Economic Studies
El Salvador

El Salvador

Population 6.5 million
GDP per capita 4,408 US$
D
Country risk assessment
B
Business Climate
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Synthesis

major macro economic indicators

  2020 2021 2022 (e) 2023 (f)
GDP growth (%) -8.2 10.3 2.8 2.4
Inflation (yearly average, %) -0.4 3.5 7.2 4.1
Budget balance (% GDP) -4.0 -4.4 -5.2 -5.4
Current account balance (% GDP) 0.8 -5.1 -6.1 -6.0
Public debt (% GDP) 89.4 82.4 80.3 81.3

(e): Estimate (f): Forecast

STRENGTHS

  • Relative economic diversification
  • Free trade agreements with Central America, the United States, Mexico, the European Union, Guatemala, Honduras, and South Korea
  • High population density

WEAKNESSES

  • High crime and insecurity linked to drug trafficking
  • Climatic (high exposure of the agricultural sector) and seismic vulnerability
  • Inadequate infrastructure and investment
  • Dependence on the US for investment, trade and remittances.
  • Lack of independent monetary policy (USD is the primary official currency)
  • Structural fragility of public and external accounts
  • High inequality and poverty
  • The introduction of Bitcoin as a second legal tender in 2021 has shaken market and investor confidence

Risk assessment

The global slowdown and public finances will weigh on activity

Despite the rise in commodity prices and the slowdown in activity in the United States, the main trading partner and remittances provider (24% of GDP in 2022), growth has proven resilient, on remittances inflows and higher tourism revenues. In 2023, activity is expected to weaken, constrained by sluggish growth in the US economy. The fall in remittances (91% of rebates came from the United States in 2019) will weigh on household consumption, already squeezed by high inflation, despite subsidies on fuel prices. In addition, the weakening of North American demand should weigh on exports (30% of GDP in 2019), starting with the textile and clothing sector, which accounts for about a quarter of exported goods. The strong pressure on the fiscal situation will reduce public spending capacity, limiting the contribution of public consumption. With the uncertainty surrounding the authorities' ability to cover its debt payments very high, investment, both public and private, is likely to be held back. The perception of the business environment, particularly due to crime and corruption, could deter private investment in maquilas and the construction sector. The controversial adoption of Bitcoin as a second legal tender in 2021 and increased tensions with the US administration may also discourage investment.

 

High sovereign risk

The budget deficit narrowed in 2022, as revenue growth kept picking-up after the hit from the COVID-19 pandemic. In 2023, in a context of difficult access to external financing, the public deficit should widen. The economic slowdown is notably expected to weigh on tax revenue collection. In addition, lower fuel taxes and lower import duties on some commodities will continue, reducing revenue collection. Expenditure are also expected to increase, notably with higher debt servicing cost (about 18% of public expenditure is allocated to debt servicing; more than 5% of GDP in 2023). Spending on security is also projected to rise as authorities step up the fight against gang violence. The adoption at the end of 2022 of the pension reform, which will increase pension benefits by 30%, is also likely to contribute to widen the deficit. The country is resorting to short-term domestic debt to finance the deficit, but historically high debt levels approaching a appetite of local banks and pension funds could wane. The already public debt ratio is expected to remain. External public debt, which represents almost 60% of the total, is mostly held by international bondholders. After successfully repurchasing two bonds in September and December 2022, which enabled the government to retire a bond with a notional value of US$647m that was due in January 2023, as well as a bond due in January 2025, the likelihood of a sovereign default in 2023 has decreased. Prospects for a deal with the IMF remain stalled since the adoption of bitcoin as a second legal tender, limiting external financing options.

The slowdown in U.S. demand, the strengthening of the USD and higher commodity prices have contributed to a widening current account deficit in 2022. In 2023, it could improve slightly, but would remain high, in the wake of a very large trade deficit. Moderating commodity prices and sluggish domestic demand should help reduce it somewhat, despite the poor outlook for exports. The surplus on the services account should continue to improve, driven by the recovery in tourism revenues. However, the large transfer account surplus is likely to be adversely affected by the slower flow of remittances, limiting the improvement in the current account. Repatriation of investment income and interest payments on external debt will fuel a further deficit in the income account. The large current account deficit and low foreign exchange reserves (about two months of import cover) will sustain significant external vulnerabilities. In particular, declining foreign exchange reserves could lead to pressures on the currency in circulation in this fully dollarised economy.

 

A popular president domestically, but widening relations with the U.S.

Since his election as president in February 2019, Nayib Bukele has enjoyed widespread popularity among the population thanks to a security-oriented discourse. His newly formed party, Nuevas Ideas (right), won a large majority in the February 2021 parliamentary elections with 56 of 84 seats. Despite his popularity, the opposition, freedom organisations and part of civil society have denounced human rights abuse in the effort of the authorities to fight crime. President Bukele has already indicated his intention to run for re-election in 2024. The Supreme Court of Justice has issued a resolution allowing immediate presidential re-election in mid-2021, even though opposition critics say the constitution prohibits it. While the U.S. remains a key economic partners, relations with the Biden administration has deteriorated in recent years. In this context, authorities are building closer ties with China, notably in the hope of promoting FDI and access to bilateral financing.

 

Last updated: April 2023

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