El Salvador's Comeback Constrained by Increased Risks

IMF News, February 16, 2022

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El Salvador's Comeback Constrained by Increased Risks

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• Published: February 16, 2022

Economic rebound and near-term projections

• After a sharp decline in 2020, the IMF team expects the economy to grow by around 10 percent of GDP in 2021, and 3.2 percent in 2022.
• The rebound reflects:
  • A pick-up in external demand.
  • El Salvador’s pandemic response: one of the lowest reported rates of COVID-19 infections and fatalities in the region and a relatively high vaccination rate.
  • Strong remittance inflows: about one-fifth of the population is living in the US and remittances were more than 25 percent of GDP in 2021.
• US real GDP growth is an important growth driver because of the large Salvadoran diaspora.

Medium-term outlook and constraints

• The IMF team expects medium-term growth rates in El Salvador to decline to around 2 percent as policy stimulus in the US wanes.
• Key constraint: El Salvador’s increase in public debt will constrain medium-term growth prospects given the risks associated with high and growing financing needs.
• Drivers of the constraint:
  • Persistent budget deficits and continuous expansionary fiscal policies during a strong economy have resulted in a rapidly growing public debt-to-GDP ratio.
  • Higher borrowing costs demand more budget resources to service debt, crowding out private investment and limiting resources for social and infrastructure spending.
• Consequences if unchecked:
  • Public debt will continue to grow.
  • Reduced fiscal space for the authorities’ social and inclusive growth agenda.
  • Increasingly difficult policy choices and elevated risks.

Fiscal policy recommendation

• The IMF recommends a permanent reduction in the fiscal deficit (the difference between government revenue and spending), to be implemented over a 3-year period.
• Expected effect: put the debt-to-GDP ratio on a firm downward trend and create fiscal space to finance development needs and support higher long-term private investment.
• Additional recommended actions: measures to support the vulnerable, improvements to governance frameworks, and efforts to minimize risks from Bitcoin to ensure higher growth and macroeconomic stability.

Risks and policy options related to Bitcoin and digital payments

• IMF view: Digital means of payment such as Chivo (government e-wallet) can promote financial inclusion, especially if used in US dollars. However, using Bitcoin as legal tender entails large risks; the IMF does not recommend it. In the short-term, the costs and risks largely outweigh the benefits.
• Identified risk categories and concerns:
  • Financial stability:
  • Banks and other financial institutions could be exposed to massive fluctuations in crypto-asset prices.
  • Banks will need new prudential rules, such as capital and liquidity requirements, to fully hedge Bitcoin exposures or ban deposits in Bitcoins.
  • Because the payments ecosystem is highly concentrated in Chivo, strengthening its regulation and supervision is recommended.
  • Financial integrity:
  • Crypto assets could facilitate illicit money, terrorism financing, and tax evasion due to anonymity.
  • Theft or cybercriminal activity could jeopardize system stability and relationships with foreign countries and correspondent banks.
  • Anti-money laundering and combating the financing of terrorism requirements are not uniformly implemented; much is left to the discretion of Bitcoin-service providers.
  • International standards for virtual asset providers are needed; IMF recommends more intense and uniform regulation for all entities.
  • Consumer protection:
  • Households and businesses holding Bitcoin balances could lose wealth through large swings in value; cybercrime and theft are additional risks.
  • With a quarter of the population already living in poverty, Chivo’s use should not lead to further destitution.
  • Recommended measures:
  • (i) Strengthen legal requirements for e-wallets, particularly Chivo, to fully safeguard users' funds (in both Bitcoins and US dollars).
  • (ii) Set legal limits on Bitcoin transactions and holdings.
  • (iii) Boost the consumer protection framework with stricter transparency requirements, higher institutional involvement, and clearer disclosure of Bitcoin use and the risks it carries due to price volatility.
  • Contingent fiscal liabilities:
  • Adoption of Bitcoin as legal tender is fully funded by public money through a trust fund.
  • If the price of Bitcoin were to plummet, the trust could be rapidly depleted.
  • To guarantee convertibility between Bitcoin and the US dollar, the government would need to fund the trust through additional resources or the issuance of debt.

Policy options to restore market confidence

• The IMF has proposed policy options aimed to:
  • Restore confidence of the market.
  • Ensure sufficient resources to service the country’s debt.
  • Finance large development needs.
• Urgent and decisive policy action is emphasized to avoid compounding future policy difficulties and risks.

El Salvador Country Team

• Alina Carare — Deputy Division Chief in the Western Hemisphere Department
• Jaime Ponce — Senior Financial Expert in the Monetary and Capital Markets Department
• Javier Kapsoli — Senior Economist in the Western Hemisphere Department
• Juan Francisco Yépez — Economist in the Western Hemisphere Department
• Justin Lesniak — Research Assistant in the Western Hemisphere Department
• Laura Doherty — Senior Economist in the Fiscal Affairs Department
• Lorena Rivero del Paso — Technical Assistance Advisor in the Fiscal Affairs Department
• Yorbol Yakhshilikov — Economist in the Western Hemisphere Department

By the El Salvador country team, IMF Western Hemisphere Department; February 16, 2022.

References

• https://www.imf.org/en/News/country-focus
• PRESS CENTER
• https://www.imf.org/en/publications/weo
• Global Economy in Crosscurrents of War and Technology
• https://www.imf.org/en/publications/gfsr
• Global Financial Markets Confront the War in the Middle East and Amplification Risks
• https://www.imf.org/en/publications/fm
• Fiscal Policy under Pressure: High Debt, Rising Risks
• https://www.imf.org/en/publications/reo
• Asia and Pacific
• Europe
• Middle East and Central Asia
• Sub-Saharan Africa
• Western Hemisphere
• https://www.imf.org/en/publications/areb
• Getting to Growth in an Age of Uncertainty
• More Publications
• Read the Article IV
• The IMF and El Salvador
• Crypto-assets as National Currency? A Step Too Far
• anti-money laundering and combating the financing of terrorism
• https://www.imf.org/en/home