Public Information Notice: IMF Concludes Article IV Consultation with El Salvador

November 15, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On November 5, 1999, the Executive Board concluded the Article IV consultation with El Salvador.1


El Salvador has maintained its record of macroeconomic stability over the past year, notwithstanding the uncertainties associated with developments in emerging markets, the political transition to a new administration, the adverse effects of Hurricane Mitch, and the drop in coffee prices.

Economic performance in 1998 was broadly in line with the authorities' projections in the period through September, but there were some deviations in the last quarter. The overall fiscal deficit was contained at 2.7 percent of GDP, as projected, but public sector savings were lower than envisaged because of higher outlays on wages and transfers. The external current account balance shifted from surplus to a deficit of 0.7 percent of GDP in 1998, as coffee exports were seriously affected by the El Niño weather phenomenon and the decline in international prices. Following a substantial reserve accumulation, net international reserves (NIR) declined from mid-October to early November owing to the turmoil in emerging markets and central bank assistance to cover withdrawals of deposits from an intervened commercial bank (CREDISA). In November the authorities announced a phased increase in reserve requirements (remunerated) to an average of 24 percent, which contributed to easing pressures in the foreign exchange market. For 1998 as a whole, NIR increased by US$300 million to US$1,770 million, compared with a targeted accumulation of US$400 million. Real GDP grew by 3.2 percent in 1998 (compared with 4 percent envisaged originally), mainly because of the effects of Hurricane Mitch on the agricultural sector, while consumer prices rose by 4.2 percent (3½ percent in the authorities' projections), due to the impact of the hurricane on food prices.

Developments in 1999 point to a slowdown in economic activity associated in part with a further decline in coffee export receipts; real GDP growth is projected by the staff at 2-2½ percent for the year as a whole. Consumer prices declined by a cumulative 0.2 percent in the first 10 months of 1999, reflecting a drop in food prices; end-year inflation is expected to be below 1 percent. The authorities intend to contain the fiscal deficit at 3 percent of GDP in 1999, with public savings weakening to approximate balance, from a surplus of 1 percent of GDP in 1998, owing to a further increase in the wage bill. Liquidity conditions were tight in the first half of 1999, resulting in some increase in interest rates, notwithstanding the decline in inflation. In April-October the central bank reduced reserve requirements in steps by 2½ percentage points and extended an additional credit related to the liquidation of CREDISA, which has contributed to some decline in interest rates in recent months. The external current account position has weakened because of the drop in coffee exports and slower growth in the nontraditional and maquila sectors. NIR strengthened further by US$140 million to US$1.9 billion (about 115 percent of base money) from end-1998 through end-October 1999, aided by proceeds from the privatization of thermal plants and a government bond placement in international markets. In June 1999, the authorities submitted to the assembly a tax package that strengthens the revenue base and introduces a new tax code. In September the assembly approved part of the package, involving mainly a broadening of the income tax base and procedures to reduce customs evasion. In addition, the assembly has approved a new banking law strengthening bank supervision and prudential regulations, and introducing a limited deposit insurance scheme under a risk-sharing arrangement with banks.

Executive Board Assessment

Executive Directors noted El Salvador's success over the past year in maintaining macroeconomic stability, notwithstanding adverse exogenous developments, in particular Hurricane Mitch, and the political transition to a new administration. Directors commended the authorities for the progress made in 1999 in reducing inflation and further strengthening the international reserve position. They observed, however, that the fiscal position, most notably public savings, had weakened in 1998/99, and that the country faces the difficult challenges of attaining higher rates of economic growth, reducing poverty, and strengthening external competitiveness. Directors underscored the importance of a strong fiscal effort to preserve macroeconomic stability, ease the pressures on domestic interest rates, and free resources for much needed investment in infrastructure and social programs.

Directors emphasized that the achievement of a sustainable fiscal position over the medium term would require further revenue measures, wage restraint, and reforms to smooth the fiscal pressures associated with the pension system. Directors regarded the tax effort as insufficient in view of the country's social needs and environmental concerns. Therefore, they welcomed the recent passage of legislation aimed at broadening the income tax base and reducing customs evasion, but stressed that prompt approval of the remaining measures that have been submitted to the assembly to broaden the base of the value-added tax and introduce a new tax code was essential. They encouraged the authorities to explore the possibility of a tax on fuels to help finance investment in infrastructure. Directors urged the authorities to exercise strict control over expenditure by reducing the subsidy on electricity consumption while improving its targeting to vulnerable groups, and limiting wage increases.

Directors welcomed recent steps to lower reserve requirements, as well as the authorities' plans to proceed with further reductions and their eventual unification, while placing increased reliance on indirect monetary instruments. They also encouraged the authorities to continue with steps to standardize and develop a secondary market for open market instruments, and to improve the central bank auction mechanism.

Directors welcomed the progress made in recent years in improving bank supervision and prudential regulations, but stressed that further efforts were required in these areas to put the financial system on a sounder footing. Directors encouraged the authorities to proceed promptly with the implementation of the recently approved new banking law, further strengthen loan-loss provisions, introduce regulations to limit maturity mismatches in bank operations, and tighten regulations concerning open foreign exchange positions.

Directors observed that the de facto exchange rate peg to the U.S. dollar had been instrumental in achieving price stability. They underscored that the sustainability of the peg over the medium term required a substantial improvement in public sector savings performance, including through the adoption of a wage policy appropriate to help restrain wage demands in the private sector. Efforts were also needed to increase productivity through investment in human capital and infrastructure.

Directors noted that the authorities were giving consideration to moving eventually to a currency board arrangement. They observed that a substantial strengthening of the fiscal position and the financial system, together with a further increase in international reserves, were necessary before such a move should be envisaged.

Directors welcomed the progress made over the past two years in the areas of privatization, pension reform, and trade liberalization. They considered that prompt approval of legislation to increase transparency in procurement practices, and to reform the civil service, was important.

El Salvador: Selected Economic Indicators

1995 1996 1997 1998 Proj.

Real economy (change in percent)
Real GDP 6.3 1.8 4.0 3.2 2-2.5
GDP deflator 10.6 7.0 3.9 2.6 1.0
CPI (end of period) 11.4 7.4 1.9 4.2 1.0
Unemployment rate (in percent) 7.7 7.7 8.0 7.5 7.5
Gross national savings (in percent of GDP) 17.2 13.6 15.8 15.9 14.2
Gross domestic investment (in percent of GDP) 20.0 15.2 14.9 16.6 16.0
Public finance (in percent of GDP)
Overall balance of the nonfinancial public sector
(after grants) -0.1 -2.5 -1.8 -2.7 -3.0
Savings position of the nonfinancial public sector 3.2 1.9 1.9 1.0 0.1
Money and credit (end-year, percent change) 1/
Net domestic assets 16.5 14.3 8.0 2.5 7.5
Of which
Nonfinancial public sector (net) -2.2 0.7 -0.4 -9.5 0.2
Private sector 23.3 13.1 15.5 11.6 6.4
Broad money 12.7 17.3 12.3 9.5 8.0
Interest rates (end of period) 2/
Six-month deposit rate 16.4 12.0 12.7 10.7 10.4
Six-month government bonds 14.5 12.3 10.9 10.0 9.8
Prime lending interest rate 20.0 16.7 15.7 15.1 15.4
External sector (in percent of GDP)
Trade balance -19.5 -15.9 -14.4 -15.6 -17.0
Private transfers 12.6 11.5 11.7 12.5 12.3
Current account (after official transfers) -3.8 -1.6 0.9 -0.7 -1.8
Overall balance of payments position (deficit -) 1.5 1.6 3.2 2.6 0.8
Net international reserves
(In millions of U.S. dollars) 935 1,100 1,462 1,766 1,866
(In months of imports of goods and services) 3.6 5.3 4.9 5.7 5.8
External public debt 23.7 24.3 23.9 22.2 22.4
Real effective exchange rate 3/
(percent change, end of period, depreciation -) 8.4 5.6 3.9 1.3 0.5

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

l/ In relation to the stock of liabilities to the private sector at the beginning of the period.
2/ In 1999 data refer to October.
3/ In 1999 data refer to the period January–August.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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