United States of America
Guatemala
Honduras
Nicaragua
Costa Rica
China
MexicoActivity affected by the US economic slowdown
In 2023, El Salvador's economy was hindered by the impact of the slowdown in its neighboring countries on exports and that of monetary tightening and inflation on domestic demand. The robustness of public spending and private investment were compensating factors.
Business activity in 2024, even if sustained by public spending in an electoral context, is likely to weaken as a result of the slowdown in the United States. The slowdown in remittances (23% of GDP in 2023) from the United States (93% of remittances) will impact household consumption, which is fortunately supported by disinflation and solid employment. Inflation is set to slow, notably under the influence of El Salvador's fiscal policy, with tax exemptions on fuel, other combustibles, and certain basic foodstuffs, as well as the stabilisation of electricity prices. The complete dollarisation of the economy considerably limits the influence of local authorities on monetary policy. Last, global prices are likely to ease further.
In addition, weaker US demand will weigh on exports of goods, especially clothing parts, 39% of which were destined for the US in 2022 (mainly clothing, plastics, coffee, and sugar). Tourism (12% of GDP in 2023, with 45% of visitors coming from the US in the first half of the year) is also likely to suffer. Easing inflation will be accompanied by rising real interest rates, which will squeeze private investment. The controversial adoption of bitcoin as a second legal tender in 2021 and the perception of the business environment, notably due to crime and the president's authoritarian drift, will also weigh on investment.
Public finances still a cause for concern and external accounts vulnerable
The public deficit widened in 2023, in a pre-election context. In 2024, public finances will remain under pressure, as electoral spending continues on projects such as the reconstruction of the Rosales hospital in San Salvador and the development of sports facilities. Increased investment in technology via public-private partnerships and in road infrastructure will also contribute to maintaining the high deficit. However, once the electoral deadline has passed, a return to budgetary rigor is not out of the question. This would involve, first and foremost, the abolition of tax exemptions for basic products and improvements in tax collection, aided by the digitisation of invoicing. However, fiscal vulnerabilities persist, not least due to the adoption of bitcoin as legal tender in 2021. The lack of IMF support for this move, and the exorbitant cost of tapping international capital markets, led the country to turn to other partners such as China and regional development banks. This led to the early redemption, in September and December 2022, of two bonds maturing in 2023 and 2025. Furthermore, in October 2023, the government launched a programme to restructure its short-term debt, consisting of a refinancing of around $1.5 billion out of a total of $2.8 billion. This reprofiling by lengthening maturities (in return for an increase in interest rates) aims to reduce the refinancing burden on short-term debt held by local banks.
However, sovereign risk is likely to remain high. It will arise from bond repayments of USD 800 million and USD 601 million due in 2027 and 2029 respectively, plus maturities under the reprofiled debt. Despite the reduction in its weight in GDP until 2023, public debt remains highly risky. Mainly denominated in US dollars, which is El Salvador’s national currency, it matures mainly in the medium to long term (60% in more than 11 years’ time). Its annual servicing, representing around 5% of GDP, is mainly tied to domestic debt and absorbs 24.5% of public spending, thereby fuelling the deficit. External debt accounts for 59% of the total. Bondholders hold 52% (2022 percentage), multilateral creditors 45%.
The current account deficit fell sharply in 2023 thanks to a rebound in tourism driven by a marked improvement in the country's security situation, and moderating prices for imported raw materials. It will improve slightly in 2024. The terms of trade will continue to improve, and the upturn in tourism will continue, improving the surplus on the services account. Nevertheless, the trade deficit (-31% of GDP in 2022) will widen slightly due to the North American slowdown. Remittances from the United States are likely to slow. The balance of income deficit is also likely to be impacted by external debt servicing. The continuing reduction in foreign exchange reserves will accentuate the vulnerability of the external accounts. Full repayment of two bonds will make it more difficult to attract capital and obtain debt flows to finance the current account deficit, which will put pressure on foreign exchange reserves. The latter, covering two months of imports, have fallen by an average of 23% year-on-year since the start of 2023. As El Salvador's economy is entirely dollarised, this could put a squeeze on the currency in circulation.
High probability of a second mandate for President Bukele
President Nayib Bukele and the deputies of his right-wing Nuevas Ideas party, who hold two-thirds of the seats in the Legislative Assembly, owe their re-election in February 2024 to their success in fighting crime and gangs. The homicide rate fell from 18.1 per 100,000 inhabitants in 2021 to 7.8 in 2022. The constitutional ban on the President running for a second consecutive term was circumvented with the help of the Supreme Court of Justice, which ruled that it was sufficient for him to step down six months before the election (in this case, to someone very close). Notching up over 85% of the ballot, Nayib Bukele won the February 2024 presidential election. His party has won almost all the seats in Parliament, consolidating its hold on the country. The results confirm his vast lead, as revealed in a November 2023 CID Gallup poll, in which 9 out of 10 Salvadorans intended to vote for him. However, opponents and freedom groups criticise the repression, which includes muzzling of the press, suspension of due process rights and indefinite preventive imprisonment. Since the introduction of the state of emergency in March 2022 to curb violent crime, the authorities have reportedly imprisoned over 73,000 individuals suspected of belonging to gangs, but only 7,000 declared innocent have been released.
On the external front, growing tensions with the United States, critical of Bukele's authoritarianism and his desire to reduce his country's dependence on the United States, could lead to new sanctions beyond those already in place against former Salvadoran officials. At the same time, ties with China have been strengthened, with the aim of stimulating FDI and securing bilateral financing. However, the United States will remain El Salvador's main trading partner, mainly in tourism and remittances. This dependence encourages Bukele to maintain ties with the United States.
