El Salvador

Why El Salvador's economy is in trouble

Bnamericas Published: Wednesday, January 18, 2023
Why El Salvador's economy is in trouble

Factors like strong dependence on foreign markets and the upcoming general elections could push El Salvador and its neighbors into recession this year.

In this interview, the head of private companies association ANEP, gives BNamericas more details and, among other things, explains why the cryptocurrency policy failed.

BNamericas: Why could El Salvador experience recession this year?   

Selva: In general, we share the projections of the IMF and the World Bank that El Salvador's growth could reach 1%-1.8% in the best cases. That implies an economic slowdown, perhaps not a recession, but there are challenges that we will certainly continue to face.

The first is inflationary. Our inflation follows almost the same trend as that of the US, and inflation there is just beginning to yield to the decisions of the Federal Reserve, but that implies that during 2023 the Salvadoran population will continue to face this problem, which at the end of 2022 was positioned as the main economic challenge in opinion polls.

BNamericas: What factors were key to reach this point?

Selva: Mainly external market dependence on exports, being the main productive engine of the economy, and our hyper-dependence on remittances. The internal factor that must be considered is that it is an election year. Election years traditionally tend to be paralyzed in terms of new investment or foreign investment.

Our electoral calendar normally begins in June or July with internal elections, and in this case, I think President Nayib Bukele's aspiration for re-election will be particularly thorny. I think we will be able to financially take advantage in the first half of the year, because in the second, the electoral calendar will contaminate the economic environment a little.

BNamericas: When would the effects of the recession be felt?

Selva: I think we could start to see them in the second quarter. This period is also important because the results on tax collection will be published and the finance minister already said it will be more moderate than last year.

BNamericas: Could a similar scenario play out in other Central American countries?

Selva: Central American countries, especially in the northern triangle [Guatemala, Honduras, El Salvador], will see a similar scenario, but not countries like Panama due to the exchange rate. However, in terms of attracting foreign investment, El Salvador lags significantly behind other countries such as Nicaragua or even Honduras, which, despite the political uncertainty, continue to attract foreign investment. I believe Guatemala will best navigate regional instability. It also has an electoral process, but I think it will be less turbulent.

BNamericas: What other economic challenges will El Salvador face this year?

Selva: Dependence on remittances, which represent 17% of GDP and are the only or main livelihood for many Salvadoran families. Our internal consumption is highly dependent on what happens in the US. So far, a couple of things have helped us: wages and low unemployment in that country, but the construction sector is collapsing. That is where many migrants find employment and this represents a challenge.

At the same time, an opportunity opens, since [migrants] who cannot buy real estate in the US could buy it in El Salvador. That has happened in recent years and it has benefited the construction sector … I think this recession will be quite unique because it presents some opportunities for some economic sectors and some risks for others. It is not a general collapse.

BNamericas: And what challenges will the private sector face in particular?

Selva: Competitiveness. I think nearshoring and friendshoring will offer opportunities. What will that depend on? The private sector pushing deepening customs and investment, more agile logistics mechanisms – the digitization of processes, more efficient agreements between suppliers and customers.

Nearshoring requires that we depend less on the Asian market for raw materials and inputs and generate and complement regional value chains. It is a challenge. And the third one, I think, is always access to credit.

BNamericas: What do you mean by customs deepening?

Selva: I would say Central American integration has hit a snag, so we have migrated to the existence of two sub-regions in Central America, with Nicaragua as an imaginary border: the northern triangle, with a very similar reality, and then Costa Rica and Panama with a very different one.

Right now, what is being pushed the most is the customs deepening plan for the northern triangle, which is the most affordable. The idea is to unify processes, standardize invoices, and standardize the quality of road infrastructure. In this sense, I think El Salvador has fairly solid road infrastructure, but we have seen that it has deteriorated a lot in Guatemala and that hurts both Honduras and us because Guatemala is a necessary transit route.

BNamericas: Is the government managing investment projects adequately?

Selva: I would separate it into two parts. The public works ministry (MOP), in charge of road infrastructure, and Fovial, an autonomous entity in charge of maintenance, have had good execution capacity, hence El Salvador has good roads.

Another thing is the megaprojects, which this administration and past ones have had a lot of difficulty implementing, [as seen with] Cutuco port, which was a bet to complete a dry canal that would compete a little with the Panama Canal. [It] had a lot of potential, but it has been a white elephant for over 20 years and has not been concessioned.

Then there are the megaprojects offered by this administration for a second airport, a train and other works. It has never been clear how these projects will be designed and how they fit into an economic acceleration plan: not knowing if the train is for passengers or cargo or what points it would connect, or the feasibility of a second airport.

So, these are not bets we, as the private sector, are waiting for because they were never framed in an economic plan. We hope that megaprojects such as the Los Chorros viaduct will be executed with more agility, but on many, we do not have information.

BNamericas: How does the cryptocurrency policy fit in?

Selva: As an economic bet, we believe bitcoin regulation was not done properly. Specifically, I believe the mandatory nature greatly distorted expectations in terms of financial stability during the first year.

[El Salvador] is under evaluation by international organizations in matters of money laundering and we advocate regulation of cryptocurrencies that prevent this crime, because this can affect access to international markets. We could be seen as a kind of tax haven, so that worries us, but it can be resolved with regulation.

The bitcoin law has had practically no effect on daily economic activity. Most companies do not report operations in cryptocurrencies, simply because consumers have not found in them an added or different value to the use of the dollar.

It was a moment of curiosity, but that's it. As a matter of public finances, it must be said that we have never had transparency regarding the real cost of this public policy. We don't know how much the loss really is, but for us, the biggest loss is opportunity cost. We know that more has been spent on implementing bitcoin than on the entire health system. So, for us, the first concern is why money is being used for this and not for other issues that directly affect human capital or the country's competitiveness.

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