SACA'S 2006 BUDGET APPROVED ON TIME

UNCLAS SECTION 01 OF 03 SAN SALVADOR 000252

SIPDIS

STATE PASS AID/LAC
USDOC FOR 4332/ITA/MAC/MSIEGELMAN
USDOC FOR 3134/ITA/USFCS/OIO/MKESHISHIAN/BARTHUR

E.O. 12958: N/A
TAGS: ECON EFIN PGOV ES
SUBJECT: SACA'S 2006 BUDGET APPROVED ON TIME



1. (U) Summary. On December 21, 2005, the Legislative
Assembly approved President Saca's $3.3 billion budget
proposal for 2006--an 11.6 percent increase over the
previous year--to cover higher spending on health and
education, pensions, public-sector salaries, and debt
payment. The fiscal deficit for 2006 will reach $458.1
million, 2.7 percent of GDP, and public debt will rise
slightly to $7,198.2, 40.8 percent of GDP, as spending
increases slightly outpace projected increases in tax
collection. The budget was approved with the support of
ARENA, the PCN, and the G-14--a new coalition of left
leaning deputies--after the government agreed to G-14
demands on pension funding, municipal debt, and mechanisms
to prevent evasion of local taxes. Legislative approval
prior to the start of the January-December fiscal year will
help avoid detrimental delays in expenditure as in previous
years. End summary.


2. (U) On December 21, 2005, the Legislative Assembly
approved President Saca's $3.3 billion budget proposal for
2006, an 11.6 percent increase over the previous year. The
Ministry of Education's budget increases by 5.6 percent over
the 2004 budget to $510.7 million (2.9 percent of GDP). The
government will continue strengthening the quality and scope
of the education system through the implementation of Plan
2021, as well as increase teacher salaries (see para. 7).
Spending on grades 1-6 increases by 12.1 percent, and at
$309 million, spending for these grades is 60.1 percent of
the Ministry's budget. Two World Bank loans used to fund
construction of new school buildings were almost completely
disbursed in 2005, and investment in educational
infrastructure will fall from $48.3 in 2005 to $21.8 million
in 2006.


3. (U) The budget for the Ministry of Public Health
increases by nearly 13.6 percent to $313.1 million (1.8
percent of GDP). Healthcare spending goes toward improving
the free care provided at national hospitals and toward
continued efforts to rebuild hospitals and other healthcare
infrastructure damaged by the earthquakes in 2001.
Meanwhile, the Solidarity Fund for Health (FOSALUD) a $20
million off-budget program funded by a tax on alcohol,
fireworks, and firearms--supports local health clinics in
underserved areas.


4. (U) The Ministry of Tourism sees its budget increase
from $0.2 million in 2005 to $5.8 million in 2006. The
increase includes support for the Salvadoran Tourism
Institute ($2.4 million) and the Salvadoran Tourism
Corporation ($3.2 million),both of which were previously
funded through the ministry of Economy. Tourism Minister
Ruben Rochi plans to finish the reconstruction of two
popular tourism centers damaged during the earthquakes and
plans to revitalize the Port of La Libertad. The Ministry
of Economy budget is $46.1 million, a 12.7 percent increase
over 2004. Efforts to establish a new Consumer Protection
Office receive $1.3 million in funding, while $6.5 million
is devoted to update economic and social statistics at the
Census and Statistics Office (DIGESTYC). The budget
increase will also support the creation of the new
Superintendency of Competition and a special trust fund for
the creation of employment in strategic productive sectors.
The Ministries of Finance, Defense, and Labor also
experience slight budget increases.


5. (U) The Ministry of Agriculture's budget holds steady at
$35.6 million, while the Ministries of Environment, Foreign
Affairs, and Public Works experience cuts of $5.9 million,
$12.4 million, and $14.6 million, respectively. The
Governance Ministry, which runs the country's police force,
has capital expenditure cut by $10.3 million, falling to
only $5.5 million, and overall spending cut by 8.9 percent
to $187.3 million. The budgets of the Human Rights Offices
and the Attorney General remain unchanged. The Judiciary
sees a $16.7 million increase in funding for capital
projects--including the construction of several courthouses
and prisons--and an overall budget increase of 18.5 percent
to $160.9 million.


6. (U) Transportation infrastructure, such as road
maintenance and construction, is allocated $126.3 million.
A separate Fund for Road Construction and Maintenance
(FOVIAL),funded by a gas tax, contributes $67.5 million to
this total, down 7.8 percent from 2005 thanks to higher fuel
prices (and less driving). The government is also funding
reconstruction and mitigation works to rebuild from
Hurricane Stan and the Llamatepec volcano eruption, but
budget figures for this effort are not yet available.
Transfers to municipalities, by law fixed at 7 percent of
the total budget, grow by 12.7 percent or $18.2 million, to
reach $161.5 million.


7. (U) The budget includes a salary increase for public
sector employees that costs the government $40 million.
After 8 years without a raise, those employees who earn
$400/month or less get a 10 percent raise; between $401 and
$700, 8 percent; between $701 and $1,000, 7 percent; and for
those earning above $1,000/month, 3 percent. Teachers hired
on an hourly basis see their rate increase by 9 percent.
The President, Ministers, and agency heads receive no raise.
Pension costs for 2006 reach $400 million, a 13.3 percent
increase over 2004, for pensions of employees under the
previous public pensions system.


8. (U) Tax revenues jumped from $1.857 billion in 2004 to
$2.162 billion in 2005, a 16.4 percent increase over 2004
collections. It also represents a 5.5 percent increase over
what the government projected in the 2005 budget ($111.8
million above projections). Gross tax collections were
approximately 13.2 percent of GDP. Some tax reforms passed
in 2005, including measures aimed at reducing tax evasion,
went into effect January 1, 2006, and tax collection for
2006 is forecast at $2.3 billion, a 10.3 percent increase
over the 2005 budget. For 2006, taxes finance 68 percent of
the budget. The largest source of revenue is the 13 percent
value-added tax (VAT),which provides $1,244.2 million, 55.1
percent of all taxes collected. Income tax is the second-
largest source of tax revenue, providing $734.1 million, or
32.5 percent of the total. With CAFTA implementation,
import duties fall by 15.5 percent to $177 million,
contributing only 7.8 percent of total tax revenues. Other
taxes contribute $100.8, 4.5 percent of the total.


9. (U) The fiscal deficit for 2006 is forecast at $458.1
million, 2.5 percent of GDP; in 2005, the deficit was 4.7
percent of GDP. The deficit will be financed with the sale
of $663.7 in bonds and $183.1 million in loans from the
Inter-American Development Bank, World Bank, Central
American Bank for Reconstruction, and Government of Taiwan
($600,000). The cost of the privatization of the pensions
system is included as a separate category in the budget and
will grow from 2.1 percent of GDP in 2005 to 2.3 percent of
GDP in 2006, reaching $400 million, $46.9 million above the
2005 outlay. Consolidated public debt in 2006 will increase
by $458.1 million to $6,990.3 million, or 39.6 percent of
GDP. The nonfinancial public sector debt will rise to
$7,198.2, 40.8 percent of GDP, up from $6,721.7 million in
2005, a $476.5 million increase. The budget is based on a
real GDP growth rate of 3-4 percent, at the high end of most
forecasts for 2006, and an inflation rate of 2.5 percent.
[Comment: If growth does not meet expectations, additional
debt issuance (rather than spending cuts) is likely. End
comment.]


10. (U) The budget was approved with the support of ARENA,
the PCN, and the G-14; the left-leaning deputies of the
Revolutionary Democratic Front (FDR),Democratic Change
(CD),and the Christian Popular Social Party (PPSC) comprise
the G-14, while the FDR includes several former FMLN
deputies who last year voted for the budget and were
expelled as a result. The FMLN did not vote in favor of the
budget--the party's leadership had conditioned budget
approval on the return to the colon (currency) and a 30
percent salary increase for government employees, among
other things.


11. (U) In exchange for approval of the budget (simple
majority) and related financing (super majority),the G-14
requested and received a pension increase for retired
workers not covered by the new private system and increased
municipal control of tax revenues and local debt. On
pension funding, the Legislative Assembly sent a letter to
the Ministry of Finance recommending that the 2007 budget
increase pensions by 6 percent for those who receive $114 or
less and 3 percent for those who receive more. The Ministry
of Finance also agreed to establish a nonpartisan technical
commission on pension funding and government debt.


12. (U) The G-14 also pushed through a law allowing
municipalities to borrow on their own behalf using central
government transfers as collateral. The law limits the
municipalities' debt to less than 1.7 percent of their
operational revenues.


13. (SBU) Comment: The 2006 budget is the first in three
years to be approved by January 1, the start of the fiscal
year. The 2005 and 2004 budgets were delayed because the
FMLN had made unrealistic demands in exchange for support,
similar to those made this year. In both cases, FMLN
defectors broke the stalemate, and the budget went through.
This year, with the FMLN having made itself irrelevant by
kicking moderates out of the party, the GOES found itself
negotiating with the G-14 for budget approval (support from
the conservative PCN is a given). Negotiations were civil
and for the most part conducted behind closed doors, but one
senior GOES official told emboffs that dealing with the FDR
was more difficult than with the FMLN. The rub for this
GOES official may have been unfamiliarity in participating
in actual give-and-take negotiations, rather than the all-or-
nothing approach used with the FMLN.


14. (U) Comment Continued: Despite real progress on tax
collection, the government is still borrowing heavily.
Higher oil prices have no doubt had a significant impact.
We are impressed the government has again followed through
on its commitment to increase spending on health and
education, no doubt influenced by a desire to remain
eligible for MCC funding. If implemented, and in previous
years that has been an issue, this is a pro-growth budget.
End comment.


15. Table I. Government Budgeted Expenditures (millions of
dollars)

2005 2006 % change

Legislative Branch 22.8 23.8 4.4

Judicial Branch 135.8 160.9 18.5

Executive Branch 1,466.6 1,504.3 2.6
President's Office 61.5 62.7 2.0
Ministries 1,405.1 1,441.6 2.6
Finance 48.5 49.6 2.3
Foreign Affairs 43.6 31.2 -28.4
Governance 196.2 187.3 -4.5
Defense 106.0 106.4 0.4
Education 483.4 510.7 5.6
Public Health 275.5 313.1 13.6
Labor 7.0 8.6 22.9
Economy 36.9 41.6 12.7
Agriculture 35.6 35.6 0.0
Public Works 158.6 144.0 -9.2
Environment 13.6 7.7 -43.4
Tourism 0.2 5.8 2,800.0

Other Institutions
Comptroller 20.3 24.2 19.2
Elections Council 11.1 9.8 -11.7
Civil Service 0.2 0.3 50.0
National Judicial Council 3.9 3.9 0.0
Human Rights Office 4.2 4.2 0.0
Attorney General 19.4 19.4 0.0
Public Defenders Office 17.1 15.5 -9.4

Public Debt 587.3 779.9 32.8

State General Obligations 474.5 483.5 1.9

Various Transfers 228.8 308.3 34.7

FOVIAL: Road construction/ 73.2 67.5 -7.8
maintenance

FOSALUD: Health care NA 20.00 NA

Total 2,992.0 3,338.0 11.6



16. Table II. Government Anticipated Tax Revenue (millions
of dollars)

2005 2006 % change


A. Income tax 640.1 734.1 14.7

B. VAT 1,093.1 1,224.2 13.8

C. Import duties 209.4 177.0 -15.5

D. Other 105.0 100.8 -4.0

Total tax revenue 2,047.6 2,256.1 10.2

Source: Ministry of Finance

Barclay