EL SALVADOR ECONOMIC UPDATE

UNCLAS SECTION 01 OF 02 SAN SALVADOR 001112 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 UPDATE Summary -------------- ¶1. According to the economic cabinet's mid-year report to the President, El Salvador's first quarter Gross Domestic Product (GDP) grew at 4.2%, but the annual growth projection has been cut to 4%. Through June, the annual inflation rate reached a record 12-year high of 9.6%. During the first half of the year, total exports increased by 18.9% while total imports grew by 18%. Tax revenues also increased by 9.2%. The first half of 2008 was better than expected for the Salvadoran economy, but external factors, including high food and oil prices, are likely to weaken GDP performance in the second half of the year. While economic growth is slowing, the growth rate is still well above what El Salvador experienced over the last decade. End summary. GROWTH PROJECTION LOWERED -------------- ¶2. According to the mid-year economic report to the President, the official economic annual growth projection has been lowered from 4.5% to 4% for 2008. During 2007, the economy grew by 4.7%. According to the President of the Central Bank, Luz Maria de Portillo, the main factors hindering growth are higher petroleum prices and higher food prices. The latest Central Bank official figures show that GDP grew at 4.2% quarter of 2008, similar to the rate reported for the first quarter of 2007. Agriculture showed the highest growth at 6.1%. RECORD INFLATION -------------- ¶3. The annual inflation rate for the first half of the year reached a record 12-year high of 9.6%, the highest level since August 1996. (Note. Through August, the annual inflation rate rose to 9.9%. End note.) Miguel Corleto, the General Director of the Statistics and Census Office, stated that higher oil and food prices are the main factors driving inflation up. A Salvadoran newspaper poll in August 2008 reported that 40.4% percent of families surveyed considered the cost of living to be their main problem, while 17.5% said poverty and 16.1% said unemployment. LABOR STILL GROWING -------------- ¶4. The figures for private sector workers ascribed to the Salvadoran Social Security Institute (ISSS) reported a 4.3% rise in formal employment between January and May. While this is a positive development, it is still lower than the last year's 8% growth for the same period. Jobs increased for all sectors except construction, which dropped 2%. EXPORTS UP -------------- ¶5. Total exports increased by 18.9% between January and June 2008 to $2.3 billion. Non-traditional exports generated 47% of total exports and expanded by 37%. Within non-traditional exports, goods exported to the Central American region represented 65% of the total. Traditional exports increased by 37% to $249.5 million because of the increased value of coffee exports. Maquila (textile) exports grew by 12.5% to $956.4 million. ¶6. Total imports grew by 18% during the same period. Imports from outside of the region increased by 20.5%, while imports from the Central American region grew by 16.6%. Family remittances increased by 6% to $2.3 billion, although, the remittance growth rate has slowed to 4.9% through August. FOREIGN DIRECT INVESTMENT -------------- ¶7. The total Foreign Direct Investment (FDI) stock through March 2008 totaled $5.2 million, a 0.7% increase over December 2007. The industrial sector accounted for 28% of the FDI increase. The financial sector accounted for 28% of total FDI in the first quarter of 2008, while the industrial and communications sectors each accounted for 17% and 16% of FDI in the first quarter was in the electricity sector. TAX REVENUES ON THE RISE -------------- ¶8. Tax revenues increased by 9.2% to $1,686.1 million during the first half of 2008. Value Added Tax (VAT) revenues increased by SAN SALVAD 00001112 002 OF 002 11.5% to $833.1 million, while income tax revenues grew by 7.2% to $647.4 million. The public debt was reduced from 37.2% of GDP to 36.4% of GDP. Public investment increased by 18.2% to $249.1 million. ¶9. The government expects to further increase tax collection with a fiscal amnesty approved in June 2008. With this amnesty, all tax taxpayers that have debts with the Ministry of Finance would have the corresponding interest and fines waived if they pay between July 11 and December 19. Minister of Finance William Handal expects the amnesty to draw between $20 and $25 million of about $80 million in outstanding tax debts. Approximately 20,000 people took advantage of a similar 2004 amnesty. For the 2009 budget, Minister Handal explained that tax revenues are expected to increase between 7 and 9% to around $3.5 billion, $300 million more than the 2008 budget. The Saca Administration will present its proposed 2009 budget to the Legislative Assembly by the end of September. SUBSIDIES GROWING -------------- ¶10. The cost of government subsidies continues to rise. The electric energy subsidy grew by 140% to $79.6 million, the gas propane subsidy expenditures increased by 57% to $66.9 million, and the public transportation subsidy grew by 480% to $14.5 million. The cost of other social transfers also increased. Expenditures for the anti-poverty program "Red Solidaria" grew from $4 million during the first semester of 2007 to $10.1 million in the first semester of ¶2008. In sum, the Central Bank expects the total amount of subsidies to rise to $700 million this year. COMMENT -------------- ¶11. Given world events, the Salvadoran economy enjoyed a better than expected first half of 2008, save for rising inflation. The effects of high food and oil prices plus bank failures in the U.S. economy, however, are more likely to cause problems in the second half of the year. Other analysts, including from the World Bank, have cut their growth estimates to 3.5% for the year. Fiscal problems caused by rising subsidies are also likely to take their toll. On the other hand, while economic growth is slowing, the growth rate is still well above what El Salvador experienced in the decade prior to the implementation of CAFTA in 2006. Blau