VZCZCXYZ0000
RR RUEHWEB

DE RUEHSN #1088/01 1161501
ZNR UUUUU ZZH
R 261501Z APR 06
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC 2114
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEATRS/DEPT OF TREASURY WASH DC
RUEHQT/AMEMBASSY QUITO 0833

UNCLAS SAN SALVADOR 001088 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR OTA 
QUITO FOR D.TITUS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ES
SUBJECT: NEEDED CENTRAL BANK RESTRUCTURING NOT FORTHCOMING 
 
¶1. (SBU) Summary.  El Salvador adopted the dollar as legal 
tender in 2001, but the Central Bank still maintains 
institutional vestiges of a monetary authority, issuing 
short-term and long-term debt and keeping on its balance 
sheet more than $700 million in government debt.  Completing 
the institutional aspects of dollarization is a prerequisite 
to making the Central Bank an effective lender of last 
resort.  Focusing instead on pension reform and maintaining 
the country's split sovereign investment grade credit 
rating, the Salvadoran Government is unlikely to take action 
on this issue, despite recommendations that it do so in the 
short term made by the International Monetary Fund (IMF) and 
U.S. Treasury's Office of Technical Assistance (OTA).  We do 
not recommend further OTA assistance on this topic until the 
Salvadoran Government demonstrates tangible progress on the 
core recommendations first made in 2003 and effectively 
reinforced in 2006.  End Summary. 
 
¶2.  (SBU) A July 2005 IMF report on El Salvador's 2004 
Article IV Consultations noted that the country has not 
fully implemented the Monetary Integration Law that launched 
dollarization on January 1, 2001.  In particular, Article 11 
of the law requires the Ministry of Finance to assume 
outstanding Central Bank liabilities.  Instead, the Central 
Bank continues to issue short-term debt to meet operational 
expenses, with $490 million currently outstanding, and it 
also issues long-term debt, with $191 million outstanding. 
The Central Bank also holds $704 million in illiquid long- 
term government bonds.  Finally, it is the custodian of the 
banking sector's liquidity reserves, about $1.66 billion at 
year-end 2005, to protect against deposit runs--these 
reserves are also the Central Bank's foreign reserves.  The 
Central Bank debt and the government debt held by the 
Central Bank are included in the IMF's estimate of total 
public debt as a percentage of GDP, 46.2 percent for 2005. 
Meanwhile, nonfinancial public debt for 2005 was estimated 
at 40 percent. 
 
¶3.  (SBU) The July 2005 IMF report indicated that Salvadoran 
officials had agreed to restructure the Central Bank's 
balance sheet as envisaged in the dollarization law through 
a plan approved by the Legislative Assembly in 2005 and 
carried out over the next 2-3 years.  A December 2004 IMF 
Financial System Stability Assessment noted a similar 
commitment from the Salvadoran government.  Such 
restructuring would improve transparency regarding 
government debt policy, but is also a prerequisite to 
converting the Central Bank into an effective lender of last 
resort for the financial sector.  The banks have access only 
to their own liquidity reserves, and the Central Bank cannot 
serve as a lender of last resort--it had a negative 
liquidity mismatch of about $840 million by year-end 2005. 
 
¶4.  (SBU) Meanwhile, the Central Bank invited OTA to assess 
its operations in 2003, with an eye toward shoring up 
financial system vulnerabilities during a time of political 
uncertainty, and OTA made specific recommendations on 
cleaning up the Central Bank's balance sheet.  A January 
2006 OTA follow-up assessment found there had been no 
progress on Central Bank restructuring, and recommended 
again, among other things, gradually transferring the bank's 
debt to the central government.  Doing so would improve 
transparency, but also give the Central Bank much-needed 
liquidity. 
 
¶5.  (SBU) Central Bank First Vice President Marta Evelyn de 
Rivera told econoff that the Central Bank and Ministry of 
Finance are preparing a medium-term plan to implement the 
OTA recommendations.  She said in the short-term, however, 
the Central Bank and Ministry of Finance would begin to 
better coordinate their bond sales, and the Central Bank 
would look to retire some debt used to finance the 
Multisectoral Investment Bank (BMI), a state-owned 
development bank.  She said she felt pressured to show some 
progress on these institutional issues in advance of IMF 
consultations scheduled for May.  She cautioned, however, 
that dealing with the more difficult debt issues would take 
more study and more time. 
 
¶6.  (SBU) Manuel Rosales, the Ministry of Finance's Director 
of Public Credit and a top advisor within the government on 
debt policy, reinforced the Central Banks's message telling 
econoff recently that there were no plans to restructure the 
Central Bank's balance sheet in the near future.  Rosales, 
who was well informed on conclusions of the IMF reports and 
the OTA assessments, said this was an inopportune time to 
deal with dollarization legacy issues.  Highlighting the 
 
work of an eminent persons group tasked by the government 
and the G-14 (a center-left legislative coalition) to study 
public debt issues, he stated categorically that there is no 
debt crisis in El Salvador, but there are a number of thorny 
issues that would challenge the government's ability to 
maintain debt at a sustainable level over the next few 
years.  Dealing with those issues--rising pension costs and 
pressure to increase spending on health and education--will 
take priority over restructuring the Central Bank balance 
sheet, Rosales said. 
 
¶7.  (SBU) Mauricio Choussy, Fitch Ratings' managing director 
for Central America and a former Central Bank president, 
also told econoff that El Salvador is unlikely to tackle 
these Central Bank institutional issues in the near term. 
Moving the Central Bank debt to the Ministry of Finance 
would increase El Salvador's reported nonfinancial public 
debt.  Choussy said that Moody's, another influential U.S.- 
based rating agency and the only one of the major agencies 
to give El Salvador an investment-grade rating, has focused 
on that measure of debt--not the financial public debt.  He 
reported that Moody's is looking to downgrade El Salvador, 
but has been reluctant to do so without some change in the 
status quo--consolidating the balance sheet would give 
Moody's the excuse it needs.  Choussy suggested there was 
more at stake here than the price of Salvadoran Government 
bonds.  He cautioned that the banking sector in El Salvador 
has been able to access cheap capital overseas riding on the 
coattails of the government's investment-grade credit 
rating.  The banks would see the interests rates they pay 
for offshore loans rise quickly, damaging their 
profitability, and cutting-off a useful source of finance 
for bank growth given falling savings rates in El Salvador. 
 
¶8.  (SBU) Roberto Rubio, a prominent center-left economist, 
also suggested that now would be an inopportune time to 
restructure the Central Bank balance sheet.  In particular, 
he pointed to ballooning pension costs that would challenge 
the government's already tight fiscal position.  Rubio, the 
most well-known of the economists named to the eminent 
persons group to study debt policy, suggested that the 
government must focus on a second generation of pension 
reform and look for ways to increase government revenue, 
including new taxes such as a property tax. 
 
¶9.  (SBU) Comment:  Government officials and independent 
economists believe that, contrary to advice offered by both 
the IMF and OTA, now is not the time to restructure the 
Central Bank balance sheet.  Until the Central Bank balance 
sheet is restructured, the Central Bank is not a true lender 
of last resort, and that task would fall on the central 
government should a bank need more than its own prudential 
reserves maintained by the Central Bank.  Completing the 
institutional aspects of dollarization would also make the 
process harder to reverse in El Salvador, providing a strong 
signal that the dollar is here to stay.  OTA technical 
assistance has been useful in focusing attention on the 
issue, but we do not recommend further assistance until the 
Salvadoran Government demonstrates tangible progress on the 
core recommendations first made in 2003 and effectively 
reinforced in 2006.  End Comment. 
 
Please visit San Salvador's Classified Website at 
http://www.state.sgov/p/wha/sansalvador/index .cfm. 
 
Barclay