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Public Information Notice (PIN) No. 03/149
December 22, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with El Salvador

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On July 18, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with El Salvador.1

Background

Over the past decade, El Salvador has built a good macroeconomic policy track record and demonstrated considerable reform ownership. After the end of the civil war in 1992, the authorities maintained a sound fiscal policy, which helped reduce public debt from about 50 percent of GDP in 1992 to about 30 percent in 2000. They also implemented a comprehensive structural reform process, including privatization, trade liberalization, and civil service and pension reform.

In recent years, the authorities have reinforced their strategy. They introduced official dollarization in January 2001 to reduce domestic interest rates, exchange rate risk, and transaction costs and, thus, to reinvigorate private investment and exports. Structural reforms have strengthened public banks and financial supervision, expanded the role of the private sector, and further progress has been made regarding trade integration.

Partly due to adverse shocks, growth has weakened in recent years. These shocks include the earthquakes in 2001, adverse terms of trade developments (coffee and oil), and the global economic slowdown. Economic growth was 2.1 percent in 2002, consumer price inflation remains subdued (2 percent in 2002), and domestic interest rates have declined. Civil service reform has created room for the public sector wage bill to decline, and tax revenues increased to 11.2 percent of GDP in 2002 on account of measures to broaden the tax base and improve tax administration and enforcement. Still, the fiscal deficit increased to 4.6 percent of GDP in 2002, largely because of reconstruction expenditures following the 2001 earthquakes. Hence, public debt has reached almost 40 percent of GDP by end-2002.

The outlook for 2003 suggests that macroeconomic stability will continue. Economic growth is projected to remain practically unchanged from 2002 at 2.2 percent. The negotiations for a Central American Free Trade Agreement (CAFTA) with the United States are expected to encourage new investments as exporters start to position themselves for an expansion in trade. Some deficit reduction is projected for 2003 (to 4.1 percent of GDP), reflecting large cutbacks in capital expenditures, which will be partially offset by new expenditure commitments in the social area.

Executive Board Assessment

The Executive Directors commended the authorities for their strong record of sound fiscal policies and comprehensive structural reforms since the early 1990s, which have contributed to a marked reduction in inflation, a decline in public debt relative to GDP, a rapid growth of non-traditional and maquila exports, and impressive advances in social indicators. The new monetary regime introduced in 2001, with the U.S. dollar as legal tender in parallel with the colón, has contributed to halting the appreciation of the real exchange rate and reducing domestic interest rates, and appears to have gained broad domestic acceptance.

Directors welcomed the authorities' efforts to maintain overall sound economic policies in the face of the adverse shocks of recent years, including two major earthquakes, deteriorating terms of trade, and slower U.S. growth. At the same time, however, they observed that the recent weakening of the fiscal position and sluggishness of output growth pose challenges which will need to be addressed going forward. Directors therefore encouraged the authorities to build on the credibility of the new monetary regime by continuing to implement sound fiscal and financial sector policies and sustaining their structural reform efforts. This will require continued efforts to mobilize broad-based support for a further strengthening of the policy framework, notwithstanding the challenging political environment.

While recognizing that the rise in the fiscal deficit and public debt in 2002 were largely due to reconstruction expenditures following the earthquakes and to pension system reform, Directors observed that, absent further fiscal adjustment, the public debt could increase relative to GDP and public sector financing requirements would remain large. Directors therefore encouraged the authorities to pursue their fiscal consolidation efforts to put public debt on a declining path while, at the same time, buttressing the dollarization regime. They generally supported the view that a fiscal adjustment of about 3 percentage points of GDP would be appropriate, and would need to include a revenue enhancing effort by strengthening tax enforcement and taking, in due course, steps toward increasing VAT and excise rates. Directors also encouraged the authorities to continue to press for a modification of the generous early retirement provision, which allows many workers to retire before age 50. To reduce El Salvador's vulnerability to adverse shocks, they recommended that the authorities combine the fiscal adjustment with efforts to build up a strong international reserve cushion. Over the medium term, the authorities were encouraged to give consideration to the adoption of a fiscal rule to further enhance the credibility of their commitment to fiscal prudence.

Directors welcomed the progress made by the authorities in implementing FSSA recommendations aimed at reinforcing financial supervision, in particular the steps to strengthen the regulatory framework and modernize the payment system. They encouraged the authorities to continue their efforts to strengthen the supervision of cross-border lending and of financial conglomerates, and to address remaining vulnerabilities stemming from banks' exposure to impaired assets. To reduce the exposure of private pension funds to the government, Directors supported the authorities' efforts to allow the funds to invest a larger share of their portfolio in high-quality investments abroad. They looked forward to the follow-up FSAP exercise to identify areas for further improvements on financial sector issues. Directors commended the authorities for their exemplary efforts to combat money laundering and the financing of terrorism.

Directors welcomed the steps to strengthen the safety net under the financial system, including efforts to establish contingent credit lines with some multilateral institutions. They noted, however, that in view of the possibility of future adverse shocks, a further strengthening of the safety net would be helpful, and encouraged the authorities to consider steps to increase the capitalization of the deposit insurance fund and to keep under review the possible strengthening of a lender of last resort facility. They also encouraged further study of possible improvements in the central bank's liquidity operations in line with the new monetary regime.

While commending the authorities for the comprehensive structural reform agenda implemented over the past decade, Directors saw a need for sustained further efforts to enhance competitiveness and productivity growth. They encouraged the authorities to press ahead with their reform plans aimed at increasing private sector participation in the economy, including full privatization of the electricity company and the sale of concessions in the transportation sector. Directors also welcomed the steps to increase labor market flexibility, while stressing that the maintenance of a prudent minimum wage policy will be equally important to keep labor costs competitive in the maquila and nontraditional export sectors. While recognizing the considerable progress that has been made in recent years in addressing institutional and governance weaknesses, Directors encouraged the authorities to continue their efforts in these areas.



El Salvador: Macroeconomic Flows


 

   

Proj.

 

1999

2000

2001

2002

2003


           

(Annual percent change)

Income and prices

         

Real GDP

3.4

2.2

1.7

2.1

2.2

Real GDP per capita

1.4

0.2

-0.2

0.2

0.3

GDP deflator

0.3

3.1

3.4

1.3

2.9

Consumer prices (end of the year)

-1.0

4.3

1.4

2.8

3.0

Consumer prices (average)

0.5

2.3

3.7

1.9

2.9

           

Monetary sector

         

Domestic credit

4.1

1.1

-1.8

7.3

6.3

Liabilities to private sector

6.5

3.6

2.6

-2.6

5.2

Interest rates (annual, time deposits)

10.7

9.3

5.5

3.4

...

           

External sector

         

Export f.o.b. volume (including maquila)

-6.4

17.5

-1.3

5.3

8.7

Import f.o.b. volume (including maquila)

-3.0

21.3

2.8

3.2

8.9

Terms of trade

-4.6

-3.7

-0.1

-0.7

0.1

Real effective exchange rate

1.0

5.1

1.2

-2.3

...

           

(In percent of GDP, unless otherwise indicated)

           

Current account (after official transfers)

-1.9

-3.3

-1.4

-2.7

-3.2

Trade balance

-10.9

-13.2

-13.8

-13.3

-13.9

Exports f.o.b. (including maquila)

19.8

22.1

20.7

21.1

21.9

Imports f.o.b. (including maquila)

-30.7

-35.3

-34.6

-34.5

-35.7

Services

-3.7

-3.7

-4.1

-3.4

-3.5

Income

-2.2

-1.9

-1.9

-2.0

-2.2

Transfers

12.7

13.7

16.5

14.0

14.1

           

Capital account

5.3

3.0

2.4

3.0

3.6

Capital transfers

0.6

0.8

1.4

0.5

0.5

Public sector

1.0

0.4

2.4

4.6

1.2

Private sector

2.1

0.1

-1.6

-4.0

-0.2

           

Net official reserves (increase -)

-1.7

0.3

1.3

0.9

-0.1

           

Gross domestic investment

16.4

16.9

16.7

16.4

15.9

Public sector

2.9

2.7

2.9

3.3

3.1

Private sector

13.5

14.2

13.8

13.1

12.9

           

National savings

14.5

13.6

15.3

13.8

12.7

Public sector

0.2

-0.6

0.4

0.8

-0.4

Private sector

14.3

14.3

14.9

12.9

13.0

           

External savings

1.9

3.3

1.4

2.7

3.2

           

Overall public sector

         

Overall balance

-2.6

-3.0

-4.3

-4.6

-4.1

Overall primary balance

-1.2

-1.4

-2.9

-2.9

-2.1

           

Financing

2.6

2.9

4.2

4.5

4.1

External

1.0

1.5

4.5

8.9

3.0

Domestic

0.3

1.4

-0.3

-4.4

0.9

Privatization proceeds

1.3

0.0

0.1

0.0

0.2

           

Memorandum item:

         

Nominal GDP (in millions of U.S. dollars)

12,465

13,134

13,804

14,284

15,009

 

 

 

 

 

 


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

 

1 Under 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.




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