Identifier
Created
Classification
Origin
08SANSALVADOR861
2008-07-18 13:57:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy San Salvador
Cable title:  

EL SALVADOR SEEKS DEBT RESTRUCTURING LOAN, NEW TAX

Tags:  EFIN ECON PGOV IBRD ES 
pdf how-to read a cable
VZCZCXYZ0000
PP RUEHWEB

DE RUEHSN #0861/01 2001357
ZNR UUUUU ZZH
P 181357Z JUL 08
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC PRIORITY 9818
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
UNCLAS SAN SALVADOR 000861 

SENSITIVE
SIPDIS

DEPT PLEASE PASS AID/LAC, USTR

E.O. 12958: N/A
TAGS: EFIN ECON PGOV IBRD ES
SUBJECT: EL SALVADOR SEEKS DEBT RESTRUCTURING LOAN, NEW TAX
REVENUES

REF: A. 06 SAN SALVADOR 2351

B. 07 SAN SALVADOR 1185

C. 07 SAN SALVADOR 2431

D. 07 SAN SALVADOR 2383

UNCLAS SAN SALVADOR 000861

SENSITIVE
SIPDIS

DEPT PLEASE PASS AID/LAC, USTR

E.O. 12958: N/A
TAGS: EFIN ECON PGOV IBRD ES
SUBJECT: EL SALVADOR SEEKS DEBT RESTRUCTURING LOAN, NEW TAX
REVENUES

REF: A. 06 SAN SALVADOR 2351

B. 07 SAN SALVADOR 1185

C. 07 SAN SALVADOR 2431

D. 07 SAN SALVADOR 2383


1. (SBU) SUMMARY. According to a senior Ministry of Finance
official, the Government of El Salvador (GOES) is privately
pursuing $1.2 billion in new World Bank loans to restructure
existing debt, prevent a fiscal crisis in 2011, and free new
money for social spending. The Ministry of Finance is also
struggling to make up budget shortfalls of over $100 million
caused by commodity price-driven subsidies. New taxes and
government austerity measures are expected to raise $65-70
million, while the budget deficit is expected to increase by
0.4-0.5% of GDP. Separately, the state-owned hydroelectric
authority is exploring issuing new debt to cover a projected
$100 million shortfall caused by its electricity subsidies.
The economic pressures are weighing heavily on the incumbent,
pro-U.S. ARENA government that is trying hard to get
reelected but sometimes loses its way in the process. END
SUMMARY.

DEBT RESTRUCTURING
--------------


2. (SBU) On July 14, Manuel Rosales, Advisor to the Minister
of Finance, told Econoff that the Government of El Salvador
(GOES) hopes to pursue $1.2 billion in loans from the World
Bank to restructure its existing debts. (NOTE. El Salvador
faces a potential fiscal crisis in 2011, when an
approximately $650 million Eurobond comes due.)


3. (SBU) The GOES has been privately negotiating with the
World Bank, after previous approaches to the Inter-American
Development Bank (IDB) and the Central American Bank for
Economic Integration (CABEI) did not provide adequate debt
relief. El Salvador would receive two tranches of loans -
$550 million to be used to pay off existing, higher interest
debt from the IDB and other sources, and $650 million to pay
off the 2011 Eurobond. Minister of Finance Handal was
briefing President Saca on the proposal the morning of July
14, and Hacienda will not discuss the proposal publicly until
they get the go-ahead from President Saca.


4. (SBU) Rosales said the World Bank offered 30-year loans at
LIBOR plus 5 basis points. The loans include a 5-10 year

grace period and an initial commission of 0.25%, with no
additional commissions. Rosales estimated that the GOES
would save $75 million per year in 2009 and 2010 in debt
service payments, money which could be used to finance new
social programs. Overall, the World Bank loans would smooth
El Salvador's debt payments into a gradual, declining curve.
Under the current situation, El Salvador faces three massive
spikes from 2011, 2025, and 2036 Eurobonds.


5. (SBU) World Bank staff told Rosales that the leftist
opposition FMLN had approached the Bank earlier this year,
during Presidential Candidate Mauricio Funes's visit to
Washington, to talk about debt issues. (NOTE: ARENA
Presidential Candidate Rodrigo Avila is scheduled to meet
with the World Bank during his July 16-18 visit to
Washington. END NOTE.) Rosales stated that the World Bank
would initially approach the FMLN deputies about the
proposal, and it could be presented to the Assembly in
mid-August. In Rosales' view, the FMLN is "so confident that
it will win the (March 2009) election" that it would vote for
the proposal to ensure a strong fiscal position for its
government. (NOTE. New debt issuance requires a
super-majority -- 2/3 approval -- vote in the Assembly. The
FMLN has opposed any new debt for the last two years, and
some of its votes are needed to obtain that super-majority.
END NOTE.)


6. (SBU) Rosales "had been burned by the FMLN before" on debt
issues, however, so the Ministry would continue to plan for
alternatives. If the Assembly should fail to approve this
new loan, Rosales stated that the 2011 fiscal situation was
not as dire as some, such as Citibank, had forecast.
According to his projections, El Salvador should run a $100
million surplus in the 2010 budget and a $150 million surplus
in the 2011 budget, so the next government would only need to
come up with $400 million to cover the 2011 Eurobond debt.
Should no new debt be issued, he speculated, the most likely
solution was a trust, similar to what had been established
for the government pension fund (reftel A),and for other
government expenditures such as education and security
(reftel B).


BUDGET PROBLEMS: SUBSIDIES REQUIRE NEW REVENUE
-------------- -


7. (SBU) According to Rosales, tax receipts have been growing
better than expected in 2008, but not fast enough to meet
budget projections. Conversely, a few policy changes have
contributed to a drop in revenues. First, the GOES had
created new income tax deductions for health and education
expenses, which caused the bulk of the decline. Second, to
combat higher oil prices, the 1% tariff on oil imports had
been cut to zero. (NOTE. However, in a move criticized by
everyone except those receiving the subsidy, the GOES did
impose a $0.10 per gallon tax on gasoline to pay for bus
transportation company subsidies and is about to grant them
another subsidy. Reftel C. END NOTE.) Finally, after the
bread bakers' protest earlier in the year, the import duties
on wheat and flour had been cut from 10% to zero.


8. (SBU) Rosales expected tax revenues to decline later in
the year, however, as higher energy and food prices drive
more consumers to shop in the informal economy, where
value-added taxes (VAT) are seldom collected. The tax
authorities were stepping up enforcement, but the informal
sector is large and disperse enough where this would have
minimal effect. Rosales also noted that revenues from the
$0.20 per gallon gasoline tax, which goes to a dedicated fund
for roads, was already down 6% for the year, as gasoline
consumption has declined due to the high prices.


9. (SBU) At the same time, Rosales said energy and commodity
prices were driving up the cost of government subsidies. At
$140 per barrel for oil, the GOES' propane gas subsidy would
cost an estimated $175 million. Rosales said that the 2008
budget had used an International Monetary Fund (IMF) estimate
of $70 per barrel. Similarly, the electricity subsidy for
families who use less than 99 kilowatts per month will cost
at least $60 million at current prices. Separately, the
state-owned Hydroelectric Executive Commission of Rio Lempa
(CEL),requires at least an additional $100 million to meet
its energy subsidy obligations (reftel D). Overall, Rosales
projected that El Salvador would run a deficit of 2.3%-2.4%
of GDP for 2007, up from the budget projection of 1.9%.


10. (SBU) The Ministry of Hacienda (Finance) was looking to
make up the budget shortfall through a series of new
measures. First, the minister had instructed the Directors
of Taxation and Customs to develop an plan to increase
collection (Rosales had no specifics). Second, President
Saca had ordered all ministries to adopt an austerity
program, which Rosales estimated would save $15 million.
Third, the Assembly had approved a tax "amnesty," where
penalties and interest for non-payment would be waived.
Rosales said the previous amnesty was successful, and they
expected at least $25 million in new tax payments from this
one. (NOTE. The GOES last offered an amnesty in 2004,
shortly before the 2005 Presidential election. END NOTE.)
Finally, Rosales estimated that a $0.04 tax on telephone
calls originating outside El Salvador, which has passed the
Assembly but not yet entered into force, would raise $25-30
million, which would directly fund the electricity subsidy.
According to the draft law, the new telephone tax is to fund
new social programs.


11. (SBU) Rosales said CEL was seeking loans to cover its
$100 million shortfall. CEL was applying for a $40 million
loan from Central American Bank for Economic Integration
(CABEI),and the state-owned Multisector Investment Bank
(BMI) is investigating an international bond offering to
raise the other $60 million. Rosales did not specify whether
the GOES would seek legislative approval for this new debt or
establish a new trust.

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


12. (SBU) El Salvador faces many financial pressures: rising
rates of inflation (9% in the first six months of the year
versus 4.7% in 2007),slower remittance growth (about 6%
versus double digit growth in previous years),and no short
term end in sight to high food and fuel prices. Its
escalating subsidy costs combined with a slowdown in the
economy (reduced growth projections from 5% to 3.5-4% growth)
and more movement into the informal sector and concomitant
reductions in fiscal revenue also spell trouble for the
incumbent ARENA administration.


13. (SBU) El Salvador has elections in January and March

2009. We will have a better indication of where the FMLN
stands when it releases its fiscal and economic plan in
mid-to-late August. Though they have indicated a renewed
willingness to consider multilateral financial institution
loans, the FMLN's commitment to new loans is by no means
assured. Several prominent macroeconomists have described
the 2011 debt crisis as a "political problem," not an
economic one, but unless the two parties are able to reach
some accommodation, it will have serious economic
consequences for the country.


14. (SBU) ARENA's steadfast refusal to target or reduce
subsidies forces it to look for additional funds to pay for
them, with the tax on incoming long distance calls only the
latest example. This short-sighted approach hurts El
Salvador's long-term competitiveness and business climate,
and the GOES risks complaints filed against it under
CAFTA-DR. In their preoccupation to get ARENA re-elected,
the Saca administration is laying aside some of the good
economic policies that helped ARENA get elected the previous
four times.
GLAZER