El Salvador: Risk Assessment
Country Risk Rating
Business Climate Rating
- Relative economic diversification
- Free trade agreements with Central America and the United States (CAFTA-DR), as well as with Mexico, the EU, and South Korea, and member of the customs union with Guatemala and Honduras
- Strong demographics
- High crime and insecurity linked to drug trafficking
- Lack of natural resources
- Climate and seismic vulnerability
- Inadequate infrastructure and investment
- Dependence on the United States (number-one destination for exports and main source of expatriate remittances)
- Structural fragility of public and external accounts
- Significant inequality and poverty
Return to long-term growth that is both structurally constrained and dependent on the U.S.
El Salvador’s growth will remain heavily dependent on economic activity in the country’s main trading partner and source of migration remittances, namely the United States. External demand is expected to drive net exports, particularly of electronic chips, agricultural products, and textiles. Expatriate remittances, 95% of which come from the United States, should remain extremely strong after hitting new records in 2021. This strength is due to a drop in unemployment among the U.S. Latino population (6.4% in August 2021 against 5.2% for the general population) and the maintenance of Temporary Protected Status for some U.S.-based expatriates until December 2022. These remittances (24% of GDP in 2020) will benefit household consumption, which is the mainstay of growth in domestic demand. Inflation is expected to slow as commodity prices and the oil bill stabilize. However, the adoption of bitcoin as a second official currency alongside the dollar could lead to some price volatility and affect household incomes. Public investment is expected to remain constrained by public financing difficulties and weak budget execution (just 12.8% of public spending planned for 2021 in the first half of the year), despite the plans in the 2022 budget. Private investment will suffer from a lack of investor confidence in government policy, especially after the much-criticized implementation of the Bitcoin law in September 2021, and strained relations with the United States. The agricultural sector is expected to benefit from higher sugar prices because of the drought in Brazil, one of the world's leading producers. Manufacturing activity should be boosted by growth in the maquila sector, which will benefit from increased external demand for electronics, textiles, and clothing.
Weak public accounts and current account
El Salvador's debt was already well above the level of its neighbors, and the pandemic has only exacerbated the difference. The situation has been further accentuated by investors' doubts about the government's fiscal policy, which have increased the interest burden. Under the 2022 budget, the deficit is forecast to decrease, but it will still be partly financed by commercial debt, while interest rates on government bonds reached the record high of 23% on the shortest maturities. The adoption of bitcoin will strain the public accounts through the expenditure needed to make the system work. Strongly criticized by international organizations, the decision to adopt bitcoin is affecting negotiations with the IMF to obtain an Extended Credit Facility of USD 1.3 billion and to refinance part of the debt at lower interest rates. Some of the necessary financings should again come from other multilateral organizations (World Bank, CABEI), but tensions with the United States could make it more difficult to obtain other loans. In this context, there is a risk that the central bank's foreign exchange reserves, which were used to finance part of the aid during the pandemic, could again be drawn on to provide financing.
In terms of the external accounts, the current account deficit is expected to narrow thanks to a U.S.-demand-driven rebound in exports of textiles, plastic and rubber goods, and agricultural products (sugar, coffee). Imports are set to weaken with slower activity (particularly capital goods). Continued strong remittances from expatriates should also help to reduce the current account deficit. However, the deficit will remain substantial and will not be offset by foreign direct investment, which will continue to be skittish. This will strain the already weakened foreign exchange reserves (-19% between June 2020 and 2021), which stood at a little over two months of imports in August 2021. The adoption of bitcoin as an official currency alongside the dollar also poses a risk to these reserves, with the need to ensure the convertibility of bitcoin into dollars.
End of the showdown between the country’s branches of power, but increased external tensions
Since he was elected president in February 2019, former outsider Nayib Bukele has enjoyed widespread popularity thanks to a populist discourse focused on security. His newly formed party, Nuevas Ideas, won a large majority in the February 2020 elections, taking 56 out of 84 seats, plus the five seats held by the allied party Gran Alianza por la Unidad Nacional. This victory of the presidential party ended the confrontation between the president and parliament after severe tensions during 2019. However, growing voices are denouncing the president's stranglehold on the various branches of power, with much of the criticism focusing on the Assembly's vote to dismiss Supreme Court judges and replace them with officials closer to the executive in May 2021, as well as the proposed constitutional reform in September 2021. The Biden administration has taken up these concerns and introduced sanctions in September 2021 against certain officials. Against this backdrop, El Salvador is building a new relationship with China and signed a bilateral cooperation deal including investments of USD 500 million in May 2021.