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El Salvador Economy
 
 
 

General

Despite being the smallest country geographically in Central America, El Salvador has the third largest economy with a per capita income that is roughly two-thirds that of Costa Rica and Panama, but more than double that of Nicaragua.

Most of El Salvador's economy has been hampered by natural disasters such as earthquakes and hurricanes, but El Salvador currently has a steadily growing economy. GDP in purchasing power parity (PPP) in 2008 was estimated at $ 25.895 billion. The service sector is the largest component of GDP at 64.1%, followed by the industrial sector at 24.7% (2008 est.). Agriculture represents only 11.2% of GDP (2010 est.). The GDP has been growing since 1996 at an annual rate that averages 3.2% real growth. The government has recently committed to free market initiatives, and the 2007 GDP's real growth rate was 4.7%. Growth has been modest in recent years and the economy contracted nearly 3% in 2009.

In December 1999, net international reserves equalled $1.8 billion or roughly five months of imports. Having this hard currency buffer to work with, the Salvadoran government undertook a monetary integration plan beginning 1 January 2001, by which the US dollar became legal tender alongside the Salvadoran colón and all formal accounting was done in US dollars. This way, the government has formally limited its possibility of implementing open market monetary policies to influence short term variables in the economy. As of September 2007, net international reserves stood at $2.42 billion. However, in 2004, the colón stopped circulating and is now never used in the country for any type of transaction.

A challenge in El Salvador has been developing new growth sectors for a more diversified economy. In the past the country produced gold and silver. As many other former colonies, for many years El Salvador was considered a mono-export economy – an economy that depended heavily on one type of export. During colonial times, the Spanish decided that El Salvador would produce and export indigo, but after the invention of synthetic dyes in the 19th century, Salvadoran authorities and the newly created modern state turned to coffee as the main export.

El Salvador signed the Central American Free Trade Agreement (CAFTA) — negotiated by the five countries of Central America and the Dominican Republic — with the United States in 2004. CAFTA requires that the Salvadoran government adopt policies that foster free trade. El Salvador has signed free trade agreements with Mexico, Chile, the Dominican Republic and Panama and increased its trade with those countries. El Salvador, Guatemala, Honduras, and Nicaragua also are negotiating a free trade agreement with Canada. In October 2007, these four countries and Costa Rica began free trade agreement negotiations with the European Union. Negotiations started in 2006 for a free trade agreement with Colombia.

The government has focused on improving the collection of its current revenues with a focus on indirect taxes. A 10% value-added tax (IVA in Spanish), implemented in September 1992, was raised to 13% in July 1995.
Inflation has been steady and among the lowest in the region. Since 1997 inflation has averaged 3%, with recent years increasing to nearly 5%. As a result of the free trade agreements from 2000 to 2006 total exports have grown 19% from $2.94 billion to $3.51 billion, and total imports have risen 54% from $4.95 billion to $7.63 billion. This has resulted in a 102% increase in the trade deficit from $2.01 billion to $4.12 billion.

Remittances from Salvadorans living and working in the US, sent to family in El Salvador, are a major source of foreign income and offset the substantial trade deficit of $4.12 billion. Remittances have increased steadily in the last decade and reached an all-time high of $3.32 billion in 2006 (an increase of 17% over the previous year), approximately 16.2% of GDP.

Remittances have had positive and negative effects on El Salvador. In 2005, the number of people living in extreme poverty in El Salvador was 20%, according to a United Nations Development Program report, without remittances the number of Salvadorans living in extreme poverty would rise to 37%. While Salvadoran education levels have gone up, wage expectations have risen faster than either skills or productivity. For example, some Salvadorans are no longer willing to take jobs that pay them less than what they receive monthly from family members abroad. This has led to an influx of Hondurans and Nicaraguans who are willing to work for the prevailing wage. Also, the local propensity for consumption over investment has increased. Money from remittances has also increased prices for certain commodities such as real estate. Many Salvadorans abroad earning much higher wages can afford higher prices for houses in El Salvador than local Salvadorans and thus push up the prices that all Salvadorans must pay.

In anticipation of the declines in the apparel sector's competitiveness, the previous administration sought to diversify the economy by promoting the country as a regional distribution and logistics hub, and by promoting tourism investment through tax incentives. El Salvador has promoted an open trade and investment environment, and has embarked on a wave of privatisations extending to telecommunication, electricity distribution, banking and pension funds.


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