IMF Executive Board Concludes 2008 Article IV Consultation with El Salvador

Public Information Notice (PIN) No. 08/151
December 31, 2008

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 12, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with El Salvador.1


Like in other Central American countries, economic growth is expected to decelerate, on the back of the U.S. slowdown. While real GDP growth rose to 4.7 percent in 2007, a record high in the last decade, it is expected to decelerate to 3.2 percent in 2008. However, the monthly economic activity indicator has signaled a mild but steady slowdown thereafter, reaching an average growth rate of 3.2 percent in the year to August. Headline inflation increased from 4.9 percent (year-on-year) in December 2007 to 9.9 percent this August, mainly due to soaring global commodity (food and fuel) prices. With the sharp decline in commodity prices more recently, inflation fell to 5.3 percent in November. The current account deficit widened in the first part of the year, with strong exports and resilient remittances only partly offsetting higher fuel prices, but is expected to moderate reflecting lower commodity prices and a slower domestic demand. Foreign Direct Investment flows have subsided after their unusually high level in 2007 related to the foreign purchase of banks, but remain relatively strong so far.

The banking system-now mainly foreign-owned-remains highly liquid, and has shown resilience to the global financial turbulence so far. Over the last two years, the three largest banks were acquired by foreign banks; about 90 percent of the banking system assets in El Salvador are now foreign owned. The banking system shows liquidity ratios above 34 percent. Average profitability levels fell in 2007, mainly on account of acquisition-related restructuring costs, but have recovered this year. With a rising share of consumer and housing loans in total credit, non-performing loans have been on an upward trend since 2006.

The fiscal position improved substantially in 2007, but was undermined in 2008 by the impact of high fuel prices on energy subsidies. The public sector fiscal deficit for the first half of this year increased relative to the same period a year earlier, driven by higher spending on energy subsidies and government actions to mitigate the impact of food prices. Strong revenue performance, particularly regarding income tax and VAT receipts, cuts in nonpriority spending, and some government measures to rationalize energy subsidies, have partly offset the deterioration in the operating surplus of public enterprises and the rapid increase in subsidies. The government has actively responded to high commodity prices with key measures that include expanding well-targeted social programs such as Red Solidaria (a conditional cash transfer program), increasing allowances for a tax credit program for middle-income families, eliminating import tariffs on wheat and agricultural inputs, delivering seeds and fertilizers for agricultural production, and granting a selective increase in wages of low-income public servants of between 2.5-5 percent.

Executive Board Assessment

Executive Directors welcomed the strength of El Salvador's macroeconomic fundamentals, which is the result of several years of sound policies, well-oriented structural reforms, and a favorable external environment. However, economic growth has decelerated recently, as in other Central American countries, on the back of the U.S. slowdown and the food and fuel price shock. The global financial crisis and electoral uncertainty have led to some tightening in domestic financial conditions, although the banking system remains resilient.

Directors considered that El Salvador's main challenge in the short run is to maintain macroeconomic stability and mitigate the impact of the shock on the poor. The policy priorities are to improve crisis preparedness in the financial sector, maintain fiscal restraint, and secure government financing in the coming year. Over the medium term, fiscal and financial sector reforms should continue to aim at enhancing the economy's resilience and growth potential. Directors agreed that El Salvador's real effective exchange rate is broadly in line with economic fundamentals, and that the export sector remains competitive.

Directors stressed that, in the face of global shocks and political uncertainty, it will be critically important to prepare the financial sector for potential liquidity or solvency problems and move forward with contingency planning. The introduction of a temporary 3 percent liquid asset requirement and the negotiation of a credit line for the central bank with a regional development bank are welcome steps in this direction. Directors encouraged the authorities to closely monitor banks' short-term borrowing and liquidity positions, enhance cooperation with home supervisors, draw up concrete action plans to deal with possible stress in the banking system in the future, and negotiate additional contingent credit lines to bolster the central bank's ability to provide liquidity for emergency assistance to banks. Careful monitoring of asset quality and credit risk will also be important.

Executive Directors noted that the fiscal deficit targets-2.3 percent of GDP in 2008 and 2.2 percent of GDP in 2009-are consistent with the objective of maintaining fiscal restraint. In this context, they supported the planned expansion of well-targeted social programs and reduction in nonpriority expenditure, while encouraging efforts to enhance controls of energy subsidies and to limit public wage increases.

Directors welcomed recent actions to secure additional financing and to improve the maturity structure of public debt. In particular, they commended the government for reaching a political agreement with the opposition to ensure congressional approval to negotiate loans amounting to US$950 million from the World Bank and the Inter-American Development Bank.

Directors supported the authorities' strategy of anchoring medium-term fiscal policy on the goal of reducing public debt to about 30 percent of GDP by 2013 while increasing well-targeted social and infrastructure spending. This would increase the ability of fiscal policy to react to external or domestic shocks and adopt a counter-cyclical stance, and at the same time enhance the economy's growth potential. Achieving this goal will require measures in several areas, including tax revenue enhancements, further cuts in nonpriority spending, improvements in the efficiency and targeting of subsidies, and a parametric reform of the pension system.

Directors also stressed the importance of further reforms of the financial sector to strengthen El Salvador's resilience to shocks. Key measures include passing the bill to strengthen financial supervision; enhancing the central bank's legal power to provide liquidity to banks in distress; and bolstering the deposit insurance fund. A few Directors expressed reservations against a recommendation, made in the case of El Salvador, for strict regulations to prevent asset originators from fully passing on credit risks to third parties.

El Salvador: Selected Economic and Financial Indicators









2004 2005 2006 2007 2008


Real economy (change in percent)


Real GDP

1.9 3.1 4.2 4.7 3.2

Consumer prices (end of period)

5.4 4.3 4.9 4.9 5.9

National savings (percent of GDP)

12.2 12.4 12.4 10.6 9.4

Gross domestic investment (percent of GDP)

16.2 15.7 16.1 16.1 15.4

Public finances (percent of GDP)


Consolidated public sector deficit

-3.0 -3.0 -2.9 -1.9 -2.9

Consolidated primary deficit

-0.8 -0.8 -0.5 0.5 -0.5

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

43.5 42.0 41.9 40.8 41.7

Money and credit (end-year, percent change)


Net domestic assets 1/

0.0 6.5 7.0 6.8 5.0

Of which


Nonfinancial public sector 1/

-2.5 1.3 -1.3 2.0 2.9

Private sector 1/

4.0 7.8 8.0 6.7 5.2

Liabilities to private sector

0.1 7.8 12.9 18.4 -2.4

Interest rates (average)


Deposit rate (six months)

3.3 3.4 4.9 4.4 4.1

Lending rate (more than one year)

7.7 8.2 9.0 9.4 9.6

External sector


Trade balance (percent of GDP)

-16.8 -17.2 -19.0 -20.0 -19.9

Current account balance (percent of GDP)

-4.0 -3.3 -3.6 -5.5 -6.0

Change in net international reserves


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

52.5 58.9 -71.6 -280.2 -397.8

Terms of trade

-6.1 -2.9 -0.9 -5.7 -6.6

Real effective exchange rate (end of period)

-0.7 2.4 -0.2 -0.8 ...

Net foreign assets of the banking system


Millions of U.S. dollars

1,063 1,115 1,441 2,177 2,390

Percent of deposits

14.2 14.6 17.3 22.9 25.2








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

1/ Relative to previous year's broad money.

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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