Global context weighs on activity

The country’s growth has been strongly affected by the deterioration of the global economic environment. The rise in commodity prices and the slowdown in the United States, the country’s leading trading partner and provider of remittances, are holding back activity. Although less dynamic, remittances (24% of GDP in 2020) should remain the primary source of household income thanks to a still-low unemployment rate in the United States. However, they will not be able to compensate for the loss of purchasing power caused by the rise in inflation. As a result, the momentum of private consumption, the main pillar of the recovery from the pandemic, is likely to falter. In a dollarized economy, the central bank lacks the tools to fight inflation, favoring fiscal instruments such as lower fuel taxes and import tariffs on commodities. This drop in revenue is expected to deal a further blow to public consumption, which is already constrained by financing difficulties and weak budget execution (only 60% of the public investments planned for 2021 were carried out during the year). Private investment will need more investor confidence in government policies, especially after the much-criticized passage of the Bitcoin law in September 2021 and strained relations with the United States. In the maquilas (textiles, apparel, electronics), the main destinations of these investments, rising input costs will weigh on production. The construction sector will be the most affected by this rise in production costs. The agricultural industry, for its part, will remain primarily exposed and not very resilient to climate risks.

Weak public accounts and current account

El Salvador’s debt was already far higher than its neighbors. Still, the pandemic and the war in Ukraine have only increased the difference, compounded by investors’ doubts about the government’s fiscal policy, which has increased the interest burden. Measures implemented to minimize the inflationary impact of the Russia-Ukraine war are expected to widen the government deficit, despite the planned reduction in the 2022 budget. The price of the shortest maturity bonds issued by the government has reached record lows, with interest rates reaching 23% in September 2021 and estimated to reach 30% in May 2022 if another issue is made. To circumvent this constraint, the government has considered issuing bonds in bitcoin. Scheduled for March 2022, the issue was postponed (without another date announced) in the face of the fall in the price of digital currency since the beginning of the year. Strongly criticized by international organizations, adopting bitcoin as a second official currency is blocking negotiations with the IMF to obtain an Extended Credit Facility of USD 1.3 billion that could refinance part of the debt at lower interest rates. The increased tensions with the United States could also affect funding from other multilateral organizations (World Bank, CABEI). In this context, there is a risk of financing from the central bank’s foreign exchange reserves, which were used to finance part of the aid to the population during the pandemic. Without an agreement with the IMF, the possibility of a default on the bonds maturing in 2023 cannot be ruled out.

Regarding the external accounts, the current account deficit is expected to widen. The balance of goods deficit will widen due to weaker export dynamics, affected by the slowdown in U.S. demand, especially for textiles, plastics, and rubber. The import bill is expected to increase considerably as the cost of raw materials and manufacturing inputs rises. Expatriate remittances will only limit the widening of the current account deficit. Foreign direct investment will not offset this deficit, which will remain sluggish. This will weigh on the already weakened foreign exchange reserves, which covered just under two months of imports in May 2022. Adopting bitcoin as an official currency alongside the dollar also poses a risk to these reserves, with the need to ensure its convertibility into dollars.

Clashes between branches of power end, but increased external tensions

Since his election to the presidency in February 2019, former outsider Nayib Bukele has enjoyed widespread popularity among the population thanks to populist rhetoric focused on security. His newly formed party, Nuevas Ideas, won a large majority in the February 2020 elections with 56 out of 84 seats, plus the five seats held by the allied party Gran Alianza por la Unidad Nacional. This victory for the presidential party ended the confrontation between the president and the parliament after high tensions in 2019. However, growing voices denounce the president's stranglehold on the various branches of power. The Assembly’s vote to dismiss the Supreme Court justices and replace them with officials closer to the executive branch in May 2021 and the proposed constitutional reform in September 2021 are essential points of criticism. These were echoed by the Biden administration, which introduced sanctions in September 2021 against certain officials deemed undermining democracy. The Bukele administration’s support to Russia in the Russia-Ukraine war has only increased these tensions. In this context, a rapprochement with China was undertaken in May 2021 with a bilateral cooperation agreement, including investments of up to USD 500 million.