El Salvador: Country outlook

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Economist Intelligence Unit
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Economy, Outlook, Forecast, Overview
Political Geography
El Salvador

El Salvador: Country outlook

FROM THE ECONOMIST INTELLIGENCE UNIT

POLITICAL STABILITY: The political scene will be dominated by the need to combat the ongoing coronavirus (Covid-19) pandemic while reopening the economy. The Economist Intelligence Unit expects an economic reform agenda to increasingly take precedence after the legislative election on February 28th 2021, when the president, Nayib Bukele, is likely to consolidate his governing position with stronger congressional support, bolstering governability in 2021-22. However, his political capital will diminish as the end of his presidency approaches (in 2024), as he cannot stand for re-election without amending the constitution.

ELECTION WATCH: Political parties that support the president are well positioned to win a legislative majority at an election due on February 28th 2021. Mr Bukele came to power following a presidential election on February 3rd 2019, standing for the right-wing Gran Alianza por la Unidad Nacional (Gana). He has since registered his own party, the right-wing Nuevas Ideas (NI), which is attracting strong support. An opinion survey carried out in December by CID-Gallup, a regional pollster, shows that the NI is the most popular party (with 37% of support), followed by Gana (with 5%). The once dominant traditional parties, the left-wing Frente Farabundo Martí de Liberación Nacional (FMLN) and the right-wing Alianza Republicana Nacionalista (Arena) have been marginalised, garnering just 6% of support between them. However, the poll also revealed a large number of undecided voters. Given El Salvador's system of proportional representation, if the poll result were repeated at the February legislative election, an NI-Gana alliance would win an outright majority of the 84 seats. However, Mr Bukele may fall short of the two-thirds majority (56 seats) needed to approve the budget and borrowing limits.

INTERNATIONAL RELATIONS: The administration will prioritise maintaining good relations with the US--its main trade and investment partner and home to 1.7m Salvadorans, whose remittances are a mainstay for the local economy. El Salvador-US relations will warm under the incoming US government led by Joe Biden. Compared to his predecessor, Mr Biden will seek to offer stronger support to socioeconomic development projects in Central America; however, his administration will also be more critical of any heavy-handed measures from the Bukele administration. Furthermore, in the first year of its term the new Biden administration will be largely focused on shoring up the domestic economy, meaning that channelling significant amounts of fresh US funding abroad will not be a priority. This may hamper El Salvador's ability to maintain heightened security and continue to combat drug gangs. Temporary Protected Status (TPS) for Salvadorans in the US is set to be cancelled in October 2021, although there is now a greater chance of it being extended. The cancellation would affect over 200,000 Salvadorans who have been living in the US since 2001. Changes to an agreement with the US reached in September 2019--under which migrants from across the region passing through El Salvador (to seek asylum in the US) can be held there pending resolution of their cases--may also be reviewed. Mr Bukele will seek to strengthen El Salvador's relationship with China, which will lead to increasing Chinese interest in the country in the 2021-25 forecast period. Nevertheless, the president faces a tricky balancing act if he is to keep both China and the US as allies, particularly amid worsening relations between those two countries.

POLICY TRENDS: Economic policy in 2021-22 will be dominated by the response to the coronavirus crisis and the need to finance revenue shortfalls, unemployment relief schemes and business continuity programmes. The Bukele government is pursuing broadly orthodox macroeconomic policies and a business-friendly approach. In the short term, the government will extend some stimulus measures in a bid to blunt the impact on households where incomes have been affected by the pandemic. El Salvador has built up a US$2bn fund (about 8% of 2019 GDP) to pay for the pandemic response. The country will gain access to 1.3m coronavirus vaccines through the Covid-19 Vaccine Global Access (COVAX) Facility sponsored by the World Health Organisation (WHO). The Bukele administration has also agreed to buy 2m doses of the Oxford University-AstraZeneca (UK) vaccine and is currently in talks regarding the Pfizer/BioNTech (US/Germany) vaccine. Purchased vaccines cover 35% of the population at present. Policymaking will be complicated by the need to ensure progress on tackling Covid-19 contagion as an extended quarantine period is slowly lifted.

ECONOMIC GROWTH: Following the sharp recession in 2020, we expect El Salvador's economy to recover very gradually over 2021-25. Downside risks to the near-term outlook stem mainly from the possibility that any marked resurgence in coronavirus cases could result in fresh control measures that would restrict travel and harm trade, remittance income or employment. Delays in the government's Covid-19 vaccination schedule also present downside risks to our projections. We expect that, helped by external factors, the economy will only expand by 3.3% in 2021--a weak recovery from last year's estimated 7.5% contraction--and we do not expect real GDP to reach its 2019 level until 2023. Despite an eventual re-opening of the economy, a combination of fiscal constraints, low domestic savings and moderate credit growth will limit a stronger recovery.

INFLATION: Following modest deflation in 2020, we expect mild consumer price pressures to return in 2021-22 as domestic demand gradually recovers and global commodity prices rise--lifting year-end inflation to 1.3% in 2021 and 1.6% in 2022. We expect consumer price increases to remain contained in 2023-25 (anchored by dollarisation), with year-end inflation averaging 2.1%. Supply-side risks to our inflation forecasts stem from the potential for weather-related disruptions, such as droughts and floods, and from unforeseen commodity price spikes. The main risk to this forecast is that inflationary pressures would be lower than currently projected if the global economic recovery proves weaker than we expect.

EXCHANGE RATES: The US dollar became the official currency of El Salvador in 2001 and is broadly accepted across the political spectrum; we do not expect dollarisation to come under threat in 2021-25. We anticipate that the dollar will depreciate in 2021 as the euro zone economy rebounds more quickly than the US economy, before appreciating in 2022 as the US economic recovery finally takes hold. The dollar will lose ground again slightly in 2023-25 as the global economic recovery continues, easing investor demand for safe-haven assets. An overall weakening trend for the US dollar will lead to a depreciation of the real, trade-weighted exchange rate and will aid El Salvador's export competitiveness in 2021-25.

EXTERNAL SECTOR: Our external sector forecast anticipates that the current-account deficit will widen to 2.3% of GDP in 2021 (following a marked narrowing in 2020, to an estimated 1.5% of GDP), owing to a moderate recovery in domestic demand and stronger inflows of remittances. The deficit will then narrow slightly in 2022, to 2.1% of GDP, as exports of goods and services recover. El Salvador's substantial trade deficit is heavily influenced by global commodity prices (given the country's dependence on imported oil and staple goods) and US import demand. In 2021-22 we expect the trade deficit to remain broadly stable, at a gaping 22.4% of GDP, as a result of firmer commodities prices and recovering import demand, before narrowing gradually in 2024-25.

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