Country Report El Salvador July 2009

Outlook for 2009-10

• Mauricio Funes of the left-wing Frente Farabundo Marti para la Liberacion (FMLN) assumed office on June 1st 2009, ending nearly two decades of rule by the right-wing Alianza Republicana Nacionalista (Arena).
• Mr Funes faces major challenges, complicated by the lack of a legislative majority, divisions within his own party and a strong opposition from the outgoing Arena.
• The deep recession in the US, El Salvador's main source of export sales, foreign direct investment (FDI) and workers' remittances, will drag GDP growth down in El Salvador and its Central American trading partners.
• GDP growth will contract by 2% in 2009, owing to falling consumer spending and investment. GDP will recover to 1.5% in 2010 on the back of gradually improving domestic demand.
• After falling to 1.2% in May from a peak of 9.9% in August 2008, we now expect that inflation will end 2009 around 1.5%, rising to 2.5% by end-2010.
• After widening to over 7% of GDP in 2008, the current-account deficit will narrow sharply in 2009. It will be largely financed by long-term debt inflows as FDI inflows will weaken substantially

Monthly review

• The line-up at Mr Funes's inauguration reflected his aim of a moderate left-wing government with close relations with the US. Despite close FMLN ties, Venezuela's Hugo Chavez and Bolivia's Evo Morales were notably absent.
• The reality that Mr Funes will have to govern with the help of the radical FMLN leadership was reflected in the new cabinet line-up, with former guerrillas taking up many ministries, including the interior and defence.
• Concerns over the growing fiscal deficit led the parties of the recently inaugurated Congress to join forces and approve a series of foreign debt measures that will provide some fiscal flexibility for the new government.
• More details emerged of the new president's plans to create 100,000 new jobs in the next 18 months, a central promise of his presidential campaign.
• The monthly economic activity index of the Central Bank posted its eighth consecutive month of negative growth when it contracted by 6.2% in March.
• Lower expectations of growth by the private sector, combined with higher borrowing costs (average lending rates stood at 9.4% in May up from 7.4% in May 2008), have impacted the demand for loans from the private sector.