El Salvador

Fiscal and external vulnerabilities

Country Rating B2

Strengths

  • International economic power
  • Diversified economy
  • Robust foreign direct investment, high level of foreign exchange reserves and moderate external debt
  • Expanding middle class

Weaknesses

  • Vulnerable to global commodity prices
  • High production costs
  • High taxation and red tape
  • Persistent inflation and large fiscal deficits
  • Political and social tensions, corruption and income inequality

 

Economic Overwiew

Growth remains resilient

El Salvador fell behind the region for over a decade but has recently achieved to flip the situation. The economy is expected to register grow figures above its neighbors. Private consumption should remain an important driver of growth. Credit growth has accelerated, supporting economic activity. Foreign direct investment has increased and negatively impacted the current account deficit. 

Monetary policy should remain accommodative in order to support still lagging domestic private sector investment and consumer spending. Inflation is gradually picking up from negative territory and is expected to remain moderate in the following years. Remittances are at their highest level in the country’s history (around 17% of GDP) and capable of financing consumption to a substantial extent.  

 

Despite an impressive track record of reforms, structural weaknesses remain

El Salvador has achieved important structural reforms over the past years, including trade liberalization and privatization of many state holdings. However, doing business in the country remains challenging. Access to credit notably deteriorated according to the World Bank, while violence, crime and drug-trafficking hampered business activity and discouraged investment. In addition, exports are still overly concentrated in low value added and labor intensive goods and agricultural products.

The public accounts are in a fragile state. Despite recent fiscal reforms, the public deficit is expected to widen, driving public debt upward. Fiscal consolidation should continue along with tax and institutional reforms. Regarding the current account balance, the deficit shrank as a result of low oil prices, but is expected to widen again.
High dependence on the US economy

 

The Salvadorian economy is highly dependent on the US cycle through different channels, such as remittances, exports and investment. The current account deficit will likely be sensitive to potential protectionist policies adopted by the new US administration. 

The dollarization of the economy entails that the amount of liquidity in the domestic market depends on USD inflows. Moreover, the foreign exchange reserves held by the Central Bank have been on a downward trend and cover just over three months of imports.

The tightening of monetary policy in the US could become a major challenge if it departs from the expected path of normalization.