UNDER PRESSURE: CREDIT AND THE GOES

C O N F I D E N T I A L SECTION 01 OF 03 SAN SALVADOR 001353 E.O. 12958: DECL: 12/08/2028 TAGS: EFIN ECON PGOV ES SUBJECT: UNDER PRESSURE: CREDIT AND THE GOES REF: SAN SALVADOR 1338 Classified By: AMBASSADOR CHARLES L. GLAZER, REASONS 1.4(B,D) ¶1. (C) Summary. While the banking sector is prepared for even a major bank run, it cannot insulate itself completely as a recent rumor involving Citibank has shown. El Salvador is also feeling the effects of the worldwide credit crunch. GOES missteps and populist measures are not helping the situation. Minimum wage hikes, for example, could cause layoffs in the labor-intensive textile sector. End Summary. BANKING SECTOR LIQUIDITY STRONG BUT WORRIES PERSIST -------------- -------------- ¶2. (SBU) Overall, El Salvador's commercial banks remain very liquid, with effective reserves at 40% of deposits. According to Dr. Armando Arias, President of the Salvadoran Banking Association (ABANSA),however, the banks remain concerned that the 30-35% of bank reserves that are held by the Central Bank are not liquid enough. Arias was told by the Central Bank that that it would take "a couple of days" to transfer the Central Bank reserves from New York to El Salvador. Arias told Econoffs November 28 that it if those reserves are needed, they would be needed in "minutes, not days." ABANSA is lobbying the Central Bank to bring several hundred million (in paper bills) back to El Salvador to have on hand through the March 2009 presidential election. ¶3. (C) One possible bank run thwarted, but the possibility of another remains. ABANSA President Arias (protect) described a potential run on Citibank on November 28. Early that morning, he received calls from a few of his law clients, who together had about $6 million in deposits with Citibank. They had all heard rumors that Citibank was in trouble and wanted to find out if they should move their money. Before talking to Arias, they had contacted officials at other banks, who were unable to confirm or deny these rumors. Arias said that he reassured each of his clients and also had the President of Citibank El Salvador phone them to personally reassure each client, thus keeping them from pulling out their deposits. The rumors were ultimately traced back to an offhand remark by a Citibank El Salvador executive that had been taken out of context. Arias and ABANSA Executive Director Marcela Jimenez said that the banks had improved their coordination since October, but the sector would still look to the Central Bank to respond to any bank runs (reftel). ¶4. (SBU) According to ABANSA, the biggest risk for capital flight was after the January 2009 legislative and municipal elections. Arias said that the worst capital flight in the country had been only 17% in 1980 and prior to dollarization. ABANSA was counting on the stability that the dollarized economy helped to provide and hoped to be able to absorb 20% capital flight while still maintaining normal liquidity. ¶5. (C) Arias opined that a strong showing by the (left-wing) FMLN in the Assembly would be a negative signal to the sector, while a victory by (pro-U.S., center-right) ARENA's candidate for Mayor of San Salvador would be a positive, calming sign. The banking sector was not projecting much past these elections, because, in ABANSA's view, "January is now long-term." (Comment: Due to the proportional representational system for the legislature that allots seats to smaller parties, we think it is unlikely that the FMLN would win a majority of seats in the January 18 Legislative Assembly elections. However, the FMLN could increase its current number of 32 seats in the 84-seat Assembly, at the expense of ARENA and its 34 seats. End comment.) CREDIT MARKETS TIGHTENING -------------- ¶6. (SBU) According to the IDB, real credit to the private sector decelerated from 4.4% annual growth in 2007 to a reduction of .2% at the end of August 2008. More recent numbers are not yet available, but anecdotal evidence indicates an even greater slowdown since September. Press reports suggest that many businesses, especially in the construction and coffee sectors, are struggling to obtain credit or obtain credit at rates they can afford. ¶7. (SBU) Dr. Amy Angel, agricultural economist for leading think tank FUSADES, reported to Econoffs November 24 that the president of Banco Fomento de Agropecuario had told her they had more demand for credit from coffee growers than they had credit to give. (Note. November-January are peak coffee-harvest months and coffee growers depend on short-term loans to pay coffee pickers. End note.) Former Minister of Economy Miguel Lacayo advised that many stable businesses he knew were having their credit lines cut. Lacayo, former Minister of Finance Hinds, and former Central Bank President Barraza all commented that a number of major Salvadoran enterprises had previously obtained credit directly from now-defunct U.S. institutions like Lehman and Wachovia. These businesses were now forced to compete for limited credit in the local market. ¶8. (SBU) Access to consumer credit may also be slowing and rumors abound on this front too. Former Minister of Economy Lacayo told Econoffs that on November 1 Citibank canceled 70,000 credit cards in El Salvador and 250,000 across Central America. However, Citibank El Salvador Vice President of Corporate Finance Francisco Nunez told us that Citibank had not terminated any more credit card accounts than normal. Though, one of our Locally Employed Staff reported a 7 percentage point jump in Scotiabank's credit card interest rate during a single billing cycle. ¶9. (SBU) Citibank VP Nunez acknowledged that Citibank had been tightening lending, but not because of the international financial crisis. One of the Salvadoran banks that Citibank purchased, Banco Cuscatlan, had been a very aggressive lender, and Citibank had been bringing in its more cautious risk management rules since the acquisition. For example, Banco Cuscatlan had frequently funded construction projects at 100-110% of long-term value, which had encouraged speculative projects. ¶10. (SBU) Citibank, on the other hand, would only lend at 80-85% of long-term value. This, Nunez argued, had led some in the construction sector to run to the press and claim that Citibank and other major banks weren't lending. He added that Citibank understood some of its clients were engaged in "liability management" because of the economic contraction in El Salvador, and so it was not being "as aggressive" in enforcing payments as it would be under normal economic conditions. Nunez also acknowledged that Citibank was engaged in "global balance sheet reductions," but Citibank El Salvador was accomplishing this primarily "on the asset side." GOES: PART OF THE PROBLEM -------------- ¶11. (C) On November 27, the Superintendent of the Financial System sent a letter to Salvadoran banks instructing them to roll back any recent interest rate increases. ABANSA President Arias said that the banks were trying to keep this letter "secret" until they met with the Superintendent. (Note: The letter leaked on December 2. End Note.) Arias argued that the banks were raising interest rates in part to maintain profitability given increased reserve requirements, and noted that the Superintendent's letter was on shaky legal ground. ¶12. (C) Separately, Citibank VP Nunez commented that the letter showed "a basic lack of understanding of how banking works" and said that the bank presidents gave the Superintendent a lesson in "Finance 101." While Arias understood the letter to be the Superintendent's "personal initiative," former Minister of Finance Manuel Hinds advised that the decision actually came from President Saca's office. Hinds, former Central Bank President Barraza, and former Technical Secretary Eduardo Zablah had weighed in with the President to urge the letter's withdrawal. According to Nunez, the banks have now been advised that the letter had "disappeared." ABANSA Executive Director de Jimenez told Econoff December 5 that the Financial Superintendent Office was now going to send another letter to more expressly cancel its previous missive. ¶13. (SBU) The GOES decided to raise minimum wages effective in January, just before the legislative and municipal elections. The maquila sector (textiles and apparel for export) minimum wage will increase 4%, while the rest of the labor market will see an 8% minimum wage hike. The Administration had been reaching out to the private sector the last several weeks proposing minimum wage hikes in both January and March (just prior to the presidential election). ¶14. (SBU) A Fruit of the Loom representative told us, they had already reduced their work force (through attrition) by 700 and had recently closed their operations for two weeks. The representative told us several weeks ago that if there was a wage hike, they would likely be forced to lay off workers. Similarly, Lacayo said that their spring season orders for their maquila operation had dropped by 30%. His company was avoiding layoffs by eliminating the annual Christmas party and shutting down the air conditioning a few extra hours each day. He too warned that he would be forced to lay off workers if minimum wages were raised. The maquila association, CAMTEX, was quoted in the December 5 press that layoffs were certain to come as a result of the December 4 minimum wage announcement. Comment -------------- ¶15. (SBU) The worldwide financial situation and the uncertainty about the upcoming elections are the two main drivers of the rise in interest rates and credit tightening in El Salvador. Fortunately, the banks seem fairly well-prepared for even a significant bank run. Still, incidents like the rumors about Citibank can quickly get out of control and ruin even the best laid plans. Unfortunately, the GOES does not seem to be helping the situation by taking rash actions, such as trying to limit loan interest rates or raise the minimum wage and perhaps instigating layoffs. It would be ironic if ruling party ARENA lost the elections as a result of its efforts to attract votes with poorly thought-through economic policies. The party had won prior elections by having made El Salvador a stable country and good place to invest. GLAZER