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IMF Executive Board Concludes 2018 Article IV Consultation with El Salvador

May 17, 2018

On May 11, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with El Salvador.[1]

Background

Real GDP grew above potential, at 2.3 percent in 2017, supported by lower oil prices, continued U.S. recovery, and a surge in remittances. However, El Salvador’s growth continues to lag regional peers. Inflation remained low at 1 percent, anchored by dollarization. The current account deficit continued to shrink in line with the region through 2017.  

The authorities’ adjustment efforts have improved the fiscal balance since 2014 and stabilized debt. Higher revenues and expenditure restraint resulted in a primary surplus of 0.9 percent of GDP in 2017. However, the high interest bill led to an overall deficit of 2.5 percent of GDP. Revenues increased partly due to additional taxes on the profits of large firms and telecommunications services. Cash-based primary fiscal expenditure declined in 2015-17, reflecting measures to restrain spending on goods and services, subsidies and, to a smaller extent, limiting the indexation of the wage bill. Capital expenditure declined in 2017 due to weak execution, as well as the political stalemate that affected the approval of project financing. A downward adjustment of nominal GDP, due to the revision of the national accounts, increased the 2017 debt-to-GDP ratio from 63 to 71 percent.

The banking sector appears solid and credit growth is moderate, but sovereign risk concerns and declining margins are affecting the (mostly foreign-owned) banks. The banking system’s capital adequacy ratio (16.6 percent) remains well above the required minimum of 12 percent. The NPL ratio is 2 percent and problem loans are amply provisioned. However, abundant liquidity, including due to the lack of viable investment projects, and a declining net interest spread continue to dent bank profitability. Credit growth is moderate at 6 percent in real terms, but is slightly below the CAPDR average, varying significantly by sector.

In 2018-19, growth is expected to remain above potential at 2.3 percent, reflecting the temporary acceleration of U.S. growth from the recent U.S. tax reform and higher grant-financed investment. The fiscal deficit would further fall to 2.2 percent of GDP in 2018, as savings from the pension reform kick in, but would rise to 2.7 percent of GDP in 2019. The external deficit would increase both in 2018 and 2019 as remittances’ growth moderates while imports expand, and the income balance worsens due to rising interest rates as U.S. monetary policy normalizes. 

Key risks include tighter global financial conditions, due to the normalization of the U.S. monetary policy, and more restrictive U.S. immigration policies. El Salvador is also vulnerable to domestic policy slippages, which could delay the implementation of much needed structural reforms. On the upside, better-than-expected growth in the U.S. would have positive spillovers to the local economy. In addition, promoting regional cooperation, including the customs union with Guatemala and Honduras, could boost trade and economic growth.

Executive Board Assessment [2]

The Directors welcomed the continued economic recovery in El Salvador and the recent improvement of the public debt dynamics. However, they noted that potential growth continues to be lower than desirable, the debt level remains high, and large financing gaps are projected for 2019 and beyond. Against this background, Directors emphasized the need for further fiscal consolidation, strengthening the financial sector, and implementing far‑reaching structural reforms to improve the business environment and support formal employment.

Directors commended the authorities for the progress achieved in improving the political dialogue between parties on key policy issues. They welcomed the substantial fiscal adjustment efforts, which contributed to a reduction in the deficit and stabilization of debt. However, Directors considered that further fiscal consolidation is needed due to high medium‑term gross financing needs, the risk of global financial shocks, and of higher global interest rates. While a number of Directors favored a front‑loaded adjustment to put debt on a firm declining trajectory, a number of others saw scope for a more gradual approach given the possible impact on growth and the need for a broad political consensus.

Directors welcomed the new pension reform, which reduces medium‑term fiscal pressures and contributes to lowering the fiscal deficit. They saw merit in further strengthening the sustainability of the pension system by increasing the retirement age, while simultaneously allowing for improvement in benefits coverage for the poor.

Directors were encouraged by the authorities’ efforts to improve the business environment and competitiveness, as reflected in the significant jump in the country’s ranking in the 2018 World Bank’s Doing Business report. They welcomed the implementation of the country’s productive transformation plan, and noted that supporting growth requires continued efforts on structural reforms to foster investment and formal job creation. Private investment can be bolstered by reducing red‑tape and bureaucracy, and by fighting crime, while public investment can be increased by addressing weaknesses in planning, execution and monitoring of investment projects. Directors welcomed the progress made in the implementation of the “El Salvador Seguro” plan to reduce crime, and the ongoing adherence to the customs union with Guatemala and Honduras.

Directors noted that El Salvador’s banking system is well capitalized and very liquid. Recent credit growth to the productive sectors has been encouraging, but further room for healthy credit expansion remains. Directors acknowledged the recent progress made in risk‑based and cross‑border supervision, and the approval in 2017 of the reforms to the law on financial inclusion. To further improve the resilience of the banking sector, they encouraged the authorities to accelerate the adoption of the crisis management and bank resolution draft law, to strengthen the financing of the lender of last resort facilities, and to create a bank liquidity fund. Directors encouraged continued efforts to strengthen the AML/CFT framework.

Directors commended the authorities for the publication of the revised national accounts in March 2018, which improves substantially the quality and the transparency of the national accounts statistics.

El Salvador: Selected Economic Indicators

I.  Social Indicators

Rank in UNDP Development Index 2015 (of 188)

117

    Population (million, 2016)

6.3

Per capita income (U.S. dollars, 2016)

4,224

    Life expectancy at birth in years (2015)

73

Percent of pop. below poverty line (2016)

33

    Infant mortality (per 1,000 live births, 2016)

13

Gini index (2015)

41

    Primary education completion rate (percent, 2015)

100

II.  Economic Indicators (percent of GDP, unless otherwise indicated)

 

Est.

Proj.

 

 2011

2012

2013

2014

2015 2/

2016 2/

2017

2018

Income and prices

               

Real GDP growth (percent)

3.8

2.8

2.4

2.0

2.4

2.6

2.3

2.3

Consumer price inflation (average, percent)

5.1

1.7

0.8

1.1

-0.7

0.6

1.0

1.8

GDP deflator (percent)

5.9

2.5

0.4

0.8

0.2

0.6

1.4

2.3

Terms of trade, percent change

-2.5

0.5

-1.6

3.3

12.4

-2.9

0.0

0.3

Real effective exchange rate (+ = appreciation)

1.7

-1.5

-0.9

2.8

5.5

-1.2

-0.5

External sovereign bond spread (basis points)

374

448

378

400

497

600

520

Money and credit

               

Credit to the private sector

45.3

44.8

47.1

48.9

50.1

51.1

51.7

51.9

Broad money

49.7

48.1

47.9

46.8

48.5

48.5

51.7

51.7

Interest rate (time deposits, percent)

1.8

2.5

3.4

3.8

4.2

4.4

4.4

External sector

               

Current account balance 5/

-5.5

-6.0

-7.2

-5.4

-4.0

-2.2

-2.5

-3.5

Trade balance

-23.5

-23.0

-24.1

-23.0

-21.6

-19.4

-19.5

-20.5

   Exports (f.o.b. excluding maquila)

20.9

19.8

19.7

18.8

18.9

17.5

18.3

18.3

   Imports (f.o.b. excluding maquila)

-44.4

-42.8

-43.8

-41.9

-40.5

-36.9

-37.9

-38.7

Services and income (net)

-0.8

-1.7

-1.7

-1.1

-1.2

-2.0

-3.3

-3.4

Transfers (net)

18.9

18.7

18.6

18.7

18.8

19.1

20.3

20.3

Foreign direct investment

1.1

2.3

0.8

1.4

1.7

1.6

1.3

1.3

Gross international reserves (millions of U.S. dollars)

2,503

3,175

2,745

2,693

2,787

3,238

3,671

3,799

Nonfinancial public sector

               

Overall balance 2/

-4.5

-4.3

-4.5

-3.9

-3.8

-3.4

-2.5

-2.2

Primary balance 2/

-1.9

-1.8

-1.8

-1.2

-1.0

-0.3

0.9

1.4

Of which: tax revenue

15.7

16.1

17.0

16.7

16.9

17.4

17.8

17.9

Public sector debt 2/ 3/

59.5

63.8

63.8

65.6

67.6

69.5

70.6

70.1

National savings and investment

               

Gross domestic investment

17.8

17.8

17.2

16.4

15.6

15.1

16.9

15.7

Public sector 4/

2.2

2.6

2.5

2.2

2.2

2.2

2.2

2.5

Private sector 4/

14.1

14.0

15.1

13.4

13.4

13.2

13.3

13.2

National savings

12.3

11.8

10.0

11.0

11.6

12.9

14.4

12.2

Public sector

-2.2

-1.3

-1.3

-1.0

-1.0

-0.2

0.4

0.7

Private sector

14.5

13.1

11.3

12.1

12.6

13.0

14.0

11.5

Net foreign assets of the financial system

               

Millions of U.S. dollars

2,811

3,229

2,473

2,211

1,931

2,013

2,678

2,937

Percent of deposits

28.8

32.6

24.0

21.6

17.8

18.0

21.8

23.0

Memorandum items:

               

Nominal GDP (billions of U.S. dollars)

20.3

21.4

22.0

22.6

23.2

23.9

24.8

26.0

Sources: Central Reserve Bank of El Salvador, Ministry of Finance, and Fund staff estimates. 

1/ The data reflects the discussions during the mission on February 2018, with the exception of the national accounts numbers, which were updated with the revised statistics published on March 23, 2018.

2/ Excludes impact of the pension reform on fiscal accounts, which may reduce the fiscal deficit by up to 0.8 percent of GDP starting from 2018, but net impact on the deficit could be smaller depending on the accounting treatment of new changes to the pension system that is under discussion. 

3/ Includes gross debt of the nonfinancial public sector and external debt of the central bank.

4/ Fixed capital formation; disaggregation of inventories into public and private not available.

5/ The assessment is based on data as of February 2018 provided to the team during the mission. The most recent data indicate that the current account deficit declined to 2 percent of GDP in 2017. 

 

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

IMF Communications Department
MEDIA RELATIONS

PRESS OFFICER: Raphael Anspach

Phone: +1 202 623-7100Email: MEDIA@IMF.org

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