IMF Executive Board Concludes 2006 Article IV Consultation with El Salvador

Public Information Notice (PIN) No. 06/84
July, 31, 2006

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. The staff report for the Article IV consultation with El Salvador may be made available at a later stage if the authorities consent.

On July, 24, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with El Salvador.1


Since taking office in 2004 the government has pursued an outward-oriented strategy to boost growth and improve social conditions. The policy agenda focuses on developing new sources of growth and reducing poverty through further integration with the global and regional economy, investment and social reforms, and stabilization of the public debt level. Early achievements of this strategy include an increase in tax revenue, improved debt management, and the CAFTA-DR.

Since the last Article IV consultation, the economy has strengthened. Growth has picked up and is running at 3½ percent thus far in 2006 (2 percent per year in 2000-05), spurred by investment and exports. Despite the full pass-through of higher oil prices, year-on-year inflation fell to 3½ percent in May 2006, the lowest level in the region. The external current account deficit widened slightly to 4½ percent of GDP in 2005. Sovereign spreads have remained among the lowest in the Latin America region.

Fiscal policy has aimed at stabilizing the public debt/GDP ratio and strengthening debt management. The 2006 budget limits the deficit to 3 percent of GDP, which implies a primary deficit of some 0.7 percent and will maintain public debt at around 42 percent of GDP, with the nonfinancial public sector debt at 40 percent. Tax revenue has been strengthened by tax measures approved in late 2004/early 2005, as well as recent efforts to broaden the taxpayer base. As budgeted, this revenue gain is largely offset by higher energy subsidies, wages, interest, and pension outlays. The increase in capital spending achieved in 2005 has been maintained in the 2006 budget.

The banking system has been strengthened and appears well positioned to withstand temporary liquidity shocks. Banks' capital adequacy has improved and their net foreign asset position has remained at a comfortable level, covering 30 percent of deposits (above the statutory level of 26 percent). Meanwhile, stricter prudential norms and improved bank resolution practices have been issued, although some aspects of the dollarization regime are yet to be adopted.

To secure the implementation of CAFTA-DR in March 2006, congress approved legislation to enhance competition (mainly in government procurement and telecoms), upgrade customs procedures, and protect intellectual property rights. Congress also passed anti-trust legislation and stiffened penalties for corruption by public officers.

Looking ahead, the authorities plan to strengthen the fiscal stance in 2006 by limiting income tax exemptions and subsidies; as well as secure passage of banking reforms to underpin financial stability and deepen intermediation. Over the medium term, the strategy is to keep the public debt/GDP ratio stable through 2008 and reduce it gradually thereafter. This would be achieved by increasing the revenue effort through further reductions in tax evasion and controlling pension costs, while creating space for priority infrastructure and social spending.

Executive Board Assessment

Executive Directors commended the continued progress made by the Salvadorian authorities in implementing their outward-oriented growth strategy, which has already helped bring about strong growth based on a solid export performance, rising investment, and robust workers' remittances. Looking ahead, Directors observed that the main policy challenge for El Salvador is to place the economy on a path of sustained rapid growth and social progress, that will help the country achieve the Millennium Development Goals. This will involve continued progress on the fiscal sector, financial system, and structural reform agendas. Directors urged the authorities to take advantage of current global conditions and the benefits of the liberalized trade regime under the recently implemented CAFTA-DR, and noted that a national dialogue will be important to obtain broad-based consensus on the reforms.

Directors supported the authorities' medium-term fiscal strategy based on an increase in tax revenue, an improved targeting of tax exemptions and subsidies, and planned increases in investment and social spending. In the near term, however, these policies imply only a modest improvement in the primary balance and, as a result, the public debt ratio would remain roughly unchanged in the next few years. In light of this, Directors encouraged the authorities to build consensus in favor of a more front-loaded fiscal effort, while protecting priority spending. In this context, they recommended additional measures, which could include tightening pension parameters, reducing subsidies, including on nontraditional exports, and improving control over local government spending. To complement the authorities' efforts to reduce tax evasion, many Directors also encouraged consideration of additional tax measures, such as raising the VAT rate. Directors welcomed the authorities' support for a regional code of conduct to limit tax competition in attracting investment.

Directors commended the authorities for already securing the government's financing needs for 2006. They also supported the authorities' debt management objective of lengthening maturities and seeking external support on concessional terms.

Directors noted the strong foreign asset position of commercial banks, which limits the economy's vulnerability to potential shifts in global market sentiment. They supported the planned financial system reforms, which will underpin financial stability and strengthen the system's resilience to shocks. Directors endorsed the authorities' focus on implementing the recently issued stricter prudential norms, enhancing consolidated supervision, fostering intermediation with the passage of a securitization framework, and reinforcing the financial safety net. They also supported the authorities' regional strategy to enhance financial sector stability. Directors recommended implementing pending elements of the dollarization law of 2001 by restructuring the balance sheet of the central bank and strengthening its lender-of-last-resort function to provide an additional cushion against system-wide shocks and minimize contagion risks.

Directors supported the authorities' medium-term agenda to strengthen the economy's competitiveness through improvements in productivity and cost reductions in the dollarized economy. They endorsed the authorities' plans to upgrade basic infrastructure and human capital, eliminate red tape, tackle crime, and create new trade opportunities. To limit fiscal pressures and further improve the investment climate, Directors encouraged the authorities to enhance the framework for private sector participation in infrastructure projects, and to improve procedures for corporate insolvency, business dispute resolution, and creditor's rights.

El Salvador: Selected Economic and Financial Indicators

        Prel. Proj.


2002 2003 2004 2005 2006

Real economy (change in percent)


Real GDP

2.2 2.3 1.8 2.8 3.5

Consumer prices (end of period)

2.8 2.5 5.4 4.3 4.0

National savings (percent of GDP)

13.4 12.3 12.0 10.8 11.9

Gross domestic investment (percent of GDP)

16.2 17.0 16.0 15.4 16.5

Public finances (percent of GDP)


Consolidated public sector deficit

-4.5 -3.7 -2.9 -3.0 -2.8

Consolidated primary deficit

-2.8 -1.6 -0.8 -0.7 -0.4

Public sector debt (percent of GDP, end of period)

39.3 42.1 43.5 42.3 42.6

Of which


Nonfinancial public sector

38.6 40.3 40.5 39.9 40.3

Money and credit (end-year, percent change)


Net domestic assets

-2.8 -0.5 1.5 3.1 9.1

Of which


Nonfinancial public sector

-4.5 3.5 0.3 1.0 -0.1

Private sector

6.2 1.0 9.0 8.4 9.7

Liabilities to private sector

-2.6 1.7 2.7 4.9 10.5

Interest rates (average)


Deposit rate (six months)

3.4 3.4 3.3 3.4 4.1

Lending rate (more than one year)

8.7 8.0 7.7 8.2 8.8

External sector


Trade balance (percent of GDP)

-13.0 -15.2 -16.8 -17.7 -18.9

Current account balance (percent of GDP)

-2.8 -4.7 -4.0 -4.6 -4.5

Change in net international reserves


(millions of U.S. dollars, increase -)

123.5 -316.2 52.5 58.9 -102.0

Terms of trade

-0.6 -0.3 -0.7 0.5 -1.3

Real effective exchange rate (end of period) 1/

-2.3 -5.1 0.8 2.3 -0.8

Net foreign assets of the banking system


Millions of U.S. dollars

1,839 1,982 2,059 2,178 2,276

Percent of deposits

29.2 30.9 31.2 31.4 29.7

Sources: Central reserve bank; ministry of finance; and IMF staff estimates and projections.
1/ As of May 2004.

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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