IMF Executive Board Concludes 2007 Article IV Consultation with El Salvador

Public Information Notice (PIN) No. 08/36
March 14, 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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with El Salvador is also available.

On November 19, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with El Salvador.1


Real output growth has been maintained at around 4 percent (annually) since the first quarter of 2006, its fastest pace in a decade. The main drivers of growth on the demand side were remittance-financed consumption, investment, and nontraditional exports, while on the supply side agriculture, tourism, and services were the most dynamic sectors. Inflation peaked at 5½ percent in January 2007, due to a spike in food prices, and has moderated recently. The current account deficit, stable in 2006, has widened somewhat in the first half of 2007, reflecting robust domestic demand and still weak maquila exports. Higher foreign direct investment, partly related to the sale of the three largest banks, and government grants facilitated the financing of the larger current account deficit. The real effective exchange rate has remained broadly stable in the last year, as it had during the previous decade.

Public finances have continued to improve, in line with budget projections. The overall public sector deficit fell to less than 3 percent of GDP in 2006, and is projected to come down to 2¼ percent of GDP for 2007. Strong revenue performance in 2006 and thus far this year, due in part to improved tax administration and broadening the tax rolls, have contributed to these positive results. The projected improvement in 2007 also reflects a significant reduction in current expenditure, mainly on goods and services and current transfers. In parallel with the improvement in the fiscal deficit, public debt is projected to decline to 41 percent of GDP by the end of the year.

The banking sector experienced robust growth in deposits and domestic assets during the last 18 months. The rapid growth in deposits has boosted liquidity levels, and the banking systems profitability and overall asset quality have been maintained. Private sector credit has expanded to finance higher economic activity, particularly in response to increased consumption and investment demand. The increase in credit was mostly financed by deposit increases, partly related to the sales of the three largest banks. Meanwhile domestic interest rates remained stable reflecting improved liquidity in the banking system. During the period, the three largest banks were acquired by foreign financial groups, raising the participation of foreign banks in the financial system to 95 percent.

The authorities continue to focus on improving the business climate to enhance competitiveness in the dollarized economy. Recent modernization of land registration and simplification of customs procedures have aided El Salvador's advancement in world rankings in this area.

Executive Board Assessment

Directors commended the authorities for the increase in growth observed over the last two years, which owed much to the continued implementation of sound economic policies, the strong track record of structural reforms, and favorable global conditions. Directors encouraged the authorities to maintain the reform momentum during the next eighteen months and beyond, so as to boost El Salvador's growth potential, enhance the resiliency of the dollarized economy to external shocks, and further reduce poverty levels and achieve the Millennium Development Goals.

Directors noted that growth could moderate in 2008 on account of external developments, and to rebound in later years. They encouraged the authorities to be vigilant to short-term downside risks, particularly those stemming from a sharper-than-expected slowdown of growth in the United States, its main economic partner.

Directors agreed that the real effective exchange rate appears broadly in line with fundamentals and that the current account position is projected to be sustainable over the medium term. They also pointed to the good performance of non-traditional exports, including product and market diversification, which suggests that the export sector remains competitive.

Directors noted that fiscal policy is appropriately focused on placing the public debt firmly on a downward path and raising the tax/GDP ratio to permit higher social and infrastructure expenditures. They supported the authorities' medium-term fiscal target of improving the primary surplus to 1 percent of GDP by 2009. Directors saw scope for further measures in 2008 to secure these objectives, including additional efforts to improve tax administration, eliminate tax loopholes, and reform poorly targeted subsidies.

Directors saw merit in strengthening public financial management, including through the development of a medium-term expenditure framework and a tax expenditure budget, and expressed concerns about the efficacy of financing government expenditure through trusts and autonomous bodies. They encouraged the authorities to build broad support for the reform of the pension system to lower contingent fiscal liabilities.

Directors considered the recent foreign acquisition of the three largest domestic banks as an opportunity to press ahead with financial sector reforms, and to align the regulatory and supervisory frameworks with international best practice. They supported the authorities' intention to make further improvements in these areas, welcomed the recent passage of the law on securitization of financial assets, and urged expeditious passage of other pending financial legislation. Directors also called for fostering cross-border supervision and strengthening the central bank's balance sheet. They noted that financial soundness indicators point to a healthy situation in the financial sector, and recommended that the authorities remain vigilant to changes in global financial conditions and to the recent rapid increase in consumer credit extended by domestic banks.

Directors supported the authorities' strategy to improve competitiveness of the dollarized economy, which has been yielding positive results. They also considered that the focus on fighting crime, improving public infrastructure, enhancing labor market skills, and streamlining business regulations remains appropriate.

El Salvador: Selected Economic and Social Indicators
        Est. Proj. Proj.


2003 2004 2005 2006 2007 2008

Real economy (change in percent)


Real GDP

2.3 1.9 3.1 4.2 4.2 3.8

Consumer prices (end of period)

2.5 5.4 4.3 4.9 4.0 3.5

National savings (percent of GDP)

12.3 12.3 10.5 11.4 14.5 13.4

Gross domestic investment (percent of GDP)

17.0 16.2 15.7 16.1 20.4 19.0

Public finances (percent of GDP)


Consolidated public sector deficit

-3.6 -3.0 -3.0 -2.9 -2.2 -1.9

Consolidated primary deficit

-1.6 -0.8 -0.8 -0.5 0.2 0.6

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

42.1 43.5 42.0 41.9 40.8 39.8

Of which


Nonfinancial public sector

40.3 40.5 39.7 39.6 38.7 37.9

Money and credit (end-year, percent change)


Net domestic assets

8.3 0.0 6.9 7.8 10.4 10.9

Of which


Nonfinancial public sector

4.2 -2.6 1.4 -1.5 2.3 0.1

Private sector

8.0 4.1 8.3 9.0 10.0 9.1

Liabilities to private sector

4.3 0.1 7.8 12.9 18.2 8.2

Interest rates (average)


Deposit rate (six months) 1/

3.4 3.3 3.4 4.9 4.5 ...

Lending rate (more than one year) 1/

8.0 7.7 8.2 9.0 9.3 ...

External sector


Trade balance (percent of GDP)

-15.2 -16.8 -18.2 -19.8 -20.0 -19.8

Current account balance (percent of GDP)

-4.7 -3.9 -5.2 -4.7 -5.9 -5.6

Change in net international reserves

-316.2 52.5 58.9 -71.6 -444.9 -125.0

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


Terms of trade

-1.0 -2.5 -1.8 -2.3 -0.8 -1.5

Real effective exchange rate (end of period) 1/

-3.0 -0.7 2.4 -0.2 -0.8 ...

Net foreign assets of the banking system


Millions of U.S. dollars

1,044 1,050 1,104 1,459 2,079 1829.4

Percent of deposits

17.0 16.9 17.3 20.4 22.0 18.1

Sources: Central Reserve Bank of El Salvador; Ministry of Finance; and IMF staff estimates.
1/ For 2007, the REER shows the percentage change through July and interest rates are the average through July.

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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