El Salvador Country Forecast

Funes Testing FMLN’s Tolerance

President Mauricio Funes remains quite popular, a fact that is especially noteworthy given how little he has to show for his efforts to combat criminal violence or spur an economic rebound. It appears that it is his approach to governance, specifically, the fulfillment of his promise to maintain a moderate leftist policy course, rather than his accomplishments, that has won him the favor of a large majority of his constituents…
The president has made good on his pledge to increase social spending, highlighted by programs to provide free basic education to all children and a reform of the health-care system that has greatly expanded the availability of services to the poor. But Funes has also won the respect of numerous skeptics within the business community with his defense of market-based policies, most notably by rejecting an FMLN-sponsored bill to increase government control over the telephone industry…
The president will rely on the support of the IMF and other multilateral donor organizations, which will condition financial assistance on the maintenance of fiscal discipline, the formulation of a debt-reduction strategy, and the implementation of structural reforms aimed at shoring up weaknesses in the financial sector and eliminating bureaucratic and other obstacles to investment…
Funes will be able to use his popularity as leverage to ensure the continued cooperation of his increasingly skeptical partners in the leftist FMLN, at least in the near term. However, relations between the president and the FMLN are forecast to become increasingly prickly with the approach of legislative elections in January 2012, pointing to greater difficulty winning the necessary legislative backing for pro-business policies—such as ratification of an association agreement with the EU—over the course of the year…
Deterrents to Investment Will Persist
The expected emergence of political gridlock over the second half of the forecast period may hamper efforts to combat crime, as divisions between the executive and legislative branches impede the achievement of a consensus on security policy, slowing the approval of anti-crime measures put forward by the government…
Moreover, for all of his professed (and actual) moderation, Funes’ brand of leftism will still create some headaches for the business community, which will be most affected by the tightening of tax enforcement and changes to tax rules that are key elements of the president’s fiscal consolidation program. Likewise, the administration is standing its ground in a dispute with foreign mining companies, injecting an element of national pride into the controversy that is galvanizing support for a blanket ban on all mining in the country…
Beyond the potential financial penalties El Salvador stands to incur in the event of a judgment in favor of the mining companies, the dispute will do nothing to reassure other companies that are reluctant to take a chance on El Salvador owing to concerns about security and the reliability of the legal system…
The 2011 budget includes some $1.2 billion of public investment, which the government is counting on to inject some life into the struggling construction sector, an important source of jobs. Assuming fairly strong execution of the investment program, increased government spending will spur a modest increase in the domestic contribution to growth, but the fate of the local economy will be determined to a large degree by economic developments in the US, El Salvador’s main trade partner and its most important source of foreign investment…
Over the medium term, the halting of reform under a divided government will deter investment, undermine relations with multilateral lenders, and reduce the country’s ability to take full advantage of free-trade agreements to boost exports, with the result of persistent sluggish growth averaging less than 3% per year through 2016.

Economic Forecasts for the Three Alternative Regimes