The Big Idea
El Salvador | Watch the balance of payments
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El Salvador’s balance of payments looks set to provide valuable insight into the country’s potential for higher growth, driven by a surge in inflows from tourism and a broader shift towards growth led by private investment. While these inflows may not be transformational yet, they mark a significant turning point in the country’s economic policies.
Recent data shows a clear upswing in economic growth, with the second quarter of 2023 seeing a 3.8% year-on-year increase, surpassing the latest International Monetary Fund forecast for 2023 of 2.2%. The possibility of an IMF program looms on the horizon, which could provide an important credibility boost and spur a virtuous cycle of increased foreign direct investment (FDI) and higher trend GDP growth. This shift towards higher cyclical revenues stands as a more effective way to lower the fiscal deficit, as opposed to tax hikes or spending cuts.
One of the key indicators of El Salvador’s changing economic landscape is the current account, which came in at $365 million in the first half of 2023 compared to $1.3 billion in the same period last year. This shift can be attributed to a saturation point in sourcing financing for the fiscal deficit, particularly as foreign exchange reserves have dwindled and access to multilateral loans has entered a mature phase. Import consumption now leans more heavily on resilient workers’ remittances, which make up 23% of GDP and have become the main source for financing the balance of payments. Remittances have run at a consistent pace so far in 2023, similar to the previous year.
Sustainable growth for El Salvador hinges on attracting alternative sources of inflows, with foreign direct investment (FDI) emerging as a more stable catalyst for higher growth. FDI has shown a remarkable turnaround, transitioning from a net negative position in 2022 to two consecutive quarters of positive FDI. While this shift is impressive, annualized inflows remain relatively low at approximately 1.5% of GDP for 2023. The recent commitment of $500 million from Google is noteworthy and holds the potential to kickstart further investments in technology and tourism sectors.
In comparison to neighboring countries like Costa Rica and the Dominican Republic, which enjoy mature phases of FDI inflows ranging from 3% to 5% of GDP annually, El Salvador has substantial room for growth in this area. Reaching back to 2017 and 2018 levels of approximately 3% of GDP in FDI appears to be a logical target for the country, essentially doubling the current FDI levels.
The tourism sector, while not yet transformative for the balance of payments, shows strong momentum in the first half of 2023, outpacing 2022 levels by reaching 4% of GDP. The growth in international tourist arrivals in El Salvador has surpassed that of the Dominican Republic, with the potential for even greater expansion as it builds upon a relatively low base of 2 million annual tourists. The construction sector has played a significant role in this growth, with an average growth rate of 21% year-on-year from January to July 2023, indicating the potential for expanded tourism capacity.
If El Salvador follows the growth model of the Dominican Republic, it could achieve a diversified and high 5% GDP trend growth rate. Comparatively, El Salvador still has untapped potential across various tourism sectors, including construction, transportation, and the hotel/restaurant industry. For instance, the construction sector constitutes only 6% of the 2022 El Salvadoran economy, in contrast to the Dominican Republic’s 15%. Achieving this higher growth trajectory remains contingent on attracting more FDI and would benefit from the positive shock of an IMF program, providing reassurance for medium-term economic stability. Such a development could trigger a virtuous cycle, leading to a reduction in default risk on Eurobonds and lowering the cost of financing, enhancing budget flexibility for the nation.
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