## 1slvea2020002

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### Context
- The COVID-19 pandemic is causing serious stress on the economy due to containment measures.
- 2020 projection: Salvadoran economy expected to contract by 5.4 percent—7¾ percentage points below pre-COVID projections.
- Recovery projected to start in 2021 and continue over the medium term.
- Fiscal vulnerability: public debt (including pensions) reached 70.2 percent of GDP at end-2019.
- Primary balance improved by 2¾ percent over 2013–18—mainly due to savings from the 2017 pension reform.
- Authorities committed to further improving healthcare, as reflected in the 2020 budget.

### The Shock — Measures and Immediate Fiscal Impact
- Health and containment measures:
  - Detection measures introduced starting early February; containment measures (school closures, mandatory quarantines, shut-down of non-essential parts of the public sector) followed immediately after, before the first case was diagnosed.
  - Shelter in place on March 21, closing all non-essential businesses for 30 days, when three cases were diagnosed.
  - Since end-February, hospitals stocked with necessary equipment; wages of health workers increased; a new large hospital is being built.
- Legislative and fiscal measures:
  - Legislative Assembly approved relief measures and a bill to authorize US$2 billion (about 8 percent of GDP) borrowing to finance COVID-19 related spending and recovery beyond 2020.
  - Relief includes deferring utility payments for water, energy, telecommunication services, mortgages, consumer loans and credit cards for a three-month period; exemptions for some tourism companies; approximately 75 percent of households will receive a US$300 one-time transfer.
- Estimated COVID-19 impact on the 2020 budget (IMF staff estimates; Text Table 1):
  - Total measures 3½ percent of GDP (presented as "Total measures 9163.5" in the table), with line items including:
    - Current spending 7773.0
    - Higher wage bill; bonus for affected staff 700.3
    - Health spending (goods and services) 2601.0
    - One-off transfer to households 400
    - Utility payment freezes 2/250.1
    - Other measures for relief/recovery 240.1
    - Construction of hospitals 1400.5
- Fiscal deterioration in 2020:
  - Staff estimates the 2020 overall fiscal balance will deteriorate by about 5½ percent of GDP compared to 2019, driven by:
    - Higher spending due to COVID-19 related items (3½ percent of GDP)
    - Tax revenue loss (1½ percent of GDP)
    - Higher interest payments (about ½ percent of GDP)

### Rapid Financing Instrument (RFI) and Balance of Payments
- Authorities request to purchase 100 percent of quota (SDR287.20 million, about US$389 million) under the standard window of the RFI to cover part of the substantial balance of payments needs.
- IMF emergency lending represents about a fifth of the 2020 budget and represents about 10 percent of gross international reserves.
- External sector impact and financing (staff projections for 2020):
  - Balance of payments impact is US$1,432 million and the BoP gap can be financed mostly through multilaterals.
  - BoP and financing (Millions of U.S. dollars): BoP 876 (2019), Pre-Shock 250, Post-Shock -1,182; Change / Financing gap 1,182.
  - Of which: Prospective RFI 389; Of which: Other multilaterals 793.
- Staff 2020 projections (selected):
  - Export volumes to decline by 9 percent.
  - Tourism receipts to decline by more than US$1 billion.
  - Remittances to contract by 17 percent (versus an increase of 4.3 percent projected in January), reducing remittances from 5,869 (Pre-Shock) to 4,686 (Post-Shock) in the table.
  - Imports to decline, aided by a plunge in oil prices by 40 percent compared to January.
  - Lower FDI and other capital inflows to finance big projects by about 80 percent compared to the January projection.

### Outlook and Risks
- Staff expects the economy to contract by 5½ percent in 2020, with a recovery thereafter broadly in line with the U.S. economy.
- 2021–25 projection: real output projected to slowly converge to its potential (2½ percent growth); remittances will return to their long-term growth rate of 4 percent.
- Key downside risks:
  - Weaker-than-expected global growth and a prolonged pandemic that could further depress remittances and trade.
  - Financial risks from higher sovereign risk premia and tighter private sector financial flows (FDI and portfolio).
  - Dollarization makes the financial sector a potential amplifier of the shock if liquidity dries up.
  - Health risks: deterioration of the pandemic globally could seriously impact economic activity.

### Policy Discussions: Ensuring Fiscal Sustainability
- Public debt dynamics:
  - Shock expected to increase public debt (including pension liabilities of about 19 percent of GDP) by more than 10 percent of GDP to 82 percent of GDP in 2020.
  - Absent significant fiscal adjustment, debt would continue to edge up, reaching 85 percent of GDP by 2025.
- Main policy priority:
  - Preserve fiscal sustainability; temporary deterioration in 2020 is appropriate, but measures should be temporary and a credible fiscal consolidation plan should be announced once the crisis recedes.
  - Authorities’ commitment to an adjustment of 3 percent of GDP over 2021–24 will put public debt (including pensions) on a firmly downward trajectory, reaching 60 percent of GDP by 2030, in compliance with the Fiscal Responsibility Law.
- Staff recommendation:
  - Gradual fiscal adjustment of 3 percent of GDP over 2021–24, with the bulk implemented in 2022–23 as rollover risk intensifies due to Eurobond repayments.
- Staff-recommended permanent measures (explicit suggestions):
  - Tax administration measures of ¾ percent of GDP, as already planned by authorities (including electronic invoicing, simplified tax code for small businesses, transfer pricing initiative, anti-tax evasion measures requiring amendments and IT enhancements).
  - Increase excise duties on petrol and diesel given the sharp decline in oil prices.
  - Increase tax revenues by introducing a property tax and/or raising rates of consumption taxes (VAT or excises), with measures to protect the most vulnerable, including VAT refunds.
  - Decrease current spending by (i) reducing the wage bill (e.g., hiring freeze, early retirement of public employees) and (ii) centralizing procurement across ministries and public sector agencies.
  - Additional measures of ½ percent of GDP in 2024, either on revenues or current spending.
- Quantified measures (selected figures from table excerpt):
  - Authorities' measures (2021–23): Electronic invoicing 0.1/0.2/0.2 (Total 0.5); Other tax administration 0.1/0.1/0.1 (Total 0.3); Total (A) 0.2/0.3/0.3 (Total 0.8).
  - Additional proposed measures (2021–24): Revenues 0.8 (property tax 0.3/0.3 = 0.6; excises 0.1/0.1 = 0.2); Spending 0.9 (Goods and services 0.2/0.2 = 0.4; Wage bill 0.2/0.2/0.1 = 0.5); Total (B) 0.4/0.8/0.5 = 1.7. Total Measures (A+B) 0.6/1.1/0.8 = 2.5.
- Fiscal contingencies:
  - Risk that temporary spending becomes permanent or revenue losses are larger than envisaged.
  - Some room to compress capital spending further if risks materialize.
  - For 2021, staff recommends reversing the increase in spending due to emergency measures for about US$900 million to preserve fiscal sustainability and reprioritizing public investment over the medium term.

### Maintaining Financial Stability
- Financial sector measures taken in March:
  - Central Bank temporary normative acts (next 180 days) to alleviate COVID-19 impact on the financial system:
    - Banks can discount their reserve requirements with the Central Bank by 25 percent of newly issued loans.
    - Reduce overall reserve requirements for various other liabilities by about 5 percent of deposits (to about 17 percent).
    - Amend provisioning for NPLs through freezing credit ratings of clients to pre-shock levels and temporarily impose a moratorium on credit risk ratings.
    - Introduce a potential grace period for loan repayments.
  - Employers instructed to continue to make social security payments for workers.
- Staff recommendations and operational guidance:
  - Temporary relaxation of bank lending standards should be accompanied by:
    - Adequate preservation of the classification of NPLs.
    - Continued assessment of borrowers' financial situation and appropriate recording of deferred payments.
    - Establishment of strict criteria for acceptable loan restructuring, well communicated to avoid risk buildup and moral hazard.
    - Regular loan portfolio reviews and ongoing risk assessments.
    - Ensure additional financing or extending credit to affected firms as part of restructuring aligns with prudent risk management.
  - Superintendency actions:
    - Request banks to make an impact assessment of COVID-19 disruptions on liquidity and capital buffers.
    - Request banks to develop plans on future recapitalization within a reasonable timeframe.
  - Staff underscores need to maintain vigilance over financial stability while providing relief, including close monitoring and strict restructuring criteria.
- Staff recommendation: ensure functioning of interbank markets, adequately monitor risk and liquidity requirements, and increase buffers for emergency liquidity assistance to support financial stability through the crisis.

### Rationale, Access, and Safeguards for the RFI
- Rationale for the RFI:
  - Qualification based on a balance of payments need arising from the global COVID-19 pandemic shock.
  - Urgent needs and authorities’ focus on containment make a UCT-quality Fund-supported program infeasible quickly.
  - Magnitude of shock requires immediate emergency assistance and sizable financing of health and relief measures.
  - Rapid IMF involvement expected to be catalytic in securing external loans from other multilaterals and help preserve market access.
- Access, purchase size, and safeguards:
  - Staff considers immediate access of 100 percent of quota under the RFI appropriate.
    - Para. 19: Approved 100 percent of the quota (SDR287.2 million or about US$389 million) with an immediate purchase under the RFI standard window.
    - Para. 26: Staff supports authorities’ request for a purchase in the amount of SDR278.2 million (100 percent of quota).
  - Fund exposure and mitigation:
    - Fund’s exposure would amount to 1½ percent of GDP, less than a tenth of gross international reserves at the central bank.
    - Risks mitigated by authorities’ track record of servicing public debt and commitment to fiscal adjustment.
  - Channeling and safeguards:
    - Purchase will be channeled to the Ministry of Finance for budget support.
    - Authorities agree to a safeguards assessment of the central bank before Executive Board approval of any subsequent arrangement.
    - Authorities will provide central bank audit reports and authorize external auditors to hold discussions with Fund staff.
    - Authorities confirm a Memorandum of Understanding between the Central Bank and the Ministry of Finance related to the obligation of repayment to the Fund is signed before the purchase.

### Authorities’ commitments and views
- Authorities broadly agree with staff on external and fiscal financing needs and policies.
- Commitments and positions:
  - Relief measures are temporary and will be reversed fully in 2021.
  - Commit to gradually adjusting the primary balance over the medium term to achieve a 3½ percent of GDP primary surplus by end-2024.
  - Target a debt to GDP ratio of 60 percent of GDP by 2030 in line with the Fiscal Responsibility Law.
  - At least ¾ percent of GDP in tax administration measures are already in motion.
  - Continue work on strengthening cross-border cooperation and appropriately funding the emergency liquidity assistance framework.
  - Despite temporary relaxation of reserve requirements, banks are well capitalized and have recently increased liquidity buffers.

### Staff appraisal and fiscal strategy
- Assessment:
  - COVID-19 is severely impacting El Salvador, creating urgent large external and fiscal financing needs and sharply slowing economic activity due to global contraction and strict containment measures.
- Fiscal stance supported by staff:
  - Authorities permitted a temporary widening of the fiscal deficit to accommodate necessary health spending and crisis mitigation measures.
  - Staff strongly supports authorities’ commitment to allow temporary crisis measures to lapse and to implement a gradual fiscal adjustment of 3 percent of GDP in permanent measures over 2021–24, once the pandemic subsides.
  - Alignment with staff-recommended strategy to reach a primary fiscal balance of 3½ percent of GDP by end-2024 and ensure compliance with the Fiscal Responsibility Law.
- Staff reiterates need for vigilance over financial stability while providing relief and recovery measures.

### Key financing and balance of payments figures
- Financing gap and prospective external financing:
  - Financing gap 1,182
  - Of which: Prospective RFI 389
  - Of which: Other multilaterals 793
- RFI access and amounts (reported):
  - SDR287.2 million = about US$389 million (para. 19).
  - SDR278.2 million (para. 26).
- Table 6 (Outstanding Fund credit based on existing and prospective drawings):
  - In millions of SDRs: 287.20 (end-of-period outstanding based on existing and prospective drawings)
  - In millions of U.S. dollars: 389.05
  - In percent of gross international reserves: 8.75 (for 2020, outstanding)
  - In percent of quota: 100.00 (for 2020, outstanding)
- Capacity to repay indicators (Table 6 highlights):
  - Obligations to the Fund from existing and prospective credit, in millions of U.S. dollars: 4.27 (2020); 4.20 (2021); 4.20 (2022); 101.28 (2023); 196.77 (2024); 97.60 (2025).
  - Outstanding Fund credit (end-of-period), in millions of SDRs: 287.20 (2020, 2021, 2022); 215.40 (2023); 71.80 (2024); 0.00 (2025).
  - Outstanding Fund credit (end-of-period), in millions of U.S. dollars: 389.05 (2020, 2021, 2022); 291.79 (2023); 97.26 (2024); 0.00 (2025).

### Annex I. Public Debt Sustainability Analysis — Overview and Projections
- Public debt stock (including pensions) was 70.2 percent of GDP at end-2019.
- Pre-pandemic projection: debt drifting to 72 percent of GDP in 2025.
- After pandemic shock:
  - Debt-to-GDP ratio expected to jump to about 85 percent of GDP in 2025 under the immediate shock.
  - Under authorities’ gradual fiscal adjustment (authorities’ commitment scenario): public debt projected to peak in 2020 and decline to 74 percent of GDP in 2025 and 60 percent of GDP in 2030.
- Gross financing needs:
  - Expected to reach 14 percent of GDP in 2020 after the pandemic shock.
  - Abate to about 8 percent of GDP in 2025 due to reversing temporary measures in 2021 and the medium-term adjustment.
  - Financing needs averaging 9 percent of GDP over 2020–25 in the authorities’ commitment scenario, driven by a rise in domestic amortization payments and Eurobond payments in 2023 and 2025.

### DSA Key assumptions, drivers, and stress tests
- Debt definition and composition:
  - DSA focuses on gross debt comprising the nonfinancial public sector (NFPS) and the external debt of the central bank.
  - NFPS includes pension-related debt (CIP-A bonds) that finance current public pension payments.
  - Pension liabilities account for 18.9 percent of the total debt stock.
  - NFPS debt definition excludes municipal debt (1½ percent of GDP), pension system’s recognition bonds (CIP-B bonds) and some SOEs debt.
- Macroeconomic assumptions:
  - Active scenario reflects estimated growth potential of 2½ percent.
  - Inflation expected to remain anchored at about 1¼ percent over the medium term.
  - Interest bill projected to rise over the medium-term, widening the interest/growth differential.
- Results and drivers:
  - Public debt would jump to 82 percent of GDP in 2020 because of negative economic growth and higher spending due to the pandemic shock.
  - Debt declines to 74 percent of GDP in 2025 and to 60 percent of GDP by 2030 under authorities’ commitments, provided primary fiscal surpluses of 4.0 percent of GDP are maintained after the medium-term.
  - Interest bill is the major contributor to upward debt dynamics, averaging about 2½ percent of GDP contribution annually; primary surpluses and real GDP growth mitigate increases by about 1½ percent of GDP annually.
- Stress-test outcomes:
  - Combined macro-economic shocks could increase debt by about 5 percent of GDP.
  - A natural disaster or contingent liabilities shock could increase debt by about 10 percent of GDP each.
  - Under no fiscal adjustment scenario and shocks, public debt could reach up to 100 percent of GDP.
- Idiosyncratic risks and mitigating factors:
  - Major risks: higher primary deficit in 2020; lower primary surpluses over the medium-term; failure to reverse temporary 2020 measures; tightening global financial conditions raising financing costs; market-perception dynamics (EMBI spread more than doubled in recent weeks).
  - Mitigating factors: long average debt maturity of 12 years; stable investor base with over one-half of the debt held by domestic pension funds and official creditors; some limited scope to compress capital spending further; El Salvador uniquely incorporates pension liabilities as part of public debt (almost 19 percent of GDP).

### Commitments, public-health measures, and social support (authorities' statement)
- Commitments and fiscal policy stance:
  - Preserve macroeconomic and financial stability, especially fiscal sustainability.
  - Strengthen competitiveness, reduce public debt, combat corruption, and strengthen supervision, AML/CFT frameworks.
  - Confident fiscal operations will be fully financed during 2020.
  - If needed, re-prioritize capital spending and postpone lower priority projects not related to anti-pandemic measures.
  - Implement a gradual fiscal adjustment of at least 3 percent of GDP in permanent measures over 2021–24.
  - Target a primary fiscal balance of 3½ percent of GDP by end-2024.
  - Put debt on a declining path and comply with the Fiscal Responsibility Law; target public debt including pensions of 60 percent of GDP by 2030.
  - Maintain close policy dialogue with the IMF and abstain from measures that would further deteriorate external and public debt sustainability.
  - Comply with the Fund’s Articles of Agreement and avoid new trade restrictions for BoP purposes.
- Safeguards, transparency, cooperation:
  - Stand ready to collaborate on a safeguards assessment.
  - Implement a Memorandum of Understanding between the Central Bank and the Ministry of Finance to ensure compliance with the Fund’s Articles and RFI terms.
  - Provide most recently completed external audit reports of the Central Bank and accommodate meetings between IMF staff, Central Bank staff, and external auditors.
  - Authorize Fund to publish the Letter of Intent for the RFI request.
- Early public-health measures and response:
  - Telework law approved March 20th.
  - Education system closed starting March 12th.
  - Lockdowns and closing of borders and airports on March 17th.
  - First confirmed COVID19 case on March 18th.
  - By April 7th: 93 confirmed cases, 5 death, and 9 recovered patients.
  - 100 Contention Centers set up; accommodated more than 4,600 incoming travelers.
  - Hospitals increased capacity; more nurses and doctors contracted on temporary basis; increased testing capacity.
- Economic and social support measures:
  - One-off cash transfer of US$300 to nearly 75 percent of affected households.
  - One-time US$150 bonus for health workers and other public workers directly involved in COVID19 response.
  - Payments of utilities, mortgages, consumer loans and credit cards deferred for a three-month period.
  - Overall reserve requirements for deposits lowered for a period of 180 days.
- Financial accountability and governance:
  - President called on CICIES of the OAS to join Salvadorian Court of Audits to oversee accountability and transparent use of COVID19 funds.
  - Government committed to transparency and use of effective mechanisms and controls for disbursement, including through the Recovery Fund.

### Macroeconomic context and COVID-19 effects (forecasts and estimates)
- Key macro indicators (recent averages/levels):
  - Dollarized economy since 2001.
  - Average low inflation of 0.4 percent in the last four years.
  - Moderate average fiscal deficit of 2.8 percent (last four years).
  - Current account deficit of 2.7 percent (same period).
  - Average economic growth of 2.4 percent during the same period.
  - Debt-to-GDP of 70.2 percent in 2019; pension liabilities approximately 20 percent of GDP incorporated as part of public debt.
  - Foreign-owned banks account for 89.3 percent of the banking system, in terms of total assets.
  - On average, 97 of total loans have been financed by domestic deposits during the last four years.
  - NPLs averaged only 1.9 percent of total loans and were adequately provisioned (around 130 percent of NPLs).
  - Banks solvency averaged 16.4 percent.
  - Credit growth around 5.2 percent yearly.
  - Remittances flows in 2019 accounted for around 21.0 percent of GDP.
  - Around 95.0 percent of total remittances are originated in the United States.
- COVID-19 forecasts and fiscal effects:
  - BCR forecast as of end of March: GDP projected to decline in the range of 2.0 to 4.0 percent in 2020 (from a pre-COVID outlook of around 2.5 percent).
  - This projected decline is deeper than the 2009 recession when GDP fell 2.1 percent.
  - Fiscal deficit expected to widen temporarily above 8 percent of GDP in 2020.
  - Current account deficit expected to reach 4.1 percent of GDP in 2020.
  - Preliminary estimates indicate fiscal accounts may suffer:
    - Reduction of around 2 percentual points of GDP in tax revenues.
    - Increase of around 3 percentual points of GDP in expenditures associated with COVID19 and mitigation measures.
  - Slowdown in major trading partners will negatively affect the current account through declining remittances and lower external trade.
  - Most recent developments in the US and Central American economies indicate the recession may be even deeper.

### Conclusions and outlook
- Authorities confident policies in the Letter of Intent will enable effective use of the requested RFI disbursement.
- Authorities committed to preserve macroeconomic and financial stability, especially fiscal sustainability, and to putting economic growth on a higher trajectory while debt on a downward trajectory over the medium term.
- Committed to resume fiscal consolidation once the disease is contained, building on progress achieved over the last years.

*Source: EXECUTIVE SUMMARY and IMF staff report (El Salvador), April 8, 2020; Statement and Letter of Intent, April 14, 2020.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Context
- The COVID-19 pandemic is causing serious stress on the economy due to containment measures.
- In 2020 the Salvadoran economy is expected to contract by 5.4 percent—7¾ percentage points below pre-COVID projections.
- A recovery is projected to start in 2021 and continue over the medium term.
- Fiscal space remains at risk and relatively high public debt is the main vulnerability: public debt (including pensions) reached 70.2 percent of GDP at end-2019.
- The primary balance improved by 2¾ percent over 2013–18—mainly due to savings from the 2017 pension reform.
- The authorities are committed to further improving healthcare, as reflected in the 2020 budget.

### The Shock — Measures and Immediate Fiscal Impact
- Containment and health measures:
  - Detection measures introduced starting early February; containment measures (school closures, mandatory quarantines, shut-down of non-essential parts of the public sector) followed immediately after, before the first case was diagnosed.
  - Shelter in place on March 21, closing all non-essential businesses for 30 days, when three cases were diagnosed.
  - Since end-February, hospitals stocked with necessary equipment; wages of health workers increased; a new large hospital is being built.
- Legislative and fiscal measures:
  - Legislative Assembly approved relief measures and a bill to authorize US$2 billion (about 8 percent of GDP) borrowing to finance COVID-19 related spending and recovery beyond 2020.
  - Relief includes deferring utility payments for water, energy, telecommunication services, mortgages, consumer loans and credit cards for a three-month period; exemptions for some tourism companies; approximately 75 percent of households will receive a US$300 one-time transfer.
- Estimated COVID-19 impact on the 2020 budget (IMF staff estimates; Text Table 1):
  - Total measures 3½ percent of GDP (presented as "Total measures 9163.5" in the table, with line items including Current spending 7773.0, Higher wage bill; bonus for affected staff 700.3, Health spending (goods and services) 2601.0, One-off transfer to households 400, Utility payment freezes 2/250.1, Other measures for relief/recovery 240.1, Construction of hospitals 1400.5).
- Fiscal deterioration in 2020:
  - Staff estimates the 2020 overall fiscal balance will deteriorate by about 5½ percent of GDP compared to 2019, driven by higher spending due to COVID-19 related items (3½ percent of GDP), tax revenue loss (1½ percent of GDP), and higher interest payments (about ½ percent of GDP).

### Rapid Financing Instrument (RFI) and Balance of Payments
- The authorities request to purchase 100 percent of quota (SDR287.20 million, about US$389 million) under the standard window of the RFI to cover part of the substantial balance of payments needs.
- The IMF emergency lending represents about a fifth of the 2020 budget and represents about 10 percent of gross international reserves.
- External sector impact and financing (Text Table 2, staff projections for 2020):
  - Balance of payments impact is US$1,432 million and the BoP gap can be financed mostly through multilaterals.
  - BoP and financing (Millions of U.S. dollars): BoP 876 (2019), Pre-Shock 250, Post-Shock -1,182; Change / Financing gap 1,182.
  - Of which: Prospective RFI 389; Of which: Other multilaterals 793.
- Staff projects in 2020 (selected):
  - Export volumes to decline by 9 percent.
  - Tourism receipts to decline by more than US$1 billion.
  - Remittances to contract by 17 percent (versus an increase of 4.3 percent projected in January), reducing remittances from 5,869 (Pre-Shock) to 4,686 (Post-Shock) in the table.
  - Imports to decline, aided by a plunge in oil prices by 40 percent compared to January.
  - Lower FDI and other capital inflows to finance big projects by about 80 percent compared to the January projection.

### Outlook and Risks
- Staff expects the economy to contract by 5½ percent in 2020, with a recovery thereafter broadly in line with the U.S. economy.
- In 2021–25, real output is projected to slowly converge to its potential (2½ percent growth); remittances will return to their long-term growth rate of 4 percent.
- Risks are tilted to the downside; key risks include:
  - Weaker-than-expected global growth and a prolonged pandemic that could further depress remittances and trade.
  - Financial risks from higher sovereign risk premia and tighter private sector financial flows (FDI and portfolio).
  - Dollarization makes the financial sector a potential amplifier of the shock if liquidity dries up.
  - Health risks: while El Salvador appears reasonably well prepared compared to the region (Global Health Security Index comparisons), a deterioration of the pandemic globally could seriously impact economic activity.

### Policy Discussions: Ensuring Fiscal Sustainability
- Public debt dynamics:
  - The shock is expected to increase public debt (including pension liabilities of about 19 percent of GDP) by more than 10 percent of GDP to 82 percent of GDP in 2020.
  - Absent significant fiscal adjustment, debt would continue to edge up, reaching 85 percent of GDP by 2025.
- Main policy priority:
  - Preserving fiscal sustainability; the temporary deterioration in 2020 is appropriate, but measures should be temporary and a credible fiscal consolidation plan should be announced once the crisis recedes.
  - The authorities’ commitment to an adjustment of 3 percent of GDP over 2021–24 will put public debt (including pensions) on a firmly downward trajectory, reaching 60 percent of GDP by 2030, in compliance with the Fiscal Responsibility Law.
- Staff recommendation: a gradual fiscal adjustment of 3 percent of GDP over 2021–24, with the bulk implemented in 2022–23 as rollover risk intensifies due to Eurobond repayments.
- Staff-recommended permanent measures (explicit suggestions):
  - Tax administration measures of ¾ percent of GDP, as already planned by authorities (including electronic invoicing, simplified tax code for small businesses, transfer pricing initiative, anti-tax evasion measures requiring amendments and IT enhancements).
  - Increasing excise duties on petrol and diesel given the sharp decline in oil prices.
  - Increase tax revenues by introducing a property tax and/or raising rates of consumption taxes (VAT or excises), with measures to protect the most vulnerable, including VAT refunds.
  - Decrease current spending by (i) reducing the wage bill (e.g., hiring freeze, early retirement of public employees) and (ii) centralizing procurement across ministries and public sector agencies.
  - Additional measures of ½ percent of GDP in 2024, either on revenues or current spending.
- Quantified measures needed to bring public debt to a safe level by 2030 (table excerpt):
  - Authorities' measures (2021–23): Electronic invoicing 0.1/0.2/0.2 (Total 0.5), Other tax administration (e.g., monotributo) 0.1/0.1/0.1 (Total 0.3), Total (A) 0.2/0.3/0.3 (Total 0.8).
  - Additional proposed measures (2021–24): Revenues 0.8 (property tax 0.3/0.3 = 0.6; excises 0.1/0.1 = 0.2), Spending 0.9 (Goods and services 0.2/0.2 = 0.4; Wage bill 0.2/0.2/0.1 = 0.5), Total (B) 0.4/0.8/0.5 = 1.7. Total Measures (A+B) 0.6/1.1/0.8 = 2.5.
- Fiscal risks and contingencies:
  - Risk that temporary spending becomes permanent or revenue losses are larger than envisaged.
  - If risks materialize, there is some room to compress capital spending further.
  - For 2021, staff recommends reversing the increase in spending due to emergency measures for about US$900 million to preserve fiscal sustainability and reprioritizing public investment over the medium term.

### Maintaining Financial Stability
- Financial sector measures taken in March:
  - Central Bank temporary normative acts (next 180 days) to alleviate COVID-19 impact on the financial system:
    - Banks can discount their reserve requirements with the Central Bank by 25 percent of newly issued loans.
    - Reduce overall reserve requirements for various other liabilities by about 5 percent of deposits (to about 17 percent).
    - Amend provisioning for NPLs through freezing credit ratings of clients to pre-shock levels and temporarily impose a moratorium on credit risk ratings.
    - Introduce a potential grace period for loan repayments.
  - Employers instructed to continue to make social security payments for workers.
- Staff recommendation: ensure functioning of interbank markets, adequately monitor risk and liquidity requirements, and increase buffers for emergency liquidity assistance to support financial stability through the crisis.

*Source: EXECUTIVE SUMMARY, April 8, 2020.*

### 16.      Maintaining financial stability is important to support long-term growth. Staff

### 1slvea2020002 - 16.      Maintaining financial stability is important to support long-term growth. Staff

### Maintaining financial stability: recommendations and operational guidance
- Temporary relaxation of bank lending standards to cushion the negative impact of the economic shock should be accompanied by:
  - Adequate preservation of the classification of NPLs.
  - Continued practices of assessing the financial situation of borrowers and, when needed, appropriately recording deferred payments.
  - Establishment of strict criteria for acceptable loan restructuring, well communicated to avoid risk buildup and moral hazard.
  - Regular loan portfolio reviews and ongoing risk assessments to measure the impact of COVID-19.
  - Ensuring that additional financing or extending credit to affected firms as part of loan restructuring is in line with prudent risk management.
- Superintendency actions to preserve stability:
  - Request banks to make an impact assessment of COVID-19 disruptions on liquidity and capital buffers.
  - Request banks to develop plans on future recapitalization within a reasonable timeframe.
- Staff underscores the need to maintain vigilance over financial stability while providing relief and recovery measures, including close monitoring to ensure appropriate loan classification and strict restructuring criteria.

### Rationale for the Rapid Financing Instrument (RFI)
- The RFI is judged the most appropriate instrument because:
  - El Salvador’s qualification is based on a balance of payments need arising from the global COVID-19 pandemic shock.
  - A UCT-quality Fund-supported program is not feasible quickly given urgent needs and authorities’ focus on pandemic containment and recovery.
  - The magnitude of the shock requires immediate emergency assistance and sizable financing of necessary health and other measures, including the recently announced relief package.
  - Rapid IMF involvement is expected to play a catalytic role in securing external loans from other multilaterals and help preserve market access.

### Access, purchase size, and safeguards
- Staff considers an immediate access of 100 percent of quota under the RFI to be appropriate.
  - Para. 19: Approved 100 percent of the quota (SDR287.2 million or about US$389 million) with an immediate purchase under the RFI standard window.
  - Para. 26: Staff supports the authorities’ request for a purchase under the Rapid Financing Instrument in the amount of SDR278.2 million (100 percent of quota).
- Fund exposure and mitigation:
  - The Fund’s exposure would amount to 1½ percent of GDP, less than a tenth of gross international reserves at the central bank.
  - Risks mitigated by authorities’ track record of servicing public debt and commitment to fiscal adjustment over the medium term.
- Channeling and safeguards:
  - The purchase will be channeled to the Ministry of Finance for budget support.
  - Authorities agree to a safeguards assessment of the central bank to be completed before Executive Board approval of any subsequent arrangement.
  - Authorities will provide central bank audit reports and authorize external auditors to hold discussions with Fund staff.
  - Authorities confirm that a Memorandum of Understanding between the Central Bank and the Ministry of Finance related to the obligation of repayment to the Fund is signed before the purchase.

### Authorities’ commitments and views
- Authorities broadly agree with staff on external and fiscal financing needs and policies to address them.
- Key authorities’ commitments and positions:
  - Emphasized uncertainty around the outlook while agreeing on impacts on external and fiscal needs.
  - Relief measures are temporary and will be reversed fully in 2021.
  - Commit to gradually adjusting the primary balance over the medium term to achieve a 3½ percent of GDP primary surplus by end-2024.
  - Target a debt to GDP ratio of 60 percent of GDP by 2030 in line with the Fiscal Responsibility Law.
  - At least ¾ percent of GDP in tax administration measures are already in motion.
  - Continue work on strengthening cross-border cooperation and appropriately funding the emergency liquidity assistance framework.
  - Notwithstanding temporary relaxation of reserve requirements, banks are well capitalized and have recently increased liquidity buffers.

### Staff appraisal and fiscal strategy
- Economic impact and needs:
  - The COVID-19 pandemic is severely impacting El Salvador, creating urgent large external and fiscal financing needs and sharply slowing economic activity due to global contraction and strict containment measures.
- Fiscal stance supported by staff:
  - Authorities have allowed a temporary widening of the fiscal deficit to accommodate necessary health spending and crisis mitigation measures.
  - Staff strongly supports the authorities’ commitment to allow temporary crisis measures to lapse and to implement a gradual fiscal adjustment of 3 percent of GDP in permanent measures over 2021-24, once the pandemic subsides.
  - This is aligned with the staff-recommended gradual fiscal adjustment strategy to reach a primary fiscal balance of 3½ percent of GDP by end-2024 and ensure compliance with the Fiscal Responsibility Law.
- Staff reiterates the need for vigilance over financial stability while providing relief and recovery measures, including close monitoring of loan classification and strict loan restructuring criteria.

### Key financing and balance of payments figures (as reported)
- Financing gap and prospective external financing (Table 3):
  - Financing gap 1,182
  - Of which: Prospective RFI 389
  - Of which: Other multilaterals 793
- RFI access and amounts (as reported in text and tables):
  - SDR287.2 million = about US$389 million (para. 19).
  - SDR278.2 million (para. 26).
  - Table 6 (Outstanding Fund credit based on existing and prospective drawings):
    - In millions of SDRs: 287.20 (end-of-period outstanding based on existing and prospective drawings)
    - In millions of U.S. dollars: 389.05
    - In percent of gross international reserves: 8.75 (for 2020, outstanding)
    - In percent of quota: 100.00 (for 2020, outstanding)
- Capacity to repay indicators (Table 6 highlights):
  - Obligations to the Fund from existing and prospective credit, in millions of U.S. dollars: 4.27 (2020); 4.20 (2021); 4.20 (2022); 101.28 (2023); 196.77 (2024); 97.60 (2025) — as presented in the table.
  - Outstanding Fund credit based on existing and prospective drawings (end-of-period), in millions of SDRs: 287.20 (2020, 2021, 2022); 215.40 (2023); 71.80 (2024); 0.00 (2025).
  - Outstanding Fund credit based on existing and prospective drawings (end-of-period), in millions of U.S. dollars: 389.05 (2020, 2021, 2022); 291.79 (2023); 97.26 (2024); 0.00 (2025).

*Source: IMF staff report (El Salvador).*

### Annex I. Public  Debt Sustainability Analysis

### Annex I. Public  Debt Sustainability Analysis

### Overview and headline projections
- Public debt stock (including pensions) was 70.2 percent of GDP at end-2019.
- Pre-pandemic projection: debt drifting to 72 percent of GDP in 2025.
- After the pandemic shock:
  - Debt to GDP ratio expected to jump to about 85 percent of GDP in 2025 under the immediate shock.
  - Under the authorities’ gradual fiscal adjustment (authorities’ commitment scenario): public debt projected to peak in 2020 and decline to 74 percent of GDP in 2025 and 60 percent of GDP in 2030 (target in Fiscal Responsibility Law: public debt of 60 percent of GDP including pensions).
- Gross financing needs:
  - Expected to reach 14 percent of GDP in 2020 after the pandemic shock.
  - Abate to about 8 percent of GDP in 2025 due to reversing temporary measures in 2021 and the medium-term adjustment.
- Financing needs averaging 9 percent of GDP over 2020–25 in the authorities’ commitment scenario, driven by a rise in domestic amortization payments and Eurobond payments in 2023 and 2025.

### Key assumptions
- Debt definition:
  - DSA focuses on gross debt comprising the nonfinancial public sector (NFPS) and the external debt of the central bank.
  - NFPS includes pension-related debt (CIP-A bonds) that finance current public pension payments.
  - Pension liabilities account for 18.9 percent of the total debt stock.
  - NFPS debt definition excludes municipal debt (1½ percent of GDP), pension system’s recognition bonds (CIP-B bonds) and some SOEs debt.
- Macroeconomic outlook and financing composition:
  - Active scenario reflects estimated growth potential of 2½ percent.
  - Inflation expected to remain anchored at about 1¼ percent over the medium term.
  - Interest bill projected to rise over the medium-term reflecting normalizing global financial conditions, widening the interest/growth differential (main driver of public debt dynamics).
  - Scenario assumes financing gaps are filled mainly with long-term loans from private external creditors and short-term domestic bonds.

### Results and drivers of debt dynamics
- Active scenario results:
  - Public debt would jump to 82 percent of GDP in 2020 because of negative economic growth and higher spending due to the pandemic shock.
  - Debt declines to 74 percent of GDP in 2025 and to 60 percent of GDP by 2030 under authorities’ commitments, provided primary fiscal surpluses of 4.0 percent of GDP are maintained after the medium-term.
- Drivers of changes:
  - 2020: negative GDP growth and the interest bill are main contributors to a 10 percentage point jump in the debt-to-GDP ratio, along with temporary deterioration of the overall fiscal balance.
  - Medium-term: interest bill is the major contributor to upward debt dynamics, averaging about 2½ percent of GDP contribution on an annual basis.
  - Primary surpluses and real GDP growth mitigate increases, with annual contributions reducing debt by about 1½ percent of GDP each.

### Stress scenarios, vulnerabilities and stress-test results
- Stress-test assumptions:
  - Mostly standard shock scenarios (declines by one standard deviation of the main variable shocked).
  - Natural disaster shock: decline of GDP growth by 3 percentage points the first year and 2 percentage points the following year.
- Stress-test outcomes:
  - Combined macro-economic shocks could increase debt by about 5 percent of GDP.
  - A natural disaster or contingent liabilities shock could increase debt by about 10 percent of GDP each.
  - Under no fiscal adjustment scenario and shocks, public debt could reach up to 100 percent of GDP.
- Heat-map and indicator assessment:
  - Several standard debt profile characteristics indicate significant risk, especially relating to debt level.
  - Indicators relating to gross financing needs are benign, but the heat-map may understate risks because the measured share of “foreign currency” debt (close to zero) reflects legal adoption of the U.S. dollar, not the implied benefits of issuing own-currency liabilities.
- Additional stress-test specifics (selected scenario outcomes shown in DSA tables/figures):
  - Primary Balance Shock path shows primary balance and effective interest rate movements and corresponding debt trajectories.
  - Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, and Contingent Liability Shock each have distinct projected profiles for debt and public gross financing needs (figures in the DSA present exact year-by-year series).

### Idiosyncratic risks and mitigating factors
- Major risks:
  - Higher primary deficit in 2020.
  - Lower primary surpluses over the medium-term.
  - Failure to reverse temporary 2020 measures.
  - Tightening global financial conditions raising financing costs or higher interest bill and greater financing needs.
  - Market-perception dynamics: EMBI spread more than doubled in recent weeks (described elsewhere in the document).
- Mitigating factors:
  - Long average debt maturity: 12 years for existing debt.
  - Stable investor base: over one-half of the debt is held by domestic pension funds and official creditors.
  - Some limited scope to compress capital spending further to partly offset adverse primary balance shocks.
  - El Salvador uniquely incorporates and reports pension liabilities as part of public debt (almost 19 percent of GDP).

### Policy implications and fiscal commitments (from authorities’ scenario)
- Fiscal consolidation path embedded in authorities’ commitment scenario requires:
  - Maintaining primary fiscal surpluses of 4.0 percent of GDP after the medium-term to reach the 60 percent of GDP debt target by 2030.
  - Reversing temporary 2020 measures in 2021 as part of the medium-term adjustment to reduce gross financing needs and debt trajectory.
- Financing strategy:
  - Fill financing gaps mainly with long-term loans from private external creditors and short-term domestic bonds as assumed in the baseline financing mix.

*Source: IMF staff.*

### 6. In these trying times, we are steadfastly committed not only to maintain the health of all our

### 1slvea2020002 - 6. In these trying times, we are steadfastly committed not only to maintain the health of all our

### Commitments and fiscal policy stance
- Commit to preserve macroeconomic and financial stability, especially fiscal sustainability.
- Commit to strengthen competitiveness by improving the business environment, reduce public debt, combat corruption, and strengthen the financial supervision and regulatory framework, and the governance and AML/CFT frameworks.
- Confident that fiscal operations will be fully financed during 2020.
- If needed, will re-prioritize capital spending plans and postpone lower priority projects not related to anti-pandemic measures.
- Commit to implement a gradual fiscal adjustment of at least 3 percent of GDP in permanent measures over 2021–24.
- Target to achieve a primary fiscal balance of 3½ percent of GDP by end-2024.
- Commit to put debt firmly on a declining path and comply with the Fiscal Responsibility Law and a public debt ratio including pensions of 60 percent of GDP by 2030.
- Intend to maintain a close policy dialogue with the IMF and abstain from adopting measures or policies that would further deteriorate the external and public debt sustainability position.
- Will comply with the Fund’s Articles of Agreement (including provisions related to restrictions on payments and transfers, multiple currency practices, and bilateral payments agreements) and intend to avoid new trade restrictions for balance of payment purposes.

### Safeguards, transparency, and cooperation with IMF
- Stand ready to collaborate with IMF staff in undertaking a safeguards assessment.
- Collaborating with IMF staff to implement a Memorandum of Understanding between the Central Bank of El Salvador and the Ministry of Finance to ensure compliance with the Fund’s Articles of Agreement and with the terms and conditions of the RFI instrument used for budget support.
- Will provide IMF staff with the most recently completed external audit reports of the Central Bank (Banco Central de Reservas El Salvador).
- Intend to accommodate meetings between IMF staff, staff in the Central Bank, and external auditors.
- Authorize the Fund to publish this Letter of Intent for the request for a purchase under the RFI.

### Early public-health measures and response to COVID19
- Early preventive actions to prepare the health system and infrastructure, and to raise social awareness on social distancing, quarantines, and telework.
- Law of Special Regulations for Telework approved by Congress on March 20th.
- Education system temporarily closed starting on March 12th.
- Lockdowns and closing of borders and airports on March 17th, allowing only flow of essential goods.
- Created Contention Centers for incoming travelers to slow progression of the epidemic curve.
- First confirmed case of COVID19 on March 18th.
- By April 7th: 93 confirmed cases, 5 death, and 9 recovered patients.
- 100 Contention Centers set up; have accommodated more than 4,600 incoming travelers.
- Hospitals increased capacity; more nurses and doctors contracted on temporary basis; increased testing capacity.

### Economic and social support measures
- One-off cash transfer of US$300 grant to assist nearly 75 percent of affected households that have lost their income.
- One-time US$150 bonus for health workers and other public workers directly involved in the COVID19 response.
- Payments of utilities, mortgages, consumer loans and credit cards deferred for a three-month period.
- Overall reserve requirements for deposits lowered for a period of 180 days.

### Macroeconomic context and financial sector indicators
- Dollarized economy since 2001.
- Average low inflation of 0.4 percent in the last four years.
- Moderate average fiscal deficit of 2.8 percent (period referenced as the last four years).
- Current account deficit of 2.7 percent (same period).
- Average economic growth of 2.4 percent during the same period.
- Fiscal Responsibility Law approved in 2016 and updated in 2018.
- Debt-to-GDP of 70.2 percent in 2019; pension liabilities approximately 20 percent of GDP are incorporated as part of public debt.
- Foreign-owned banks account for 89.3 percent of the banking system, in terms of total assets.
- In average, 97 of total loans have been financed by domestic deposits during the last four years. 
- NPLs averaged only 1.9 percent of total loans and were adequately provisioned (around 130 percent of NPLs).
- Banks solvency averaged 16.4 percent.
- Credit growth was sound at yearly rates around 5.2 percent during the same four-year period.
- Remittances flows in 2019 accounted for around 21.0 percent of GDP.
- Around 95.0 percent of total remittances are originated in the United States.

### Economic and fiscal effects of the COVID19 shock (forecasts and estimates)
- BCR forecast as of end of March: GDP projected to decline in the range of 2.0 to 4.0 percent in 2020 (from a pre-COVID outlook of around 2.5 percent).
- This projected decline is deeper than the 2009 recession when GDP fell 2.1 percent.
- Fiscal deficit expected to widen temporarily above 8 percent of GDP in 2020.
- Current account deficit expected to reach 4.1 percent of GDP in 2020.
- Preliminary estimates indicate fiscal accounts may suffer:
  - Reduction of around 2 percentual points of GDP in tax revenues.
  - Increase of around 3 percentual points of GDP in expenditures associated with COVID19 and mitigation measures.
- Slowdown in major trading partners will negatively affect current account through impending decline of family remittances and lower external trade.
- Most recent developments in the US and Central American economies indicate the recession may be even deeper.

### Financial accountability and governance measures
- President has called on the International Commission Against Impunity for El Salvador (CICIES) of the OAS to join efforts with the Salvadorian Court of Audits to oversee accountability and transparent use of financial resources allocated to fight COVID19.
- Government committed to transparency and accountability and to using effective mechanisms and controls for disbursement of funds, including through the Recovery Fund.

### Conclusions and outlook
- Authorities confident that policies outlined in the Letter of Intent will enable effective use of the requested disbursement under the RFI.
- Authorities committed to preserve macroeconomic and financial stability, especially fiscal sustainability, and to putting economic growth on a higher trajectory while debt on a downward trajectory over the medium term.
- Committed to resume fiscal consolidation once the disease is contained, building on progress achieved over the last years.

*Statement by Mr. Villar and Mr. Cartagena Guardado on El Salvador, April 14, 2020; Letter of Intent signed by Nelson Fuentes (Minister of Finance) and Nicolas Martínez (Governor of the Central Bank of El Salvador).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1slvea2020002.pdf_