GOVERNMENT FOCUS ON FISCAL DISCIPLINE PAYS DIVIDENDS
The biggest source of foreign income is from the 2.2 million Salvadoreans working in the U.S.

El Salvador made the U.S Dollar the official currency in 2001 and is Now reaping the benefits of macro-economic stability

El Salvador has won itself a reputation for impressive financial and political stability since the peace agreement was signed with the guerrillas in 1992.

The country’s boldest move was to make the U.S. dollar its official currency. In 2001 the government approved the Monetary Integration Act, which made the U.S. dollar legal tender alongside the colón. However, it has now replaced the old currency, which is no longer printed and which is only used in isolated rural areas.

“We have locked in the benefits of macro-economic stability by dollarizing our economy,” says Minister of Finance, Juan J. Daboub. The policy allowed a reduction in interest rates from 21% to 7%.

With the monetary framework fixed, the government has concentrated on fiscal discipline. The 1992 peace accords committed it to expensive transition programs and social services. However, it has managed to maintain a budget deficit of 2.4% of GDP. Total debt for the non-financial public sector of less than 40% of GDP means that it has been able to improve its rating from hardship to investment grade. The total external debt at the beginning of 2003 was $5.07 billion. Net international reserves totalled $1.6 billion.

Mr. Daboub is proud of the discipline that has allowed improvements in public services to be financed responsibly over the course of a single decade. “From a corporate perspective, El Salvador is the most healthy economy in Latin America after Chile,” he says. The country is comfortably within the IMF financial criteria for the region and it will remain so thanks to policies of debt reduction, governmental efficiency, poverty alleviation, education, and employment creation.

“We cleaned up the financial sector, opened it up and privatized it,” he says. “We also separated the Central Bank from the rest of the government. We opened up the telecommunications, electricity, and pensions industries to the private sector.” The result is that the number of telephone lines per head of population has increased nearly fivefold. Just 8% of the population is without electricity compared to nearly half at the beginning of the 1990s. The number of people with access to running water has doubled to two-thirds of the population.

On the revenue side, the government has taken steps to improve tax collection. In 1999 it started selling bonds on the international finance markets to fund government operations. El Salvador Bonds have been some of the most successful in the whole emerging markets spectrum. By February 2003 it had sold $2.15 billion in bonds.

The biggest source of foreign income for the country is family remittances from the 2.2 million Salvadoreans (20% of the population) working in America. The value of remittances transferred through the banking system reached a record total of $1.93 billion in 2002 – 13.6% of GDP.

One of the most important institutions, underpinning El Salvador’s financial stability is the Banco Central de Reservas del Salvador, the central bank, which operates independently from government. Since the dollarization of the economy, the bank’s function has been to regulate the banking sector.

“One of our basic functions is to strengthen the stability of the financial system,” says the bank’s President, Luz María de Portillo. A new banking law to strengthen regulations was passed in 2002. New rules on capital requirements, risk management, and exposure of credit outside El Salvador have also been brought in to minimize contagious risk. The Central Bank manages the liquidity reserves of the commercial banks to ensure the stability of the banking system. “This is one of its most important functions as the Central Bank can no longer provide banks with loans,” explains Ms. de Portillo.

The bank has modernized its payment system and is also developing new financial instruments to improve liquidity of assets, such as the mortgage portfolios of the banks. An Investment Fund Law will allow creation of mutual funds providing more liquid and deeper markets.