El Salvador: Risk Assessment

Country Rating¹

Rating: B

Business Climate Rating¹

Rating: B

Risk Assessment²

Weaker growth than in other regional countries . . .
Salvador recovered from recession in 2010 and recorded moderate growth. Transfers from expatriate workers in the United States (where 2.5 million Salvadorians reside) increased in volume but failed to return to their pre-crisis levels, and domestic demand remained circumspect. Exports also rebounded but not as strongly as imports with net foreign demand thus making a negative contribution to growth. In 2011, the pace of economic activity will be limited by the deceleration of growth in the United States, on which Salvador is very dependent in terms of exports, investments and transfers of income. The industrial sector and especially the maquiladoras could thus perform below expectations. The government will nonetheless attempt to support the economy by pursuing social policy focused on providing support for underprivileged population segments and by increasing public investment spending. Inflation is expected to remain limited due to the softness of domestic demand and thanks to the macroeconomic stability attributable to the dollarization of the economy.

And large external financing needs in 2011
Salvador is burdened with high public sector debt that justifies the fiscal consolidation strategy undertaken under IMF auspices early 2010: The three-year $790 million standby agreement will result in efforts to reduce the public deficit by at least 1% of GDP in 2011, focused mainly on controlling spending and gradually phasing out energy subsidies (particularly as regards gas and electricity). The consolidation process will moreover enable a strengthening of the official dollarization of the economy. The $600-million Eurobond that will reach maturity in the 2011 second half will nonetheless give rise, in conjunction with the current account deficit, to substantial external financing needs. The government could turn to the international markets to refinance the sovereign debt, provided the two-thirds majority required in parliament is assembled. Success in refinancing the debt could then provide a useful reference point for actors in the private sector. Although the Salvadorian banking sector is adequately capitalized and liquid, supervision remains insufficient.

Power without real room for maneuver
The task of President Mauricio Funes, adherent of a pragmatic left, and of his government is complicated by the lack of a parliamentary majority. The opposition of the rightwing Arena Party, which had been in power for 17 years, and the need to form alliances make politics difficult, while the approach of the legislative and local elections scheduled in January 2012 could result in a deadlock of the political scene. The government's social program is nonetheless unlikely to be in jeopardy, particularly as regards education and health issues. President Funes has given priority to combating poverty with a view to reducing insecurity and violence. These two endemic scourges have been a deterrent to investors and responsible for a sharp drop in FDI inflows in past years.

Strengths

• Relative economic diversification (predominance of services and industry -via the maquilas- compared to agriculture and coffee cultivation)
• Dollarized economy since 2001
• Prudent economic policy; working with the IMF
• Free-trade agreements with Central America and the United States (CAFTA-DR), as well as with Mexico, Panama and Chile

Weaknesses

• Small in size and vulnerable to external shocks
• Significant social inequalities and poverty
• High level of insecurity, linked notably to the existence of very violent youth gangs (maras)
• Large foreign debt