose by nearly 11% year on year in the first quarter of 2006, driven by high commodity prices for traditional exporters and strong growth in the export of non-traditional products. These two sectors more than compensated for a decline in exports from the maquila (offshore assembly, mainly of textiles, for re-export) industry.

Exports continue to rise, despite fall in maquila sales

Work progresses on the rebuilding of La Union port

Calls for more investment in the energy sector

El Salvador 21


Revenue from sugar exports rose to US$34m in the first quarter of this year, compared with US$67m during the whole of 2005, and US$37m during 2004. Under the Dominican Republic-Central American Free-Trade Agreement (DR-CAFTA), El Salvador�s duty-free sugar quota has risen by 24,000 metric tonnes. Sales from coffee slowed to 18% year on year in the first quarter, compared with 33% in 2005, owing to a fall in volume exports (see Agriculture). Sales from coffee and sugar supported the growth of traditional exports, which generated 62% more revenue in the three-month period compared with last year. Maquila exports continued to fall, down 6.6% year on year, an acceleration on the 3.7% yearly fall in the year-earlier period. Maquila imports fell by 9% year on year, allowing for a small improvement in the trade surplus of the sector.

Annual growth of almost 9% in 2005 in non-traditional exports accelerated to almost 26% in the first quarter of 2006. These products, which include food, ethyl alcohol, small tools and mineral products, are mainly sold to other Central American nations, although there is a small, but growing market developing in the US for so-called �nostalgia� produce, aimed at around 2.5m Salvadoran ex-patriots there. They include maize-based products such as pupupas (thick, hand-made, stuffed corn tortillas), tamales de elote (savoury or sweet-filled corn dough wrapped in a corn husk or banana leaf), and pan dulce (sweet bread) and even home-grown red-beans. All of these benefit from duty-free status under DR-CAFTA. Figures from the Ministry of the Economy, show that after the establishment of DR-CAFTA, sales of pan dulce rose by 88% in March 2006, pupupas by 72% and red beans by 5%. A Salvadoran company specialising in nostalgia foods, Guanapack, has recently launched readymade packs containing a selection of these items for the US market.

Merchandise trade balance (US$ m: Jan-Mar)

2005 2006 % changeExports fob 820 909 10.9 Traditional exports 61 99 62.3 Coffee 54 63 16.7 Sugar 7 34 385.1 Shrimp 0.4 1 150 Non Traditional exports 314 395 25.8 Maquilaa 444 415 -6.5

Imports cif 1,561 1,777 13.8 Consumer goods 444 545 22.7 Intermediate goods 538 652 21.2 Capital goods 236 268 13.6 Maquilaa 343 311 -9.3

Trade balance -741 -868 17.1

a Offshore assembly for re-export.


Despite a first-quarter rise in export revenue, the trade deficit widened by 17%, as import spending rose by 14% year on year. The rate of increase in spending on consumer goods has more than doubled to almost 23%, fuelled by a steady

Non-traditional exports increase sharply

Consumer spending and high oil prices fuel imports

22 El Salvador


rise in workers remittances inflows. Purchases of intermediate goods rose at an annual rate of 21% in the first three months of this year, compared with 7.3% in the year-earlier period. High oil prices are partly to blame, with the Central Bank reporting that El Salvador spent 25% more on oil and its derivatives in January-March 2006 compared with the previous year, despite a 10% drop in the volume of oil imported. Capital goods imports rose by 14%, up from 1.6% in the year-earlier period. It was driven a 45% rise in capital spending by the farming sector and a 46% rise in spending by the services sector.

A widening of the trade and income deficits in the second half of 2005 caused a deterioration in the full-year current-account deficit, ending 2005 at US$778m, up from US$612m in 2004. The worsening of the trade deficit was owing to a combination of slow export growth and fast import spending growth owing to higher oil prices, whereas the income deficit expanded owing to higher interest payments on a larger debt stock. The deterioration of these two accounts could not be stemmed by an improvement in the current transfers surplus, owing to higher workers remittances, and the services surplus, owing to a strong increase in tourism receipts. According to the tourism ministry, the rise has continued during the first quarter of 2006, with revenue reported up by another 20% year on year. Around 70% of foreign visitors are from other Central American countries, according to the tourist board.

Current-account balance (US$m)

2004 2005 % changeTrade balance -2,661 -3,000 12.7Services balance -77 -72 -6.5Income balance -460 -571 24.1

Net current transfers 2,567 2,864 11.6 Workers remittances 2,547 2,830 11.1

Current-account balance -631 -786 24.6


Despite a surge in December, workers� remittances from Salvadorans living in the US rose by a slower rate in 2005, up by just 11% year on year, than in 2004 when they rose by 21%. Remittances sent in January and February 2006, months in which the inflows tend to be slower, slowed markedly from the year-earlier period, but March saw a reversal of that trend. In the first quarter, workers remittances rose by 13% year-on-year. While uncertainty surrounding the immigration debate in the US might have influenced the decision of Salvadorans to send home dollars, the decision in February by the US government to extend the temporary protection status (TPS) for 220,000 Salvadorans beyond its previous cut-off point of September 2006 guarantees that the ties with the US will remain strong.

The current-account deficit widened in 2005

El Salvador 23


Workers� remittances (US$ m)

2004 % change 2005 % change 2006 % changeJan 171 17.3 211 22.8 229 8.6Feb 170 14.2 215 26.2 239 11.2

Mar 218 28.4 245 12.1 292 19.3Apr 213 20.5 224 4.9 - -May 220 18.5 250 13.4 - -

Jun 212 19.4 234 10.4 - -Jul 210 19.5 217 3.6 - -

Aug 224 29.9 241 7.4 - -Sep 214 18.4 225 5.5 - -Oct 216 19.2 232 7.4 - -

Nov 231 31.9 236 2.5 - -Dec 246 15.3 299 21.3 - -

Total 2,547 21.0 2,830 11.1 760 13.3


The capital- and financial-account surplus increased to US$781m in 2005 from US$251m at the end of 2004, largely owing to a turnabout in the financial account. This was partly owing to increased foreign direct investment (FDI) in 2005. The healthier financial account also reflects the net inflows of commercial loans for private enterprises driven by improvements in growth in the economy. Net reserves remained stable at US$1.83bn by the end of 2005. Over the course of 2006 they have risen to US$2.15bn in April, a new record.

Net international reserves (US$ '000s)

2005 2006 May Jun July Aug Sept Oct Nov Dec Jan Feb Mar AprNet international reserves 1,740 2,031 1,902 1,727 1,750 1,734 1,826 1,829 1,728 1,857 1,765 2,151Months of import cover 3.5 4.3 4.3 3.7 3.9 3.7 4.1 3.8 3.7 4.3 3.1 n/a

Source:Banco Central de Reserva de El Salvador.

El Salvador received US$477m in FDI last year, up by 2.3% year-on-year and equivalent to around 2.8% of GDP, according to the Economic Commission for Latin America and the Caribbean (ECLAC). This is more than the Central Bank�s estimate for last year�s FDI of US$424m. According to the BCR, most of the FDI (US$317m) took place in industry, followed by the financial sector (US$102m). Most of the foreign investment in El Salvador is concentrated in industry (25%), followed by telecommunications (23%), electricity (21%) and agriculture (20%). The US is El Salvador�s largest investor, accounting for 26% of total FDI. It is followed by Mexico with 19%, Venezuela with 9% and Spain with 6%.

On April 20th the government issued US$400m in eurobonds, in line with the 2006 budget that contains a provision for issuance of US$664m in foreign debt. The yield on the issue was 7.636%, equivalent to 240 basis points over the equivalent US treasury bonds. These terms are better than for a US$375m issue in June last year, when the yield was slightly higher at 7.695% and the spread over equivalent US treasury bonds 345bps (the difference in spread is largely

International reserves are stable

FDI rises further in 2005

Government issues US$400m in eurobonds

24 El Salvador


caused by the rise in the rate on these bonds from 4.25% to 5.24%). The offering had originally been US$300m, but was increased owing to higher demand. After issuing US$39m in the local market earlier this year, the government will be able to issue a further US$225m in bonds later this year. The proceeds will be used to finance the fiscal deficit, including pension payments, to refinance a 1999 US$150m bonds issue and to provide project counter-financing. This will raise El Salvador�s total foreign debt stock to around US8.65bn (from US$8.09bn in 2005) in 2006 or 46.4% of GDP. These debt estimates are based on World Bank data for 2003, the most recent year available.

Documents

El Salvador - International University of Japan...El Salvador 5 Country Report June 2006 ' The Economist Intelligence Unit Limited 2006 Economic structure Annual indicators 2001a 2002a