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 and the EU
- Financial support from multilateral institutions
- Growing population
- High level of criminality and insecurity associated with drug trafficking
- Lack of natural resources
- Climatic and seismic vulnerability
- Inadequate infrastructures and investment
- Dependence on the United States (47% of exports, 90% of remittances and FDI)
- Structural fragility of public and external accounts
- Significant inequality and poverty
In 2018, Salvador’s growth is expected to be the weakest among the countries of Central America. Activity will likely continue to be hit by lackluster US growth, to which the Salvadorian economy is strongly correlated. In addition, low levels of national savings and credit growth, as well as the ongoing restrictive fiscal policy, will impede growth, especially as the positive impact of the exceptional 2017 harvests dissipates. Despite this, agriculture, like the textile industry, will continue to be one of the key growth sectors.
Private investment is set to be hit by high crime levels and weak household purchasing power. Added to this are structural weaknesses (small size of the market, income inequalities, poor natural resources, corruption), which will further weaken the country’s attractiveness as an investment destination, especially compared to neighbors such as Costa Rica. Moreover, the profitability of small businesses in El Salvador suffers from gang extortion rackets, which reduces their profits and ability to invest.
Consumption, the country’s main growth engine, also suffers from the high crime rates and will be hit by rising inflation despite the stability of oil prices. Finally, the country is one of the four countries in Latin America that is the most vulnerable to climate and earthquake shocks, but low rates of investment undermine the ability to build the infrastructures needed to limit the consequences.
Worsening Fiscal Position
Given the modest growth and low levels of investment, the government’s ability to mobilize tax instruments so as to increase revenues is limited. Moreover, political differences between President Salvador Sánchez Cerén’s government (FMLN, on the left) and the National Assembly, dominated by ARENA (Alianza Republicana Nacionalista, on the right) are blocking the reforms needed to reduce the deficit, which is set to further deteriorate in 2018. Budget spending cuts are likely to remain limited, as almost half of the budget is devoted to social programs and pensions, which are cherished by the population. The legislative paralysis prevented the government from obtaining the revenues needed to pay the due sums for local pension funds (USD 57 million) in April 2017, resulting in the country’s first default in over twenty years. Payment was eventually made, but the growing tension between the two political parties is increasing the risks associated with servicing the public debt in 2018. With a deal between the FMLN and ARENA looking unlikely, and with external funding still limited, the country’s financial situation will remain precarious. The persistence of the deficit is a factor in pushing the public debt to above 60% of GDP – a worrying level for a dollarized economy.
The current account deficit, which widened in 2017, is not expected to improve significantly. Dependent on the health of the US economy (48.2% of exports), exports will grow less rapidly than imports. Imports will likely continue to rise, notably with the progression, though moderate, of oil prices. The trade deficit should, therefore, remain substantial (19% of GDP). The trade deficit will continue to be hit by weak FDI, with foreign investors remaining wary of the high crime rate. By contrast, remittances from the Salvadorian diaspora, particularly from the United States, are expected to remain at high levels (18% of GDP).
Legislative and Structural Difficulties
President Cerén, who is expected to remain in power until June 2019, cannot rely on a majority in the National Assembly, which is dominated by the opposition. His popularity is falling, giving rise to fears that he may be defeated at the parliamentary elections planned for March 2018, as urgent reforms will be needed if poverty and criminality rates are to be reduced in a context of weak growth.
Homicides linked to gangs are declining, notably thanks to the extraordinary measures introduced in 2016 and extended in February 2017 until 2018 (state of emergency declared in seven prisons where gang members are concentrated, deployment of the army in rural areas). Two of the large gangs (MS-13 and Barrio 18) have expressed their willingness to begin negotiations with the government, which has so far refused to engage. Salvador is still the world’s most violent country not at war, and the business climate is therefore strongly degraded.
Even though the FMLN has historical links with the radical left-wing regimes in the region, the president is careful to maintain good relations with the United States, the country’s leading trading partner.