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U.S. DEPARTMENT OF STATE EL SALVADOR: 1994 COUNTRY REPORT ON ECONOMIC POLICY AND TRADE PRACTICES BUREAU OF ECONOMIC AND BUSINESS AFFAIRS EL SALVADOR Key Economic Indicators (Millions of current U.S. dollars unless otherwise noted) 1992 1993 1994 1/ Income, Production and Employment: Real GDP (millions of 1962 colones) 2/ 3,563.0 3,761.7 3,978.2 Real GDP Growth (pct.) 4.8 5.1 5.8 GDP (at current prices) 6,543.1 7,600.9 8,784.4 By Sector: Agriculture 606.9 651.8 797.2 Energy/Water 153.4 198.7 230.7 Manufacturing 1,236.3 1,447.8 1,669.8 Construction 186.0 237.5 279.8 Rents 367.7 400.9 450.9 Financial Services 172.7 213.5 247.7 Other Services 682.2 779.4 894.2 Public Administration 461.2 495.9 550.3 Net Exports of Goods & Services -1,028.5 -1,077.2 -1,228.9 Nominal Per Capita GDP 1,201.0 1,495.0 1,632.0 Urban Labor Force (000s) 3/ 893 965 1,041 Unemployment Rate (pct.) 3/ 7.9 7.8 7.5 Money and Prices: Money Supply (M2 annual pct. growth) 31.4 35.7 21.4 Base Interest Rate 4/ 16-18 16-19 16-19 Personal Saving Rate (on deposits) 12-14 11-15 11-14 GDP Deflator (pct. change) 8.9 14.9 8.8 Consumer Price Index 19.9 12.0 10.0 Exchange Rate (colon/USD) 8.37 8.73 8.75 Balance of Payments and Trade: Total Exports (FOB) 597 731 823 Exports to U.S. 257.3 219.0 173.0 Total Imports (CIF) 1,698.5 1,912.0 2,142.0 Imports from U.S. 650 844 910 Aid from U.S. 5/ 270 161 215 Aid from Other Countries 20.0 44.3 30.0 External Debt 2,337.5 1,924.0 2,051.0 Debt Service Payments (paid) 346 290 365 Gold and Foreign Exch. Reserves 554.2 645.0 780.0 Trade Balance -1,101.5 -1,181.0 -1,319.0 Trade Balance with U.S. -392.7 -625.0 -737.0 1/ 1994 figures are July Central Bank estimates. 2/ GDP at market cost; 1962 base currently being revised by Central Bank to 1988; no dollar figures available. 3/ Ministry of Planning household survey. 4/ Loan rate. 5/ Excludes military aid. 1. General Policy Framework The Salvadoran economy continues to reap the benefits of sound economic programs, a commitment to a free economy, and careful fiscal management. Real GDP growth in 1994 reached an estimated 5.8 percent, led by a strong performance in the service and construction sectors, while inflation was held to 10 percent. Exports, particularly to the reconstituted Central American Common market, expanded notably during the year. The new president, Armando Calderon Sol, who took office in June 1994, has stated clearly his intention to pursue the trade liberalization and economic reform programs begun by his predecessor. However, the post-war economic recovery is fragile, heavily dependent on a favorable balance of payments position maintained by large amounts of remittances from Salvadorans abroad. El Salvador turned decisively toward market-oriented economics in the four years under President Alfredo Cristiani (1989-1994). The Cristiani government rejected the import-substitution model and pursued trade liberalization and export-led growth. From a structure with tariffs as high as 240 percent, the government established a system in which most duties fall in a range of 5-20 percent. Nontariff barriers and import licensing were almost totally abolished. The Central American Common Market has been reactivated, with most commerce duty-free. Government agricultural monopolies were dismantled, as were internal price controls on 240 consumer goods. Trade has grown 12 percent (higher than real economic growth) from 1993 to 1994; although the absolute value of merchandise exports is still less than half the value of imports. The government's drive to liberalize trade has been matched by reforms in the financial markets. Parallel exchange rates were abolished, and the foreign exchange market was opened to both banks and dealers. The colon, currently valued at about 8.7 to the dollar, has traded in a narrow range for the past two years, maintained to a certain extent by modest interventions on the part of the Central Bank and remittances. The banking system has been reprivatized. Controls on interest rates have been removed, allowing rates to return to real positive levels. A generally disciplined monetary policy has reduced inflation from 12 percent in 1993 to an estimated 10 percent in 1994. Fiscal policy has been the biggest challenge for the Salvadoran government. The peace accords signed between the government and the Faribundo Marti Liberation Movement (FMLN) in December 1991 committed the government to heavy expenditures for transition programs and social services. International aid has not been as generous as expected. The government has focussed on improving the collection of its current revenues, relying more on its own resources than on foreign aid. Government revenues, half of them generated by the new Value Added Tax (IVA), have increased substantially during 1993 and 1994. The share of domestic taxes in GDP is expected to grow from 9.4 percent in 1993, to 10.6 in 1994. Efforts now are underway to improve tax collection. Government planners estimate that the IVA is presently contributing only 60 percent of its potential revenue. Overall, enhanced revenues -- including IVA and income tax and improved collection of import duties -- and some expenditure reduction are expected to sharply reduce the need for domestic financing of the deficit. The government completed implementation of an Integrated Accounting System in the public sector in June 1994. It has also taken steps to improve its financial control over public enterprises and is pursuing privatization of key institutions -- the National Telecommunications Enterprise (ANTEL), parts of the Hydroelectric Production Agency (CEL), and the Social Security Institute (ISSS). Other important fiscal reforms include the repeal of the wealth tax in April 1994, approval of a new Customs Law in May 1994, and elimination of all import duty exemptions in July 1994, including exemptions to public enterprises. 2. Exchange Rate Policy A multiple exchange rate regime that had been used to conserve foreign exchange was phased out during 1990 and replaced by a free-floating rate. The colon depreciated from five to the dollar in 1989 to eight in 1991 but has remained relatively stable since. Large inflows of dollars in the form of family remittances from Salvadorans working in the U.S. offset a substantial trade deficit. The monthly average of remittances reported by the Central Bank is slightly less than $80 million, representing more than $900 million for 1994. In addition, the Central Bank intervenes periodically in the exchange market to moderate speculative pressures and smooth out rate fluctuations. 3. Structural Policies U.S. exports to El Salvador have increased over 60 percent since 1991, accounting for some 40 percent of El Salvador's total imports. The key policy change driving this trend was the government's decision to radically lower tariff barriers. El Salvador's open trade policies are not likely to be reversed. Although the country has run up huge trade deficits in recent years, they have been more than offset by remittances, short-term capital inflows, official transfers and loans. In fact, El Salvador's net international reserves are estimated at $780 million as of December 1994, up 20 percent over 1993. Also contributing to the surge in imports is the robust rate of economic growth and a post-war construction boom. Over 73 percent of imports in 1994 were in the categories of capital and intermediate goods. Prices, with the exception of bus fares and utility rates, are set by the market. The 10 percent value-added tax is applied equally to all goods and services, imported and domestic, with a few limited exceptions (dairy products, fresh fruits and vegetables, and medicines). It has not proven to be an impediment to import sales. In October 1994, the government suspended a price band mechanism, introduced in 1990 to regulate tariffs on basic grains, and imposed a fixed tariff of 20 percent ad valorem. However, Salvadoran officials have indicated that they plan to reinstitute price bands sometime in 1995, probably on a regional basis. 4. Debt Management Policies El Salvador's external debt decreased sharply in 1993, chiefly as a result of an agreement under which the United States forgave about $461 million of official debt. As a result, total debt service decreased by 16 percent over 1992. In 1994, El Salvador received $265 million in external aid, from multilateral institutions, bilateral sources, and private sources. External debt crept up from $1.924 billion in 1993 to $2.142 billion in 1994 and debt service rose correspondingly to $365 million. However, El Salvador has eliminated all payment arrears, and its debt burden is considered moderate. The government of El Salvador has been successful in obtaining significant new credits from the international financial institutions. Among the most recent loans are a second structural adjustment loan from the World Bank, for $52.5 million, another World Bank loan of $40 million for agricultural reform, a $20 million loan from the Central American Bank for Economic Integration to be used to repair roads and a $60 million Interamerican Development Bank loan for poverty alleviation projects. 5. Significant Barriers to U.S. Exports There are no legal barriers to U.S. exports of manufactured goods or bulk, non-agricultural commodities to El Salvador. Virtually all import licenses and prohibitive tariffs were removed by the Cristiani administration. U.S. goods face tariffs from 5 to 20 percent with higher duties only applied to automobiles, alcoholic beverages, textiles and some luxury items. As of January 1, 1995 the tariff on textiles will decrease from 35 to 25 percent. Generally, standards have not been a barrier to the importation of U.S. consumer-ready food products. The Ministry of Health requires a Certificate of Free Sale showing that the product has been approved by U.S. health authorities for public sale. Importers also may be required to deliver samples for laboratory testing, but this requirement has not been enforced. All fresh foods, agricultural commodities and live animals must be accompanied by a sanitary certificate. Basic grains and dairy products also must have import licenses. Authorities also have not enforced the Spanish labeling requirement. Restrictions on foreign banks entering El Salvador have been removed. Foreign banks now face the same requirements as Salvadoran banks and can offer a full range of services. El Salvador officially promotes foreign investment in most sectors of the economy. The foreign investment law allows unlimited remittance of net profits for most types of companies, and up to 50 percent for commercial or service companies. Both electricity generation and distribution and telecommunications remain in the hands of government monopolies. The government is privatizing some services in these industries, improving the prospects of U.S. exports in these sectors. One U.S. power company has already invested in a local generating station. It is possible that the government will choose to accelerate this trend. El Salvador is a member of the GATT and expects to become a member of the World Trade Organization. The government is drafted legislation to implement the full range of its Uruguay Round commitments. 6. Export Subsidies Policies El Salvador does not employ direct export subsidies. It does offer a six percent rebate to exporters of non- traditional goods based on the FOB value of the export, but exporters have found it very difficult to collect. In addition, exporters benefit from an exemption from the tax on net worth. Free zone operations are not eligible for the rebate but enjoy a 10-year exemption from income tax as well as duty-free import privileges. In October 1994, the Salvadoran Central Bank announced that it would write off $5.7 million in credits granted to some 10,000 small businesses that sustained losses during the armed conflict. El Salvador is a not member of the GATT subsidies code. 7. Protection of U.S. Intellectual Property El Salvador's new law protecting intellectual property rights took effect in October 1994. Implementing regulations have not yet been promulgated, but the law is being enforced. Local representatives of U.S. companies report a significant drop in violations, particularly in the areas of sound and video recordings. However the government has been hampered by resource limitations and a burgeoning crime rate that has forced it to give priority to crime-related issues. El Salvador remains on the Special 301 watch list pending U.S. government evaluation of the law's implementation. The new law addresses several key areas of weakness. Patent terms are lengthened to 20 years (15 for pharmaceuticals), and the definition of patentability is broad. Compulsory licensing applies only in cases of national emergency. Computer software is also protected, as are trade secrets. Trademarks, however, are still regulated by the Central American Convention for the Protection of Industrial Property. It is an occasional practice to license a famous trademark and then seek to profit by selling it when the legitimate owner wants to do business in El Salvador. The government is working on consensual amendments to the convention to eliminate this problem. El Salvador is a signatory to the Geneva phonograms and Rome copyright conventions. The government has signed the Berne convention on the protection of artistic and literary works. The National Assembly ratified the Paris Convention on the protection of industrial property in January 1994. 8. Worker Rights a. The Right of Association Approximately 150 unions, public employee associations, and peasant organizations represent over 300,000 Salvadorans, about 20 percent of the total work force. Private sector workers can form unions and strike, while public sector workers can form employee associations, but may not strike. (Despite the restriction, there have been many strikes in the public sector.) Major reforms to the labor code were passed in April 1994, streamlining the process required to form a union; extending union rights to agricultural, independent, and small-business workers; and extending the right to strike to union federations. b. The Right to Organize and Bargain Collectively Only private sector unions and unions at autonomous public agencies have the right to collective bargaining, though in practice government workers do so as well. The employment of union officials is protected by law until one year after the end of their term. This measure is generally respected, but some organizers have been dismissed before receiving union credentials. The labor code reforms attempt to address this problem. c. Prohibition of Forced or Compulsory Labor The Constitution prohibits forced or compulsory labor except in the case of calamity and other instances specified by law. This prohibition is followed in practice. d. Minimum Age of Employment in Children The Constitution prohibits the employment of children under the age of 14. Exceptions may be made only where such employment is absolutely indispensable to the sustenance of the minor and his family, most often the case for children of peasant families, who traditionally work with their families during planting and harvesting seasons. Children also frequently work in small businesses as laborers or vendors, despite the legal requirement that they complete schooling through the ninth grade. Child labor is not found in the industrial sector. e. Acceptable Conditions of Work In July the government raised the minimum wages for commercial, industrial, service, and agro-industrial employees by 13 percent. The new rate for industrial and service workers was 35 colones per day (about $4); agro-industrial employees must be paid 26 colones (about $3), including a food allowance, per day. Despite these increases, approximately 40 percent of the population lives below the poverty level. The law limits the workday to eight hours and the work week to 44 hours, requiring premium pay for additional hours. Occupational safety remains a problem because of outdated regulations, limited enforcement resources, and a reluctance to strictly enforce regulations. f. Rights in Sectors with U.S. Investment U.S. investment in El Salvador is distributed fairly evenly inside and outside the so-called "maquilas" or free zones. The labor laws apply equally to all sectors, including the free zones. However, in practice businesses in the free zones discourage union activity; those trying to form unions have been fired. The Ministry of Labor lacks the resources and support from the legal system to adequately monitor the activities of the companies in the free zones. Extent of U.S. Investment in Selected Industries.--U.S. Direct Investment Position Abroad on an Historical Cost Basis--1993 (Millions of U.S. dollars) Category Amount Petroleum 44 Total Manufacturing (1) Food & Kindred Products (1) Chemicals and Allied Products (1) Metals, Primary & Fabricated 7 Machinery, except Electrical 0 Electric & Electronic Equipment -1 Transportation Equipment 0 Other Manufacturing (1) Wholesale Trade 2 Banking (1) Finance/Insurance/Real Estate 4 Services (1) Other Industries (1) TOTAL ALL INDUSTRIES 104 (1) Suppressed to avoid disclosing data of individual companies Source: U.S. Department of Commerce, Bureau of Economic Analysis (###)