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Country Report

El Salvador

December 2004

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

El Salvador at a glance: 2005-06

OVERVIEWAntonio Saca of the right-wing Alianza Republicana Nacionalista (Arena) tookoffice as president on June 1st, pledging reform in the areas of public health,public education, fiscal administration and electoral procedures. He commandsa clear popular mandate after his overwhelming victory in the Marchpresidential election and has a small window of opportunity to push throughhis legislative agenda before campaigning begins for the legislative andmunicipal elections due to be held in March 2006. However, Arena lacks aclear majority in the unicameral legislature, forcing the government to rely onnegotiations and compromises to implement its programme. Fiscal policy willremain tight in the forecast period, with the deficit narrowing in 2005-06--thisyear!s fiscal results will be distorted as the government had to operate with the2003 budget in the first half of the year. GDP growth is expected to increase inthe forecast period as domestic and foreign investment pick up. Inflation willdecline to around 4% in 2005-06 after reaching 6% this year. The current-account deficit will ease to below 4% of GDP by the end of the forecast periodas a result of a narrowing trade deficit.

Key changes from last month

Political outlook• The triumph of the orthodox hardliners� wing of the Frente Farabundo

Martí para la Liberación Nacional (FMLN) in its internal elections in earlyNovember will increase the party!s inflexibility in its negotiations with thegovernment. This will complicate policymaking for the government"it willbe able to pass proposals requiring a simple majority with the help of otherparties, but will need the FMLN for anything requiring an absolute majority.

Economic policy outlook• Without the votes of the FMLN, the government will struggle to get the 2005

budget passed before the year-end deadline. This raises the risk that, as in2003, this year!s budget may need to be rolled over.

Economic forecast• The Economist Intelligence Unit has revised its GDP forecast for 2004 down

to 1.8% (from 2.1%) owing to the economy�s lacklustre performance since thestart of the year. Our forecast for 2005-06 has been reduced to 2.1%, from 2.5%.

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El Salvador 1

Country Report December 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004

Contents

El Salvador

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2005-067 Political outlook8 Economic policy outlook9 Economic forecast

11 The political scene

14 Economic policy

17 The domestic economy17 Economic trends19 Agriculture20 Manufacturing20 Infrastructure21 Financial and other services

21 Foreign trade and payments

List of tables

9 International assumptions summary11 Forecast summary15 Tax revenue15 Non-financial public-sector accounts16 Approved budget, 200517 Gross domestic product growth18 Consumer prices18 Interest rates22 Merchandise trade22 Family remittances23 Current-account balance24 Net international reserves

2 El Salvador


List of figures

11 Gross domestic product11 Consumer price inflation16 Central government debt19 International coffee prices20 Index of industrial production (IVOPI)24 Stock of foreign direct investment by sector, June 2004

El Salvador 3


El SalvadorDecember 2004

Summary

Antonio Saca of the right-wing Alianza Republicana Nacionalista (Arena) tookoffice as president on June 1st, pledging reform in the areas of public health,public education, fiscal administration and electoral procedures. He commandsa clear popular mandate after his overwhelming victory in the Marchpresidential election and has a small window of opportunity to push throughhis legislative agenda before campaigning begins for the legislative andmunicipal elections due to be held in March 2006. However, Arena lacks a clearmajority in the unicameral legislature, forcing the government to rely onnegotiations and compromises to implement its programme. Fiscal policy willremain tight in the forecast period, with the deficit narrowing in 2005-06--thisyear!s fiscal results will be distorted as the government had to operate with the2003 budget in the first half of the year. GDP growth is expected to increase inthe forecast period as domestic and foreign investment pick up. Inflation willdecline to around 4% in 2005-06 after reaching 6% this year. The current-account deficit will ease to below 4% of GDP by the end of the forecast periodas a result of a narrowing trade deficit.

Mr Saca has remained popular in the polls and has made a start on his policyprogramme. Cross-party consensus broke down when the Frente FarabundoMartí para la Liberación Nacional (FMLN) withdrew from the inter-party forumdialogue. Following internal elections in which the hardliners thrived, theFMLN has raised its opposition to the government�s programme.

Congress passed the first set of tax reforms in October despite some private-sector opposition. There was a mild deterioration in the fiscal accountsbetween January and August but the government covered all of this year�sfinancing needs with the issue of a US$287m 30-year bond in September. Thebudget for 2005 was presented to the legislature in early October.

Economic growth was sluggish in the first half of 2004. Inflation had risen to5.5% in October. Agriculture has shown further signs of recovery but the perfor-mance of the manufacturing sector was disappointing in the first half of 2004.

Weak exports earnings growth and faster import spending during the first eightmonths of 2004 caused a widening of the trade deficit. Nevertheless, thecurrent-account deficit narrowed in the first half of the year, largely owing tohigher net transfers stemming from family remittances.

Editors: Ondine Smulders (editor); Martin Pickering (consulting editor)Editorial closing date: November 23rd 2004

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2005-06

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 electeddeputies, elected every three years

Universal adult suffrage

March 2003 (legislative and municipal); March 2004 (presidential); next elections due inMarch 2006 (legislative and municipal); March 2009 (presidential)

President elected for a single term of five years

The president, Antonio Saca, governs with the support of Arena, which holds 29 seats inthe legislature; He appoints and presides over a Council of Ministers

Alianza Republicana Nacionalista (Arena); Frente Farabundo Martí para la LiberaciónNacional (FMLN); Centro Democrático Unido (CDU); Partido Demócrata Cristiano (PDC);Partido de Conciliación Nacional (PCN)

President Elías Antonio Saca GonzálezVice-president Ana Vilma Alvánez de Escobar

Agriculture Mario Salaverría NolascoDefence General Otto Romero OrellanaEconomy Yolanda Mayora de GavidiaEducation Darlyn MezaEnvironment Hugo César BarreraFinance Guillermo López SuarezForeign relations Francisco Laínez RivasHealth José Guillermo Maza BrizuelaInterior René Figueroa FigueroaLabour José Roberto Espinal EscobarPublic works David GutiérrezTourism 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 indicators2000 a 2001 a 2002a 2003 a 2004 b

GDP at market prices (c bn) 114.9 120.9 125.2 130.7 139.4GDP (US$ bn) 13.1 13.8 14.3 14.9 15.9

Real GDP growth (%) 2.2 1.7 2.1 1.3 b 1.8Consumer price inflation (av; %) 2.2 3.8 1.8 2.1 4.5Population (m) 6.2 6.3 6.4 6.5 6.6

Exports of goods fob (US$ m) 2,963.2 2,891.6 3,020.8 3,162.4 3,265.8Imports of goods fob (US$ m) 4,702.8 4,824.1 4,891.7 5,436.0 5,907.3

Current-account balance (US$ m) -430.5 -150.3 -411.8 -733.6 -795.9Foreign-exchange reserves excl gold (US$ m) 1,922.4 1,741.0 1,622.8 1,942.9 1,840.0Total external debt (US$ bn) 4.0 4.7 5.8 6.4 b 6.9

Debt-service ratio, paid (%) 6.7 6.8 7.7 9.3 b 9.1Exchange rate (av) c:US$ 8.76 8.75 8.75 8.75 8.75

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2003 % of total Components of gross domestic product 2003 % of totalAgriculture, forestry & fishing 9.5 Private consumption 89.3Industry 31.2 Government consumption 10.4

Services 59.3 Fixed investment 16.6Change in stocks 0.0

Exports of goods & services 26.7Imports of goods & services -43.0

Principal exports 2003 US$ m Principal imports cif 2003 US$ mMaquila 1,881 Intermediate goods 1,851

Coffee 105 Consumer goods 1,594Chemicals 47 Maquila inputs 1,381Sugar 47 Capital goods 937

Other 1,073

Main destinations of exports 2003 % of total Main origins of imports 2003 % of totalUS 67.6 US 49.8Guatemala 11.5 Guatemala 8.1

Honduras 5.9 Mexico 5.5Costa Rica 3.3 Japan 2.3

6 El Salvador


Quarterly indicators2002 2003 20044 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Non�financial public-sector balance (US$ m)Revenue & grants 566 576 636 568 656 581 686 552Expenditure & net lending 768 601 615 645 777 609 570 667Balance -202 -25 22 -77 -122 -28 111 -115

OutputGDP at constant 1990 prices (c m)Agriculture 1,725 1,691 1,714 1,717 1,741 1,720 1,733 n/aIndustry 3,648 3,607 3,687 3,700 3,712 3,636 3,693 n/aServices 8,252 8,088 8,230 8,289 8,396 8,205 8,362 n/aTotal 15,103 14,875 15,116 15,218 15,394 15,114 15,337 n/aTotal (% change, year on year) 2.4 1.8 1.9 1.7 1.9 1.6 1.5 n/aPricesConsumer prices (2000=100) 105.9 107.5 107.8 107.9 108.5 110.4 112.6 113.6Consumer prices (% change, year on year) 2.2 2.6 1.8 1.6 2.5 2.7 4.5 5.3Producer prices (1998=100) 110.3 113.5 110.5 112.0 110.2 112.6 117.1 120.9Producer prices (% change, year on year) 3.6 7.7 1.9 2.7 -0.1 -0.8 6.0 7.9Coffee price (US cents/lb)a 66.0 64.8 64.3 63.8 63.3 76.2 77.4 76.0Financial indicatorsExchange 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; %) 3.39 3.30 3.40 3.40 3.38 3.39 3.43 3.26Lending rate (av; %) 6.76 6.59 6.48 6.61 6.56 6.60 6.21 6.28Money market rate (av; %) 4.34 3.58 2.94 4.48 4.44 5.21 4.01 2.72M1 (US$ m) 1,090.4 1,111.6 985.4 1,067.2 1,198.6 1,233.4 1,173.9 n/aM1 (% change, year on year) -9.0 -8.7 -6.7 7.5 9.9 10.5 19.1 n/aM2 (US$ m) 6,106.3 6,146.9 6,085.7 6,041.3 6,244.2 6,277.8 6,203.3 n/aM2 (% change, year on year) -3.1 -2.8 1.0 1.2 2.3 2.1 1.9 n/a

Foreign trade (US$ m)Exports fob 758 802 757 802 775 794 788 819Maquila 447 460 455 507 459 442 437 474Imports cif -1,386 -1,419 -1,411 -1,476 -1,457 -1,458 -1,538 -1,534Maquila 332 339 328 374 340 328 333 354Trade balance -628 -617 -654 -674 -682 -665 -749 -714

Balance of payments (US$ m)Merchandise trade balance fob-fob -514 -533 -578 -601 -561 -579 -662 n/aServices balance -105 -64 -50 -16 -40 -10 -17 n/aIncome balanceb 397 383 452 385 489 429 557 n/aCurrent-account balance -223 -214 -176 -232 -112 -161 -122 n/aReserves excl gold (end-period) 1,623 1,800 1,687 1,814 1,943 1,937 1,837 1,919

a ICO Indicator. b Including current transfers balance.

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

El Salvador 7


Outlook for 2005-06

Political outlook

Antonio Saca of the right-wing Alianza Republicana Nacionalista (Arena), whotook office as El Salvador�s president on June 1st, has pledged to implement areform agenda in four main areas during his five-year term in office. He willseek changes in public health legislation, the public education system, fiscaladministration and electoral procedures. Mr Saca commands a clear popularmandate after his overwhelming victory in March over the candidate of themain left-wing opposition party, the Frente Farabundo Martí para la LiberaciónNacional (FMLN). He also has a small window of opportunity to push throughhis legislative agenda before campaigning begins in 2005 for the next round oflegislative and municipal elections, due to be held in March 2006.

However, Arena lacks a clear majority in the unicameral legislature, forcing thegovernment to rely on negotiations and compromises to implement itsprogramme. Out of a total of 84 seats, the FMLN holds 30 (one deputy wasexpelled for voting with Arena and is now independent), Arena has 29, thePartido de Conciliación Nacional (PCN) has 14, and the Centro DemocráticoUnido (CDU) and Partido Demócrata Cristiano (PDC) hold five each. Mr Sacahas already shown that he is more open to negotiation with other parties thanhis predecessor, Francisco Flores of Arena, who was frequently criticised for hisaloofness and unwillingness to compromise with the opposition. Mr Sacagalvanised early cross-party support for the 2004 budget and for reforms to thecriminal legislation. He also set up a multiparty discussion forum to analyseother aspects of his reform agenda soon after taking office.

The long-term success of Mr Saca!s move towards greater political co-operationis uncertain but will be aided by a break from frequent electoral campaigning,with the next national election (congressional) not due until March 2006. Thethree smallest parties represented in Congress, whose candidates togethergained just 6% of the presidential vote in March, will offer Arena support on anad hoc basis, depending on the issue. With the support of the right-wing PCN,Arena can pass legislation requiring a simple majority. The PCN is a traditionalArena ally but the party became more independent following its better thanexpected performance in the 2001 legislative election.

Having supported the government�s early attempts at consensus-building, theFMLN has now withdrawn from the multiparty discussion forum. It alsoboycotted the legislative vote that passed a first set of tax reforms. As a result ofinternal FMLN elections in November, the hardline faction that was already incontrol of the party consolidated its position and routed the more moderateelements that have been critical of its confrontational stance. Under theleadership of the hardliners, the party"which can block any legislationrequiring a two-thirds majority"will maintain its strong opposition to Arenapolicy, particularly on privatisation, free trade and rising foreign indebtedness.The FMLN will also try to galvanise support among trade unions to opposechanges in public health and education. Overall, given that neither the FMLN

Domestic politics

8 El Salvador


nor Arena has a simple majority in Congress, coalition building on an ad hocbasis will remain necessary over the forecast period.

Close relations with the US will continue under Mr Saca, but this loyalty willcarry a political cost within El Salvador. The government is facing growingopposition to certain pro-US policy decisions, especially the commitment ofSalvadoran troops to reconstruction efforts in Iraq. The government facesdifficult negotiations over the ratification of the Dominican Republic-CentralAmerican Free-Trade Agreement (DR-CAFTA), but should be able to have thetreaty ratified.

Economic policy outlook

Mr Saca!s economic platform largely mirrors that of previous Arena admini-strations. His government will remain committed to maintaining tight fiscalpolicies, a necessity after the Flores government yielded control over monetarypolicy in 2001 with the introduction of dollarisation. Mr Saca is committed tofree trade, to the promotion of foreign investment in important sectors such asmaquila (offshore assembly for re-export), and to the maintenance of a taxregime that promotes corporate investment. A healthcare reform bill willaddress the concerns that sparked a nine-month strike at the InstitutoSalvadoreño del Seguro Social (ISSS, the social security institute), in 2002-03.The government will continue to emphasise the benefits to investors ofeconomic stability, particularly the elimination of exchange-rate risk since theformal adoption of the US dollar in 2001.

The government faces challenges in the public finances, including the rising costof pension reform, continued post-earthquake reconstruction (following twolarge earthquakes in 2001, sluggish economic growth, and a rising debt-serviceburden. Despite co-operation between Arena and the FMLN in June to pass the2004 budget, in October the FMLN voted against the tax reforms aimed attightening existing loopholes and limiting tax evasion and contraband.Furthermore, discussions over the 2005 budget, which is now before Congress,are likely to be prolonged, as the FMLN has threatened to block its approvalunless an early retirement option is reinstated in the pensions law. The partyhas also objected to Arena�s policy of replacing domestic debt with longer-termexternal debt, which has led to a sharp increase in the public-sector externaldebt ratios over the last five years.

Tax reforms approved by Congress in October will help raise revenue, butalone will be insufficient to raise tax revenue by the government�s target of 9%in 2005. New measures, including raising consumer taxes, are now underdiscussion, to be presented to Congress before year-end. With the passage ofthe 2004 budget in June, spending was set to rise in the second half of the year.But as the government was forced to work with the 2003 budget until June, thenon-financial public-sector (NFPS) deficit is estimated to be less than initiallyexpected, at 1.8% of GDP in 2004. Based on a sharper decline in post-earthquakereconstruction costs and stronger GDP growth, which should help to increasetax revenue, the Economist Intelligence Unit expects the deficit to narrow to

Policy trends

International relations

Fiscal policy

El Salvador 9


1.2% of GDP in 2005. The fiscal stance will slacken slightly in 2006 as municipaland legislative elections taking place that year raise spending pressures.

Under the presidency of Mr Flores, El Salvador relinquished control ofmonetary policy at the start of 2001 by adopting the US dollar as legal tender ata fixed exchange rate of c8.75:US$1. Since then it has been required by law thatall prices be quoted in US dollars, and both government and financial-sectortransactions have been conducted in the US currency. The effects ofdollarisation"reduced inflationary pressures and the convergence of interestrates towards those in the US"have already been felt, and should continue inthe forecast period despite a pick-up in inflation owing to higher oil prices. Thiswill help to offset a loss of policy flexibility and the potential loss of exportcompetitiveness. Interest rates will rise in the forecast period, although theywill remain below historical levels.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2003 2004 2005 2006Real GDP growthWorld 3.9 5.0 4.3 4.1US 3.0 4.4 3.1 2.9EU25 1.1 2.4 2.3 2.3Exchange rates¥:US$ 115.9 108.2 98.0 100.0US$:� 1.132 1.239 1.340 1.300SDR:US$ 0.714 0.676 0.645 0.656

Financial indicators¥ 2-month private bill rate 0.03 0.00 0.05 0.38US$ 3-month commercial paper rate 1.10 1.48 3.25 4.64

Commodity pricesOil (Brent; US$/b) 28.8 39.3 37.5 29.0Coffee (Arabica; US cents/lb) 64.2 74.6 73.0 70.5Food, feedstuffs & beverages (% change in US$ terms) 6.6 8.6 -4.2 0.9Industrial raw materials (% change in US$ terms) 12.8 20.2 -0.3 -4.2

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

Strong US growth in the forecast period will help to lift El Salvador!s economy,which is closely tied to the conditions in the US and regional trade prospects.Once implemented, DR-CAFTA will provide additional growth opportunitiesfrom the second half of 2005, including improved trade with and investmentfrom the US. However, rising interest rates will reduce international liquidity,putting pressure on emerging economies that have large financing needs.Moreover, global imbalances have raised the risk that the slowdown in 2005will be deeper than expected. Although robust prices for some of El Salvador!sexports, including coffee and sugar, will benefit export earnings, the gains arelikely to be offset by high spending on oil imports.

First half growth in 2004 was sluggish, reflecting delays in investment andconsumption decisions owing to the presidential election held in March, the

International assumptions

Monetary policy

Economic growth

10 El Salvador


uncertainty surrounding the budget approval (which finally occurred in June)and higher oil prices. Growth should have started to recover during the thirdquarter, driven by private consumption (supported by workers� remittances),which rose by nearly 21%, to US$2.1bn, in the first ten months of 2004. Public-sector capital spending in the second half of 2004 will also drive growth, aswill private-sector construction projects, particularly of retail outlets. Never-theless, the recovery in the second half of 2004 will be subdued, forcing us torevise our year-end growth forecast to 1.8%, down from 2.1%. Growth in theexternal sector should pick up in the forecast period, owing to the expansion ofnon-traditional exports. The implementation of DR-CAFTA in the second halfof the forecast period should spur export and investment growth but increasedcompetition from China in the US market, and higher inflation in 2004 (whichwill hurt competitiveness) will limit the growth upside. As a result we haverevised our GDP growth forecast for 2005-06 down to 2.1% (from 2.6%).

The year-on-year inflation rate rose to 5.5% in October, more than double thelevel in the year-earlier period, when it reached 2.3%. Growing private-sectorcredit demand will increase inflationary pressures in the forecast period. Thecontinued inflow of low-price consumer-goods imports will only partly limitinflation increases. We expect inflation to end 2004 at around 6%. In 2005falling utilities prices, resulting from a forecast decline in international oil pricesand planned government investment in new generating capacity, will lowerinflationary pressures. Nonetheless, we estimate that year-end inflation willreach 4% in 2005.

Under the Monetary Integration Law, which took effect in January 2001, theexchange rate was fixed at c8.75:US$1 and the US dollar became legal tender.The law was ratified by the Supreme Court in 2001, and has been accepted bythe public"by September 2003, 99.4% of cash and financial assets were in USdollars. In the forecast period, we expect the use of the colón to remain limitedto circulation in some rural areas and as fractional money. The regime isworking relatively well and there is little risk that it will be abandoned, but thereare concerns about the worsening competitiveness of Salvadoran goods in theregional and US markets, given that inflation is rising at a faster rate than inthe US.

After ending 2004 at 5% of GDP"above last year�s level owing to a widening inthe trade deficit"the current-account deficit will narrow in 2005-06, on the backof a decline in the trade deficit and a further rise in net transfers. A slowdownin import spending growth (helped by lower oil prices) and an acceleration ofexport earnings growth (particularly from non-traditional exports), boosted bynew investment in non-traditional sectors, will narrow the trade deficit. Thedeterioration in the services and income deficits will not be sufficient to stemthis positive trend. Moreover, a rise in remittances from Salvadorans living inthe US"continued migration, both legal and illegal, of Salvadorans to the US isfuelling these inflows"will also help.

External sector

Exchange rates

Inflation

El Salvador 11


Forecast summary(% unless otherwise indicated)

2003a 2004 b 2005c 2006c

Real GDP growth 1.3b 1.8 2.0 2.2Industrial production growth 2.3 0.7 2.0 2.0

Gross agricultural production growth 0.1b 1.0 1.0 1.0Unemployment rate (av) 6.5b 6.3 6.0 6.0

Consumer price inflation (av) 2.1 4.5 4.5 3.8Consumer price inflation (year-end) 2.5 6.0 4.0 3.9

Short-term interbank rate 6.6 6.8 8.1 8.1NFPS balance (% of GDP) -1.3 -1.8 -1.2 -1.3Exports of goods fob (US$ bn) 3.2 3.3 3.6 3.8

Imports of goods fob (US$ bn) 5.4 5.9 6.2 6.3Current-account balance (US$ bn) -0.7 -0.8 -0.7 -0.7

Current-account balance (% of GDP) -4.9 -5.0 -4.2 -3.8External debt (year-end; US$ bn) 6.4b 6.9 7.3 7.4Exchange rate c:US$ (av) 8.75 8.75 8.75 8.75

Exchange rate c:¥100 (av) 7.55 8.09 8.93 8.75Exchange rate c:� (year-end) 11.04 11.38 11.73 11.07

Exchange rate c:SDR (year-end) 13.00 13.29 13.58 13.15

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

El Salvador Latin America

Gross domestic product% change, year on year

El Salvador Latin America

Consumer price inflationav; %

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2000 01 02 03 04 05 06

0

2

4

6

8

10

12

2000 01 02 03 04 05 06

The political scene

Since taking office as president on June 1st, Antonio Saca of the AlianzaRepublicana Nacionalista (Arena) has been keen to make good on his electionpromises and build on the mandate that he won in March. During his first 100days in office, Mr Saca appears to have maintained his popularity, according tothe results of a survey carried out by the Instituto Universitario de OpiniónPública, a polling unit of the Jesuit-run Central American University in SanSalvador. Among those interviewed by pollsters, 58% said that the newpresident was doing �a good job�, against only 16% who claimed the contrary.On a scale of one to ten, those interviewed gave the new president an averagescore of 7.27. When asked about specifics, one-third named the fight against

Antonio Saca keeps up hispopularity ratings

12 El Salvador


crime as Mr Saca�s main success so far, but 45% expressed disquiet that thesluggish economic situation remained unchanged.

In a speech in mid-September marking the anniversary of El Salvador�sindependence from Spain, Mr Saca reaffirmed his main targets for the next fiveyears. They include reforms in the areas of education, health, fiscal manage-ment and electoral procedures. He also renewed his election pledge to fightpoverty and crime, create jobs and stimulate foreign investment in El Salvador.As part of the attempts to attract more foreign businesses, a government-appointed commission is already working on a series of proposals foreducation reform. Arena has also promised to introduce electoral reformsahead of the 2006 legislative election, including a proposal to reduce thenumber of deputies from 84 to 72, and to redefine the distribution of deputiesfor each province on the basis of a new population census. In late October, theTreasury presented the first tax reforms aimed at reducing tax evasion andcontraband. The reforms were subsequently ratified by a majority of deputiesin the legislative assembly (see Economic policy).

Among the early successes of the Saca government was the all-party consensusto approve a series of new crime-fighting measures and the passage of the 2004budget after months of legislative deadlock. Mr Saca established a Mesa deGobernabilidad (an interparty dialogue forum) under the direction of a veteranArena politician and former president of the legislative assembly, Gloria SalgueroGross. The first discussions have centred on reforming the representation of thepolitical parties on the Tribunal Supremo Electoral (TSE, the supreme electoraltribunal) which is charged with organising and supervising elections.

In early October, the main opposition party, the Frente Farabundo Marti para laLiberación Nacional (FMLN), walked out of the forum. The FMLN�s co-ordinator,Salvador Sánchez Ceren, declared that the decision was taken owing to Arena�sreluctance to listen to its proposals. He also accused the government of usingthe dialogue forum for �propaganda purposes�.

Mr Saca does not need the votes of the FMLN to push through those parts ofhis legislative agenda that require a simple majority as long as he can rely onthe support of the other opposition parties. In the past, the right-wing Partidode Reconciliación Nacional (PCN), with 14 seats in the legislative assembly, hasbeen Arena�s most dependable ally, although it has been known to vote againstthe government, especially in the run-up to legislative elections. As the start ofcampaigning for the 2006 legislative and municipal elections nears, theopposition will be keen to distance itself from Mr Saca, reflecting his shortwindow of opportunity to implement his policy agenda. For some proposals"including the approval of foreign accords and loans"a clear two-thirds majorityis required, which Arena cannot command without the support of the FMLN.

The FMLN held its annual national convention on November 7th to select a co-ordinator, members of the 57-seat national council and heads of the 14provincial councils. Voting took place across the country and after a series ofdelays while controversies over alleged irregularities were resolved, MedardoGonzález, a former guerrilla commander in the civil war and a representative

The early political consensusappears to have broken down

The FMLN is likely to toughenits position

Government moves aheadwith its reform programme

El Salvador 13


of the orthodox hard-line wing of the party, was declared the winner as co-ordinator. He beat Oscar Ortiz (the candidate of the reformistas, or reformists)by 53.9% to 46.1%. Mr González will be in the post for three years, and hisprincipal task will be to reunite the party to present a successful mid-termelection campaign in March 2006. Mr Ortiz was one of figures most critical ofthe party leadership!s handling of the presidential election campaign this year,which FMLN lost for the third consecutive time to Arena. The hardliners, whosecandidate, Jorge Schafik Handel, lost to Mr Saca in the March presidentialelections, also strengthened their control over the national council (winning 51of the 57 seats) which now allows them to choose a political commission withthe same political views. Mr González has called for unity, but more party splitsare likely. In early November, a group of former FMLN members, who hadpreviously split from the party, announced the formation of a new centre-leftparty, Concertación Social Democrata.

Although they voted in favour of changes to criminal legislation earlier in theyear, deputies for the FMLN boycotted the legislative vote on the tax reforms inOctober. One deputy who ignored the party whip and stayed for the vote inthe legislature, has been subsequently expelled from the party. He is now anindependent. Under the control of the orthodox wing, the FMLN, which holds30 of the 84 seats in the legislature, is likely to present further objections to the2005 budget as it makes it way through the legislative assembly. The party willalso vote against the Dominican Republic-Central American Free TradeAgreement, (DR-CAFTA), with the US, which could come before parliamentbefore the end of this year.

El Salvador is the only remaining Latin American country to have troops inIraq, after a third contingent of 380 soldiers was sent to the region in August.Their mission is set to finish in February 2005, but there appears to be no firmdecision as to future arrangements. The Salvadoran minister of defence, GeneralOtto Romero Orellana, has stated that sending a fourth contingent woulddepend on a return to normality in the political and security situation after theelections in Iraq scheduled for January 30th 2005. The decision to continue tosupport the US-led alliance has not been popular at home, yet the political costhas been negligible to Mr Saca. El Salvador remains one of the US�s staunchestallies in the region, and the Arena leadership immediately welcomed the re-election of the US president, George W Bush. In return for his support for theIraq war, Mr Saca will expect reciprocal support from Washington on trade andthe temporary migratory status of thousands of illegal Salvadorans in the US.

After the sudden resignation of the former president of Costa Rica, Miguel AngelRodriguez, from the post of secretary-general of the Organisation of AmericanStates (OAS), the Central American nations that backed his candidacy havebeen seeking another consensus candidate from the region. Francisco Flores,El Salvador�s former president, who was first mentioned before Mr Rodriguez�sappointment, is now actively seeking the backing of the region�s leaders. Hehas already secured the support of Mr Saca. Among other Latin Americannations, however, there has been opposition voiced about his candidacy.Venezuela in particular is unhappy with the way Mr Flores celebrated the

A decision on a fourthcontingent to Iraq is pending

The former president vies forthe OAS top job

14 El Salvador


impromptu change of government in the country in April 2003, when theVenezuelan president, Hugo Chávez Frías, was briefly removed from office.

Economic policy

A government-led majority in the legislative assembly has passed modificationsto no fewer than 11 separate pieces of legislation, as the ruling AlianzaRepublicana Nacionalista (Arena) made good on its pledge to implement taxreform. The measures are largely administrative in nature and close existinglegal loopholes. They seek to attack an endemic problem of tax evasion andcontraband. According to some estimates, the equivalent of around 17% of GDPin potential income-tax revenue is lost through tax evasion. Crossbordercontraband is also a serious problem. The reforms also lay out a clearerdefinition within the penal code of tax evasion and fiscal misdemeanour, andincrease the prison sentence for such offences to a maximum of eight years.Changes to the penal procedural code will now allow for the admission ofevidence obtained by undercover agents in cases of tax evasion and suspectedcontraband. Reforms to the banking laws will permit the authorities access tothe financial details of those under investigation for fiscal fraud. There has alsobeen a tightening of the deductions that can be made on value-added tax (VAT)from income tax and tax credits. In an effort to halt contraband, thegovernment has given wider powers to customs officials at border posts as wellas hardening the sanctions applicable to those who present false or altereddocumentation, or do not declare imported merchandise. Taxpayers have beengiven a three-month period of grace to put their books in order.

The Asociación Nacional de la Empresa Privada (ANEP, the country�s largestprivate-sector organisation) presented a total of sixteen objections to the taxreforms but the government took only four into account in the laws presentedto the legislature. Business leaders are still unhappy with some of the changesto the VAT regulations, including the elimination of accelerated depreciation oncapital assets, which ANEP claims will stifle investment opportunities and cutback on company profitability. The Asociación Bancaria Salvadoreña (Abansa,the main banking association) has objected to the new requirement that Salva-doran banks pay tax on interest earned from loans granted outside the country.

The government estimates that the administrative changes will raise revenue byan equivalent of 1-1.5% of GDP by the end of 2005. Although a step in the rightdirection, these measures alone will be insufficient to bring down thedebt/GDP ratio that has increased sharply since 1999 because successivegovernments have run consistently high fiscal deficits. The president, AntonioSaca, has pledged to introduce a second round of tax reforms, currently underpreparation. Details are still not clear, but they are likely to include raising someconsumer taxes, in particular on cigarettes, alcoholic beverages and munitions.Duties on cigarettes are currently 39%, those on alcoholic beverages are 20%.There appears to be no intention to raise the VAT rate.

A first set of tax reforms hasbeen passed by Congress

The private sector opposessome tax reforms

A second round of tax reformsis likely

El Salvador 15


Despite continued sluggish economic growth, tax revenue has in fact continuedto rise in the first eight months of 2004. Growth was driven by higher VATreceipts and a sharp rise in income tax revenue and customs duties.

Tax revenue(US$ m; Jan-Aug)

2003 2004 % changeValue-added tax 600 640 6.7Income tax 368 391 6.3Customs duty 109 119 9.2

Consumption taxes 41 37 -9.8Other (incl Foviala) 35 35 0.0

Property tax 9.1 8 -12.1Total 1,176 1,243 5.7

a Fondo de Conservación Vial (a road maintenance fund).

Source: Banco Central de Reserva.

Despite improved tax collection, the current surplus of the non-financial public-sector accounts (NFPS) declined owing to a faster rise in current spending.However, the budget deficit before grants fell, owing to the sharp decline incapital expenditure in the period. This was caused by an 80% fall in the outlayfrom the national reconstruction programme, introduced after the 2001earthquakes and now nearing completion. Total public investment has fallensteadily in 2004 (by 34% to August), in part because of the late approval of the2004 budget. There has also been a lower level of investment expenditure bythe quasi-autonomous electricity and water boards, as well as by the ComisiónEjecutiva Portuaria Autónoma (CEPA, the state-run port authority).

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

2003 2004 % changeCurrent revenue 1,539 1,603 4.1Current expenditure -1,369 -1,443 5.5Current balance 170 159 -6.5Capital revenue 0.38 0.06 -84.2Capital expenditure -287 -209 -27.2Balance before grants -116 -49 -57.5Grants 29 29 -0.3Overall balance -88 -20 -77.0

Source: Banco Central de Reserva de El Salvador.

Payments due on outstanding external debt and the delayed approval by thelegislative assembly on issuing new debt meant that net external financingtotalled US$69m in the first eight months of 2004, compared with US$385m inthe year-earlier period. At the same time, net domestic financing increased asthe Banco Central de Reserva de El Salvador (the Central Bank) was forced toincrease the sale of Letras del Tesoro (Letes, Treasury bills) to commercial banksand outside the banking system.

With the 2004 budget approved in June, the Treasury ventured onto theinternational markets in mid-September with a US$287m 30-year bond issuewhich carried an early redemption option at 15 years. This was the first bond

The 2004 financing needs havebeen covered

The public accounts havereturned to a deficit

16 El Salvador


issue since March 2003 and strong demand (totaling US$2.6bn) reflectedpositive emerging market sentiment and El Salvador�s specific investmentattractions. Standard and Poor�s (S&P) rating services assigned a BB+ rating tothe bond issue. It also reaffirmed El Salvador�s long-term sovereign rating at BB+and its short-term ratings at B.

T�tulos Valores US$1,421m

PrØstamos US$2,622m

Other US$30mOther US$28mPrØstamos US$8m

T�tulos Valores US$1,933m

Central government debt


Total US$6bn

External debt

Domestic debt

In early October the government presented the legislature with its draft 2005budget. It is based on GDP growth of 3% and a 9% rise in overall tax collection.The budget assumes an increase of 15% in income-tax revenue, a 3.2% rise inVAT collection and an 18% rise in customs duties. Non-tax revenue, includingfuel surcharges, is forecast to rise by 22%. Current spending is set to rise fromUS$1.71bn in 2004 to US$1.88bn in 2005. Less capital investment has beenallocated than in the current year, as a result of the underspending from the2004 budget and a reduction in spending on post-earthquake reconstruction. Asa result the financing requirement will total around US$700m, of whichUS$541m will be raised through bond issues.

Approved budget, 2005(US$ m)

Revenue 2,992 Current revenue 2,143 Capital revenue 75 Income from special contributions 73 Financing 700

Expenditure 2,992 Current expenditure 1,882 Capital expenditure 464 Financial Applications 219 Expenditure on special contributions 73 Pensions contributions 353

Source: Ministerio de Hacienda.

Delays in the approval of the budget are likely, given that the main oppositionparty, the Frente Farabundo Martí para la Liberación (FMLN) has alreadyindicated that it will dispute various issues during its passage through thelegislature. The party will object, as on previous occasions, to the increase in

The 2005 budget is presentedfor legislative debate

El Salvador 17


the public-sector debt burden, and has stated that it will push for reforms to thepension law, which was changed during the approval of the 2004 budget(September 2004, pages 15-16). A long and protracted period of negotiations islikely, especially given that the more hardline elements within the FMLNrenewed their control over the party in November�s internal elections. Thesedelays are likely to compound an already sluggish economic growth rate duringthe last quarter of 2004.

The domestic economy

Economic trends

After expanding by just 1.6% year on year in the first quarter of 2004, GDPgrowth slipped to 1.5% in the second quarter of 2004. Growth was driven bythe services sector and the government, which performed in line with overallgrowth. The performance of the services sector has been underpinned by risingremittances from the US, which have helped bolster the retail sector. Agricul-ture improved on last year�s performance, largely owing to higher commodityprices which have allowed producers to expand production this year. Butactivity in the construction sector has continued to decelerate, as it faces adownturn in demand as a result of the fall-off in post-earthquake reconstruction.

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

2003 20041 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr

Agriculture 0.2 -0.1 -0.6 0.9 0.1 1.7 1.1Industry 2.6 2.8 2.2 1.8 2.3 0.8 0.2

Construction 6.7 5.8 4.4 2.1 4.7 1.7 1.1Services 1.9 2.0 1.7 1.8 1.8 1.4 1.6Government services -1.7 -0.3 0.7 1.3 0.0 1.6 1.6

GDP 1.8 1.9 1.7 1.9 1.8 1.6 1.5


After the electoral uncertainties and budget delays during the first half of 2004,the Índice de Volumen de Actividad Económica (IVAE, the volume index ofeconomic activity) of the Banco Central de Reserva de El Salvador (the CentralBank) showed some improvement in August, with a year-on-year expansion of0.1%. Despite sharp declines in construction and manufacturing, the marginalrise was driven by expansions in agriculture and commerce.

Under pressure from rising world oil prices, the 12-month inflation rate hasrisen steadily throughout 2004, from 2.4% in January to a high of 5.5% inOctober. The increase in October�s monthly inflation rate was largely owing toa 1.8% rise in transport costs. This followed an agreement between thegovernment and the bus owners, a powerful and well-organised lobbyinggroup, for a 20% rise in fares to compensate them for the rise in their fuel costs.The increase was agreed despite existing government subsidies on fuel andspare parts. Fuel prices are deregulated in El Salvador, leaving distributors free

The economy performssluggishly

Inflation continues its upwardtrend

18 El Salvador


to set their own tariffs on a weekly basis, but the Ministry of the Economy doesprovide recommendations as to where to find cheaper fuel. However, prices atthe petrol pumps have risen continually, and by the second week of October,diesel was at a record US$2.23/gallon, while petrol was priced at betweenUS$2.50-2.58/gallon. As transport costs rise, there is a natural tendency for pricesin the marketplace also to rise. October saw a 1.2% rise in prices for householdgoods and a 0.5% rise in prices for foodstuffs. With consumer demand set toincrease ahead of the Christmas period, year-end inflation will be pushed upto around 6%.

Consumer prices(% change)

2003 2004Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Month on month 0.1 0.2 1.1 0.4 0.6 0.8 0.7 0.2 0.3 0.2 0.2 0.4Year to date 2.3 2.5 1.1 1.6 2.2 3.1 3.8 4.0 4.3 4.5 4.7 5.2

Year on year 2.6 2.5 2.4 2.6 3.0 3.9 4.8 4.6 5.3 5.2 5.4 5.5


In October the average commercial bank rate for loans of more than one yearwas 7.53%, halting the upward trend in rates that began in July and ended inSeptember. Low borrowing rates have meant that private-sector credit growthcontinued to rise (up 6% year on year in August 2004, but below the August2003 level, when the growth rate stood at 9.5%) despite the sluggish economy.Deposits in commercial banks have increased marginally, rising at a yearly rateof 3.2% by August. Excess resources in the financial system, owing to lowergrowth in the economy and lower public- and private-sector investment thisyear, have allowed the banks to expand their credit portfolio as well as meettheir own debt obligations. Lending rates in El Salvador are still below those oftheir Central American neighbours, largely as a result of the introduction of theUS dollar in January 2001. With rates set to rise further in the US, commercialbanks in El Salvador will follow suit. However, the change in the politicalenvironment with the inauguration of the president, Antonio Saca, in June, andthe likely ratification of the Dominican Republic-Central American Free-TradeAgreement (DR-CAFTA), will improve investor confidence and stimulate creditdemand. The Economist Intelligence Unit therefore expects that, despite pendinginterest rate rises, demand for credit from the private sector will increase.

Interest rates(%)

2003 2004Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Savings ratea 3.4 3.41 3.37 3.36 3.44 3.41 3.47 3.42 3.29 3.25 3.23 3.26Lending rateb 6.47 6.71 6.8 6.61 6.4 6.23 6.05 6.35 6.39 6.17 6.27 5.97Spread 3.07 3.30 3.43 3.25 2.96 2.82 2.58 2.93 3.10 2.92 3.04 2.71

a Average savings rate paid on deposits of 180 days. b Average interest rate charged on loans of up to 12 months.


Interest rates are set to risefurther

El Salvador 19


Agriculture

Activity in the farming sector has grown this year after contracting in 2003,according to the IVAE. In August agricultural production rose by 2.1% year onyear compared with contractions of 2.4% and 2.1% year on year in August 2003and 2002 respectively. Commodities such as coffee, sugar and shrimp havecontinued to fetch higher prices, although the volume of production acrossmost sub-sectors has continued to drop, albeit in some cases at a slower ratethan earlier in the season. Coffee output fell by 4.2% year on year in July, down7.5% year on year in May, although coffee export earnings rose by 18.9% year onyear in January-August. Sugar production fell just 0.2% in July (up from 0.5%year on year in May), and basic grain output was down 0.2% at the end of July.Although production from poultry farming was up 17% year on year in May, inJuly it slowed to 5.4%.

A higher yield per hectare in the 2003-04 season (which runs from Novemberto May) meant that the sugar harvest rose by 8.6% year on year, reaching arecord production of 11.5m quintales (qq, one quintal is equivalent to one 46-kgbag). Higher world prices this year has meant that with barely 56% of theharvest sold abroad, revenue was already reported to be up US$2m on lastseason. Sugar is one area that looks set to benefit from DR-CAFTA. Under theaccord, El Salvador will have a sugar quota of 27,370m metric tonnes, equiva-lent to 5% of its total national production. Salvadoran sugar farmers will benefitfrom the rising world demand for sugar, in part resulting from increased demandfrom China, as well as for the production of ethanol to mix with petrol.

Prospects for the coffee harvest (which runs from October to May) and sugarharvest appear good for the current season. The Consejo Salvadoreño de Caféforecasts a 5% rise in production in 2004-05 to 1.9m quintales, the highest levelsince the bumper harvest of 2001-02. Growers say that income from the lastharvest (2003-04) reached a record US$121.2m owing to higher prices, asproduction was the same as in the previous season.

50

60

70

80

90

100

110

Jan2002

Apr Jul Oct Jan03

Apr Jul Oct Jan04

Apr Jul Oct

International coffee prices (a)US cents/lb

(a) Average price for other mild arabicas.Source: International Coffee Organisation.

Agriculture recovers steadily

There is a record sugar harvestin 2003-04

20 El Salvador


Manufacturing

After a disappointing first quarter in which output fell by 0.8%, industrial andmanufacturing production fell again in the second quarter of 2004, by 0.2%.This is partly owing to the continuing decline of the previously buoyant maquila(offshore assembly for re-export) sector owing to increased competition fromChina in the US. Measured by the IVAE, maquila output fell by 9.3% in the 12months to July 2004, compared with a 9.1% expansion in the year-earlierperiod. Data from the Indíce de Volúmen de la Producción Industrial (IVOPI,the industrial production volume index) corroborate the declining trend, show-ing a fall throughout the first half of the year. The Asociación Salvadoreña de laIndustria de la Confección (ASIC, the industrialists� association) has called uponthe government to introduce new incentives and tax benefits for Salvadoranbusinesses. It is feared that the lifting of quotas on China�s textile exports to theUS in January 2005 could result in as many as 30,000 jobs lost in El Salvador�stextile factories. These currently employ around 90,000 people. Like otherCentral American countries, El Salvador is threatened by cheaper Chineseexports to the US, not just in garments but also in plastic and metal products.

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

Sep2003

Oct Nov Dec Jan04

Feb Mar Apr May Jun Jul Aug Sep

Index of industrial production (IVOPI)% change, year on year


Infrastructure

The renegotiation of the cost of major reconstruction work at the Cutuco seaportat La Unión, in the east of the country, could conclude in December (September2004, page 22). As a result works could begin in the first quarter of 2005"sixmonths later than originally planned. They would finish in 2006. The ComisiónEjecutiva Portuaria Autónoma (CEPA, the state-run port authority) has had toseek authorisation to renegotiate the original concession awarded to a Japanese-Belgian consortium, TOA Corporation/Jan de Nul, in April, from the Japan Bankfor International Co-operation (JBIC), which is providing US$90.9m for theproject. The head of CEPA, Miguel Angel Salaverria, told a local newspaper inlate October that a new cost-price of US$139m was under discussion (below theUS$150m the consortium had bid to carry out the works), but that there is nofixed deadline for the talks. One additional hurdle is that the legislature mustgive its approval for a US$25m loan for the work from the Banco Centro-

Industrial manufacturingoutput continues to fall

Negotiations continue overport plans

El Salvador 21


americano de Integracion Económica (BCIE, the Central American EconomicIntegration Bank).

Kema Consulting (US) has won a bid to review El Salvador�s energy policy andcome up with a new strategy for the next 15 years. The company beat 10 otherfirms that were competing for the contract, which will run for approximatelyseven months. The goal is to produce an energy policy that takes into accountthe country�s geothermal and hydroelectric resource potential, create energysaving measures and analyse the possibility of importing natural gas as analternative fuel source. The need for a national energy policy for the nextdecade has become more urgent following the sharp rise in oil prices.

Financial and other services

El Salvador�s largest bank, Banco Agrícola Comercial, has consolidated itsmarket position by securing a controlling stake in one of country�s two pensionand insurance funds. The move came in October after Spain�s Banco BilbaoVizcaya Argentaria (BBVA) sold its 62% stake in the pension fund, AFP Crecer,and its 51% share in BBVA Seguros, the insurance company linked to Crecer, forUS$42.9m. Fondo Universal, a holding company for the Salvadoran bank,Bancosal, bought the two stakes. Bancosal already had a 19% stake in Crecerand a 49% share in BBVA Seguros. Fondo Universal then sold a 62% stake ineach company to the holding company, Inversiones Financieras Banco Agrícola.

Earlier in the year, Banco Agrícola looked as if it would set up its own pensionfund to compete with AFP Crecer and AFP Confía, which is backed by thecountry�s second-largest bank, Banco Cuscatlán. The two companies dominatethe pension funds market. They emerged from five Administradoras de Fondosde Pensiónes (AFPs, private pension funds), established following reform ofprivate pension funds in 1998 which phased out public-sector pensions andobliged employees into the private sector. Between them, AFP Crecer and AFPConfía now have around 1.12m clients and manage assets worth US$1.8bn.Given the relatively small size of the market there is little room for a thirdmajor pension fund. There are also legal restrictions on AFPs makinginvestments outside the country, which has meant that investments have beendirected into less risky, but limited, government stock. The private pensionfunds would like to expand their operations by tapping affiliates in the largeinformal sector as well being allowed to offer pension savings to families thatsend their remittances home while working in the US.

Foreign trade and payments

In the first eight months of 2004, export earnings growth was subdued, risingby less than 2% year on year despite stronger commodity prices for El Salvador�straditional agricultural products. Coffee earnings expanded by nearly 19%, largelyowing to the higher price fetched on the world market. Salvadoran producersare increasingly looking to export higher quality aromatic coffee to the specialistEuropean market. This will represent around 18% of total production in the

A US firm will develop anational energy plan

Banco Agrícola Comercial tapsinto the pension funds market

Export earnings growthis weak

22 El Salvador


coming 2004/05 harvest. Exports of non-traditional goods from El Salvador havebeen rising steadily. These include generic medicines, steel and iron-laminatedproducts, light machinery and processed foods. Maquila (offshore assembly forre-export) earnings, the largest export category, declined further in the period owingto growing competition from China in the US market. In volume terms, non-traditional sales outside Central America rose by 21.3% year on year to August.

Merchandise trade(US$ m; Jan-Aug)

2003 2004 % changeExports fob 2,098 2,136 1.8 Traditional exports 130 139 6.9 Coffee 90 107 18.9 Sugar 33 30 -9.1 Shrimp 7 2 -71.4 Non-traditional exports 716 793 10.8 Maquila 1251 1203 -3.8

Imports cif 3,829 4,041 5.5 Consumer goods 1022 1132 10.8 Intermediate goods 1269 1,379 8.7 Capital goods 623 624 0.2 Maquila 916 906 -1.1Trade balance -1,732 -1,905 10.0


Import spending rose by 5.5% year on year in January-August, after slowingdown earlier in the year owing to electoral uncertainties. Most of the increasein import spending was caused by higher world oil prices. Although petroldistributors have reported a drop in demand for fuel as a result of higher pricesat the pump, the impact has had limited impact on the trade balance. In thefirst eight months of 2004, purchases by industry of petrol, diesel oil, fuel oiland lubricants rose by 4.8% in volume terms and by 17.5% in value terms. Thevolume of purchases of intermediate goods fell by 2% to August 2004 (butspending on intermediate goods rose by 8.7%), while the volume of capitalgoods fell by 6.3% in the same eight-month period. This reflected slow growthacross the economy, and in particular in manufacturing and industry. Importspending by the construction industry, for instance, fell by a massive 38.6% yearon year to August. Despite an 11% rise in spending on consumer goods imports,volume imports rose by just 2.6%. This trend was particularly stark in spendingon durable consumer goods: they showed a 12.3% drop in volume terms againstan 18.9% rise in value terms. With an increasing flow of remittances fromSalvadorans in the US, spending on imported goods will continue.

Import spending rises fasterthan export earnings growth

El Salvador 23


Family remittances(US$ m)

2003 2004 % changeJan 146 171 17.1Feb 149 170 14.1

Mar 170 218 28.2Apr 177 213 20.3

May 186 220 18.3Jun 178 212 19.1

Jul 176 210 19.3Aug 173 224 29.5Sep 180 213 18.3

Oct 181 220 21.5Nov 175 � �

Dec 214 � �Year to date total 2,105 2,071 �


The current-account deficit narrowed between the first quarter of 2004 and thesecond quarter. It fell to US$283m in the first half of 2004, from US$390m in theyear-earlier period. This was owing to the sharp fall in the services deficit andcame in spite of a deterioration in the trade and income deficits. Familyremittances (which accounted for 14% of GDP in 2003) have maintained theirrate of growth, virtually covering the trade deficit. After slowing in April andMay, the monthly growth rate in remittances picked up again from June. In thefirst ten months of this year, remittances totalled US$2.07bn, a rise of more than20% year on year. With the uncertainty related to elections in the US andEl Salvador concluded, remittances are likely to maintain this growth rateduring the rest of 2004, passing last year�s record US$2.1bn.

Current-account balance(US$m)

2003 2004Full-year 1 Qtr 2 Qtr First half

Trade balance -2,274 -589 -679 -1,268Services balance -169 -10 -17 -27

Income balance -408 -135 -95 -230Net current transfers 2,117 564 652 1,216 Workers remittances 2,105 560 645 1,205

Current-account balance -734 -161 -122 -283


Net foreign reserves slipped to US$1.7bn in July before picking up to nearlyUS$1.9bn in September. This was largely owing to a recovery in confidence andthe sovereign�s bond issue for US$287m in that month, but rising workers�remittances and an improvement in inflows of foreign direct investment (FDI)also contributed to the increase. The import cover rose to 3.8 months on theback of higher reserves.

Foreign reserves rise followinga bond issue

The current-account deficitnarrows in the first half

24 El Salvador


Net international reserves(US$m unless otherwise indicated)

2003 2004Dec Jan Feb Mar Apr May Jun Jul Aug Sep

International reserves 1,906 1,898 1,869 1,900 1,886 1,819 1,801 1,704 1,730 1,882

Import cover (months) 4.2 3.8 3.8 3.8 3.8 3.7 3.6 3.4 3.5 3.8


Electricity US$848m

Industry US$483mCommunications US$429m

Commerce US$270m

Others US$380m

Maquila US$292m

Stock of foreign direct investment by sector, June 2004


Total US$2.7bn

el salvador...el salvador 1 country report december 2004 ' the economist intelligence unit...

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