Remittances-dependent growth and low inflation
El Salvador’s growth has lagged the Latin American region for over a decade, but it is now showing resilience and is expected to grow on average by +2.5% in 2015-2017, above the average of +1.7% achieved in 2010-2014. While the country fully benefits from currently low oil prices, private consumption (93% of GDP), mainly financed by remittances, will continue to be an important driver of growth. Investment should also remain dynamic after the approval in late 2013 of a public-private partnership law and by the launch of Fomilenio II, a cooperation program with the United States that aims to support investment, increase growth and reduce poverty.
Consumer prices are well-anchored by the dollarization of the economy effective since 2001. Inflation is expected to become negative at -1% in 2015, mainly due to the fall in energy prices, and to remain at low levels thereafter.
Fiscal and external fragilities
The economy is highly dependent on the U.S. cycle, through remittances, exports and investment. Exports are concentrated in low value added and labor intensive goods (such as textiles) and agricultural products (coffee). Due to the dollarization, the amount of liquidity in the economy depends on USD inflows. Given the persistent external deficits and the relatively low level of FDI inflows (which covered less than 10% of the current account deficit), liquidity tensions cannot be ruled out. Notably, the tightening of monetary policy in the U.S. will be a major challenge. The FX reserves held by the Central Bank have been on a downward trend and cover just three months of imports.
Public accounts are fragile. On the top of this, revenue growth was weakened in 2013-2014 by the Constitutional Court reversal of some earlier tax measures that in turn caused public investment cuts and the accumulation of payment arrears. At the same time, imbalances in the pension system and electricity and water subsidies continue to weigh heavily on the budget. The fiscal deficit is expected to widen to -4.8% of GDP in 2017, driving public debt above 60% of GDP from 2016.
El Salvador has achieved important structural reforms over the past years, including trade liberalization and privatization of many state holdings. However, the business environment has space for improvement. According to the World Bank’s Doing Business 2016 survey, El Salvador ranks 86th out of 189, but shortcomings remain in particular with regard to paying taxes, dealing with construction permits, protecting investors and starting a business. Moreover, violence, crime and drug-trafficking remain areas of concern.