The main objectives of El Salvador’s economic program are to speed up the economic recovery, reduce poverty, preserve financial stability, and secure debt sustainability. One of the immediate priorities is to support domestic demand through a countercyclical fiscal policy in 2010, which includes modernizing the country’s road network and bolstering electricity generation.

Another key priority is to increase the reach and efficiency of social programs. Following El Salvador’s government focus on reducing poverty, the Fund program embeds the government’s general anti-crisis program (“Programa General Anti-Crisis – PGA), which will allow for almost 1% of GDP (or around US$200 million annually) in social spending in 2010-11. It includes an expansion in the conditional cash transfer program (Comunidades Solidarias), creation of a temporary employment program, and the launch of a special public investment program concentrated on health, education and infrastructure. Water and electricity subsidies are being redesigned to protect the most vulnerable.

The Fund arrangement is designed to maintain investor and depositor confidence by supporting the authorities’ commitment to macroeconomic stability and official dollarization. The arrangement is expected to play a catalytic role for creditors, including private investors and other international financial institutions, by laying out the authorities’ strategy to ensure medium-term fiscal and debt sustainability.

Following the Executive Board discussion on the SBA, Mr. Murilo Portugal, Deputy Managing Director and Acting Chair, made the following statement:

“The global downturn of 2009 severely affected El Salvador, despite the economy’s strong fundamentals achieved through several years of prudent macroeconomic policies and structural reforms. Trade flows and remittances declined, foreign financing contracted, while economic activity and tax collections were hit hard. Against this backdrop, the Stand-By Arrangement approved on January 2009 served an important role in reducing uncertainty by facilitating the dialogue between the outgoing and incoming administrations.

“The authorities’ Fund-supported economic program is appropriately underpinned by the strategy of continuing to support domestic demand in 2010, while safeguarding debt sustainability through a medium-term fiscal consolidation plan. In this context, the fiscal deficit target agreed for 2010 should help support the recovery and avoid a decline in key social spending and public investment.

“The revenue package and budget approved by congress in December 2009 and the ongoing efforts on tax administration will help increase the resources to address pressing social and infrastructure needs, while allowing for a reduction in the fiscal deficit over the medium term. Securing a broad-based consensus on a fiscal pact will be critical to solidify the fiscal consolidation.

“The Salvadoran financial system has been resilient to the domestic and global economic downturn. Nonetheless, it will be important to continue with reforms that enhance the system’s ability to withstand shocks. Key in this regard would be the approval in the coming months of the Financial Sector Supervision and Regulation Law, presently with congress. Continued commitment to the full dollarization regime will be paramount to maintaining financial stability,” Mr. Portugal said.
ANNEX

Recent Economic Developments

El Salvador’s economy performed well in the years leading up to the global financial and economic crisis. Sound macroeconomic policies and structural reforms, anchored by full dollarization, delivered buoyant economic growth, a declining public debt-to-GDP ratio, and low and stable inflation.

The global slowdown, however, severely affected economic performance, owing to El Salvador’s close linkages with the United States. Economic activity in 2009 is estimated to have declined by 3.3 percent, as exports, imports, and remittances fell sharply. Bank deposits remained stable and the banking system is well-capitalized with significant liquidity buffers. Nevertheless, total lending declined and asset quality deteriorated.

The economic slowdown weighed heavily on tax revenues. Total net tax revenue contracted strongly and was about US$600 million below the levels envisaged in the 2009 SBA. Despite the authorities’ efforts to adhere to austerity measures and restrain expenditure, the 2009 fiscal deficit reached an estimated at 5.4 percent of GDP, compared with 3.1 percent of GDP in 2008.

The nascent economic recovery is expected to be gradual, in line with an improving external environment, and supported by the authorities’ anti-crisis plan (PGA). Inflation should remain low, and the external current account deficit is expected to widen moderately, in line with the recovery in economic activity.

Program Summary

The authorities’ economic program seeks to support domestic demand in the short run, refocus public spending on social programs and other high-priority sectors, strengthen the medium-term fiscal position and place public debt on a firm downward path, and bolster financial stability.

Fiscal policy for 2010: The approved budget is consistent with a fiscal deficit of 4.7 percent of GDP and would provide an adequate fiscal stimulus to support economic recovery. In addition, the revenue package approved in late 2009, improvements in tax administration, strict control of current expenditure, and reforms of energy and water subsidies would open space for increasing key social spending and help mitigate the effects of the economic slowdown on the most vulnerable.

Medium-term fiscal consolidation: The authorities’ strategy envisages the adoption of a multi-year budgeting framework and reaching broad-based agreement on a fiscal pact that would increase government revenue over the medium term.

Financial sector policies: The authorities intend to continue with reforms aimed at enhancing the financial system’s ability to withstand shocks. To this end, they are seeking congressional approval of two key laws: the Financial Sector Supervision and Regulation Law (to strengthen supervision by merging three supervisory entities) and the Investment Funds Law (to enhance intermediation by providing a legal framework for investment funds).

El Salvador joined the IMF on March 14, 1946, and its quota is SDR 171.3 million (about US$261.3 million). El Salvador has had no outstanding IMF credits since 1991.