The Big Idea
El Salvador | Revenue slowdown
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El Salvador’s latest tax data for April again show revenues falling below budget. Consecutive waves of improved tax collection can deliver only marginal returns if economic activity disappoints. And El Salvador’s economy slowed sharply from December through February 2023. But there is some breathing room. The country can source incremental domestic financing as the politically more palatable alternative to spending cutbacks. The financing alternatives should support the case for El Salvador “paying for longer” beyond 2025, creating upside potential for the country’s distressed bond prices.
The latest tax collection data for April again provides a preview to the broader fiscal performance last month. The slowdown in tax revenues has become a recurrent theme after peaking on collection efficiency last year. The primary concern is the downside pressure from the economic slowdown. There has been a noticeable deceleration compared to other countries in the region with El Salvador now shifting towards the bottom of the pack with a clear divergence to growth leaders Costa Rica and Guatemala in February 2023. The fourth quarter 2022 GDP growth decelerated to 1.3% year-over-year while the monthly proxy for economic activity shows further deceleration at -0.3% year-over-year in February 2023. Although tourism represents a potential positive for growth, the net foreign divestment last year was worrisome with slower growth in hotels and restaurants over the past two quarters relative to headline growth as well as a slowdown in workers remittances.
The first quarter 2023 official report on the fiscal results confirm that local financing was the offset for lower-than-expected revenues. The underlying trends on sources of financing already show an upward shift in net domestic financing and a downward shift on net external financing. According to S&P, the cash flow relief from the debt liability with pension funds should provide significant savings through the next four years. This may reflect a bias to finance any disappointment on revenues; however actual performance shows a more pronounced contraction in spending and still consistent fiscal consolidation in the first quarter of 2023 relative to year-before levels. It will still be critical to monitor the downside risks to growth and the negative spillover to the budget performance at a mature phase of policy flexibility. The base case scenario remains “paying for longer” with incremental domestic financing resources. There is still potential for a marginal increase in bond prices for incremental carry returns beyond 2025 as the Bukele administration effectively manages liquidity risks. However, medium-term debt sustainability requires further fiscal consolidation with downsized spending that pushes the nominal fiscal deficit to balance and reduces gross financing needs.
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