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El Salvador: Staff Concluding Statement of the 2023 Article IV Mission
February 10, 2023
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IMF Communications Department
MEDIA RELATIONS
PRESS OFFICER: Randa Elnagar
Phone: +1 202 623-7100Email: MEDIA@IMF.org
February 10, 2023
PRESS OFFICER: Randa Elnagar
Phone: +1 202 623-7100Email: MEDIA@IMF.org
Washington, DC: An International Monetary Fund (IMF) mission, led by Mr. Raphael Espinoza, conducted virtual discussions during January 26-27, and visited San Salvador during January 30-February 8 for the 2023 Article IV consultation. At the end of the visit, the mission issued the following statement:
Economic Developments, Outlook and Risks
Policies to strengthen medium-term growth are a cornerstone of the government’s economic plan. Reforms to raise the growth potential are being implemented aimed at improving security (Plan Control Territorial), diversifying the economy (e.g., by promoting tourism through Surf City), reducing trade costs, and shortening the time needed to perform administrative tasks . Spending on education has risen (from 3.6 to 5.0 percent of GDP between 2019 and 2022) and efforts are underway to develop citizens’ digital skills by partnering with fintech firms. The positive and sustainable impact of these reforms hinges on efforts to strengthen macroeconomic stability.
Despite adverse shocks, the Salvadorean economy grew at a robust pace last year. The economy is estimated to have expanded by 2.8 percent in 2022, driven by domestic demand. The full recovery of activity from pre-pandemic levels was driven by the effective government response to the health crisis. Since March 2022, the unprecedented reduction in crime, and strong remittances and tourism revenues have contributed to the robust activity and investment dynamics. Meanwhile, annual average inflation reached 7.2 percent last year.
However, vulnerabilities have mounted in 2022 . The current account deficit is estimated to have risen to about 8 percent of GDP, on account of weaker terms of trade and import volume growth. While the overall fiscal deficit narrowed to about 2.5 percent of GDP, international reserves fell to around 2 months of imports, and the stock of short-term domestic debt stands at 8¾ percent of GDP. With the payment of a Eurobond in January 2023, EMBI spreads have continued dropping, but the Treasury still lacks access to international capital markets.
Under the baseline, growth is projected to moderate and macroeconomic imbalances will remain. Real GDP is projected to grow by 2.4 percent in 2023, above historical average, driven by private consumption, public investment and tourism, with average annual inflation moderating to 4.1 percent, on account of weaker global commodity prices. Improved terms of trade are expected to support some narrowing of the current account deficit this year, although it will remain high at 5.4 percent of GDP, and fiscal policy will be expansionary. Under a baseline without market access, short-term government debt is expected to grow, preventing the restoration of adequate reserve buffers.
In this context, risks to the outlook are high and tilted to the downside. On the external front, a pronounced slowdown in the United States could undermine exports and remittances, especially if the U.S. labor market cools. A drop in net private capital inflows could force a sharper correction of the current account, with negative implications for growth. On the domestic side, policy slippages could weaken investor confidence, and liquidity shocks could dampen private sector credit and growth. Shocks due to climate change and other natural disasters cannot be discarded. On the upside, the improvement in the security situation could lead to a stronger-than-anticipated boost to private investment and growth, reduce emigration, and encourage the return of migrants.
Fiscal Policy
Developing a comprehensive and ambitious fiscal and financing plan aimed at bringing debt back to a sustainable path and at facilitating international capital market access is the top priority. Public debt has fallen to 77 percent in 2022, but it remains high and is on an unsustainable path. However, efforts must continue to achieve its sustainability in the medium term. Against this backdrop, a growth-friendly and inclusive fiscal consolidation is needed, backed by structurally-sound measures amounting to around 3½ percent of GDP over the next three years, that boosts market confidence and protects priority social and infrastructure spending. The consolidation will need to be complemented with a comprehensive financing plan that gradually rebuilds reserve buffers, avoids overreliance on short-term domestic debt, and returns to international capital markets at lower costs over the medium term.
Starting this year, further efforts are needed in developing a balanced and well-articulated set of measures to support consolidation. While the approved 2023 budget keeps spending unchanged in real terms, more is needed to address financing constraints, in the context of projected declines in revenues. Key areas of focus include:
Financial Sector Issues
The banking sector remains healthy, but timely measures are required to rebuild financial stability buffers. With most COVID-based forbearance measures lifted, bank solvency and asset quality have proven resilient, with NPLs at 1.8 percent. However, and in the context of financial constraints, reserve requirements have been halved since 2019, and system-wide liquidity buffers have decreased. As a result, banks’ exposure to the government has risen, reaching 11.1 percent of total bank assets. The proposed fiscal consolidation and financing plan, along with regulatory reforms restoring reserve requirements to at least 15 percent of deposits would strengthen bank liquidity buffers without undermining private credit. These should be complemented by approval of the Financial Stability Bill, efforts to recapitalize the central bank, and an overhaul of the legal framework for cooperative banks. The central bank payments infrastructure (Transfer 365) is rapidly improving retail payments with high potential for financial inclusion.
Bitcoin’s risks should be addressed. While risks have not materialized due to the limited Bitcoin use so far—as suggested by survey and remittances data—its use could grow given its legal tender status and new legislative reforms to encourage the use of crypto assets, including tokenized bonds (Digital Assets Law). In this context, underlying risks to financial integrity and stability, fiscal sustainability, and consumer protection persist, and the recommendations of the 2021 Article IV remain valid. Greater transparency over the government's transactions in Bitcoin and the financial situation of the state-owned Bitcoin-wallet ( Chivo) remains essential, especially to assess the underlying fiscal contingencies and counterparty risks.
Financing purchases of Bitcoin by issuing tokenized securities should be eschewed because of fiscal risks. Given the legal risks, fiscal fragility and largely speculative nature of crypto markets, the authorities should reconsider their plans to expand government exposures to Bitcoin, including by issuing tokenized bonds. The use of proceeds by the new Bitcoin Fund Management should follow regular expenditure controls and good governance practices. The guarantees given by new Digital Asset Law should be equivalent to those from traditional securities regulations.
Governance Issues
Strong governance, fiscal transparency, and accountability are critical to improve resource management, lower borrowing costs, and build trust.
The mission thanks the authorities and other counterparts for their hospitality, constructive policy dialogue, and productive collaboration.
