Country Report El Salvador December 2008

Summary

The political focus will increasingly shift to the March 2009 presidential contest, which pits Rodrigo Avila of the ruling Arena against the moderate Mauricio Funes of the leftist FMLN. As a result, legislative reforms will be slow.
Our baseline forecast is premised on an Arena victory, but whichever candidate wins, policy implementation under the next government, which takes office in June 2009, will be complicated.
The government will remain committed to free trade, the promotion of foreign investment in key industries, such as maquila, and maintaining a tax regime that promotes corporate investment.
GDP growth will decelerate to 1.8% in 2009, reflecting a deteriorating external environment and the lagged impact on consumption of higher inflation. Assuming a mild US recovery, GDP will recover gradually to 2.3% in 2010.
After reaching 6.6% at end-2008, we expect that year-end inflation will ease to 5.5% in 2009 and 4.5% in 2010.
After widening to 6.5% of GDP in 2008, the current-account deficit will narrow in 2009 and in 2010. We expect that it will be largely financed by long-term debt inflows as FDI inflows will weaken substantially.

The FMLN agreed to support the acceptance of US$950m in loans from the World Bank and the IDB. The funds are destined for debt refinancing and social spending.
The funds will also help ease growing fiscal constraints as interest spending eases. Since 2006 the government has resorted to domestic financing of its fiscal requirements as the FMLN withheld its support for the foreign loans.
As the government draws away to some extent from the domestic market, money market rates will be able to fall. Interest rates are also expected to decrease over the medium term.
The next government will need to address the countrys growing energy needs as well as the long-term development of its port and transport systems.
The August IVAE index showed that the economy continued to slow, underpinning our estimate of lower growth in 2008. The index rose by just 1.1% year on year, compared with 5.1% in August 2007.
Inflation eased as the monthly index contracted for a second month in a row. Year-on-year inflation fell to 7.4% in October from 9.9% in August.

Source: Country Report