El SALVADOR: ECONOMIC AND TRADE UPDATE

UNCLAS SECTION 01 OF 02 SAN SALVADOR 002065

SIPDIS

STATE PASS USAID/LAC
STATE ALSO PASS USTR
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN
3134/ITA/USFCS/OIO/WH/PKESHISHIAN/BARTHUR
SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD EINV ES
SUBJECT: El SALVADOR: ECONOMIC AND TRADE UPDATE

REF: A. SAN SALVADOR 1913 B. SAN SALVADOR 1964


1. Summary. According to Central Bank indicators, economic activity
has remained buoyant in El Salvador during the first half of 2007.
GDP for the first quarter of 2007 increased by 4.01 percent and the
Bank's Index of the Volume of Economic Activity increased by 4.01
percent for the first half of the year. Formal employment increased
by 7.6 percent between May 2006 and May 2007, and the annual
inflation rate remains stable at 3.6 percent as of August 2007.
Although the trade deficit increased by 16.5 percent, exports of
non-traditional products have also increased. Based on performance
in the first half of the year, it seems probable that El Salvador
will meet government growth and inflation projections by the end of
the year. End Summary.

GDP UP
--------------


2. According to Central Bank estimates, GDP grew at 4.01 percent
during the first quarter of 2007, and the Central Bank's Index of
the Volume of Economic Activity (IVAE),a GDP proxy, increased by
4.01 percent during the first half of 2007. All sectors showed
growth, especially agriculture and transportation, communications,
and storage.

EMPLOYMENT UP
--------------


4. Formal employment, as measured by the number of private sector
workers ascribed to the Social Security Salvadoran Institute (ISSS),
increased by 7.6% between May 2006 and May 2007. All sectors showed
employment increases, including manufacturing, which had suffered in
previous years because of reductions in the maquila industry.

INFLATION STABLE
--------------


5. The annual inflation rate for August 2007 reached 3.6 percent
while the accumulated inflation rate for 2007 reached 2.47 percent,
below the 3.77 percent recorded in August 2006. The inflation rate
went down primarily because of lower gasoline and corn prices. El
Salvador has the lowest inflation rate in the region, and the Bank
projects it will meet the government projected inflation rate of
between 3 and 4 percent for the year.

TRADE EXPANDS
--------------


8. According to GOES trade data, during the first semester of 2007,
total exports increased by 4.7 percent to $1.94 billion, while total
imports grew by 10.6% to $4.103 billion, and El Salvador's trade
deficit grew by 16.5 percent to $2.163 billion. Non-traditional
exports were the most dynamic, expanding by 13.3 percent, while
Traditional and Maquila exports decreased by 5.3 percent and 1
percent respectively. Within non-traditional exports, goods exported
to the Central American region represented 62.8% of the total, up
13.8 percent, while goods exported outside of the region increased
by 12.6 percent.


9. A large part of the increase in non-traditional exports can be
attributed to the United States, Central America, and Dominican
Republic Free Trade Agreement (CAFTA-DR) entry into force. For
example, by taking advantage of a flexible rule of origin granted by
CAFTA-DR, ethyl alcohol quickly became the second largest
non-maquila export after coffee. Ethyl alcohol exports to the US
reached $64.6 million during the first semester of 2007,
representing 6 percent of non-maquila exports. Food & beverage and
other non-traditional exports have also increased (reftel A).


10. The Maquila sector is showing signs of stabilizing, with exports
decreasing slightly (1 percent) during the first semester of 2007,
to $860.6 million. Despite the reduction that the sector has been
experiencing for the last 3 years, Maquila still remains the most
important export category (reftel B).


12. During the first six months, total exports to the United States
decreased by 0.5 percent, to $1.06 billion, according to GOES
statistics. However, U.S. Department of Commerce and Census Bureau
figures show Salvadoran exports to the United States have actually
increased by nearly 15 percent. The U.S. share of total exports
decreased from 57.7 percent to 54.9 percent, primarily attributed to
reduced maquila exports. On the other hand, exports to Guatemala and
Honduras increased by 15 and 17 percent respectively. The main
destinations for Salvadoran exports after the U.S. are Guatemala,
Honduras, Nicaragua, and Costa Rica. Total imports from the United
States grew by 12.4 percent to $1.7 billion, and the U.S. share of

SAN SALVAD 00002065 002 OF 002


total imports increased from 41.4 percent to 42 percent. Other
important sources of imports after the U.S. are Guatemala, Mexico,
and China.

REMITTANCES GROWING, BUT SLOWER
--------------

13. Family remittances reached $2,344.7 million by the end of August
2007, a 7.7 percent increase over the previous year. This is lower
than the 18.5 percent growth rate for the same period of 2006. The
Central Bank projects that remittances will reach more than $3.5
billion by the end of 2007, equivalent to 18 percent of GDP.
FDI EXPANDING
--------------


14. The total Foreign Direct Investment (FDI) stock increased by 8.5
percent from $3.478 billion to $3.774 billion between March 2006 and
March 2007. The electricity sector accounted for almost half of
this increase ($135.3 million),while communications received more
than a quarter of the total ($77.4 million). The United States
accounted for 64.9 percent of total FDI ($192.1 million),followed
by Spain at 24 percent ($70 million). Italy invested $47.4 million,
Panama $38 million, and neighboring Guatemala $18 million.

TAX REVENUES INCREASE
--------------

15. Tax revenues increased by 12.4 percent to $1,544.6 million
during the first six months of 2007 (7.7 percent of yearly GDP).
Since 2004, when tax reforms were implemented, tax revenues have
increased by 51.4 percent. As a result, the tax burden has
increased to 7.7 percent of GDP, 0.3 percentage points over the
first semester of 2006. The Ministry of Finance forecasts that the
tax burden will reach 14.2 percent of GDP by the end of the year,
compared to 13.8 percent of GDP last year. For 2008, the Ministry
of Finance expects tax revenues to increase by 9.9 percent. They
also plan to reduce public debt from 36.8 percent of GDP by the end
of 2007 to 33.8 percent of GDP for 2008, and plan to reduce the
fiscal deficit from 2.3 percent to 1.9 percent of GDP.

COMMENT
--------------


16. El Salvador will likely achieve government growth projections of
between 4.5 percent and 5.5 percent, and the inflation rate appears
to have been kept under control despite surges in oil prices.
Increased exports, due in part to CAFTA-DR, and increased foreign
investment are also positive economic trends that suggest continued
economic expansion.


17. Nevertheless, there are still several factors hindering economic
growth and development prospects, especially public security/crime.
The latest Economic and Social Development Salvadoran Foundation
(FUSADES) survey, covering the second quarter of 2007, shows that
even though entrepreneurs perceive a favorable investment climate,
25 percent of entrepreneurs reported being victims of crime during
the 3 months previous to the survey. Political uncertainty as the
country moves towards elections may also slow growth, especially in
foreign investment, as investors may decide to wait who wins the
election before expanding or entering the market.


Glazer