UNCLAS        SAN SALVADOR 02351
CXSANSAL:
    ACTION: ECON
    INFO:   FCS AMB POL AID EXEC DCM

DISSEMINATION: ECON
CHARGE: PROG

APPROVED: DCM:MBUTLER
DRAFTED: ECON:DKRZYWDA
CLEARED: ECON:DT, POL:PT, AID:LB

VZCZCSNI159
RR RUEHC RUCPDOC RUEATRS
DE RUEHSN #2351/01 2681445
ZNR UUUUU ZZH
R 251445Z SEP 06
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC 3876
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 02 SAN SALVADOR 002351 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ES
SUBJECT: POLITICAL IMPASSE FORCES PENSION REFORM 
 
Ref: San Salvador 712 
 
Summary 
------- 
¶1.  On September 7 and 14, the Legislative Assembly passed a package 
of pension reforms that sets up a trust to fund the government's 
pension obligations incurred in a 1996 transfer from a pay-as-you-go 
to a funded pension system.  The reform includes a refinancing of 
government debt issued to finance pension costs. More important, it 
eliminates the need to get FMLN votes to approve future financing--a 
point on which the FMLN threatens to file a constitutional 
challenge.  The reform puts off at least for another decade--well 
beyond the 2009 presidential elections--the need to raise taxes to 
eventually pay for these pension obligations.  End summary 
 
Legacy Costs of Pension Reform 
------------------------------ 
¶2.  In 1996, facing the possibility that its pay-as-you-go 
government pension system would go bankrupt or require large 
transfers from the general budget, El Salvador established a pension 
system based on individual retirement accounts managed by private 
pension fund administrators.  The government allowed workers close 
to retirement to stay with the old system, with their pensions and 
the pensions of those already retired to be paid out of the general 
budget.  It forced workers who had contributed to the old system but 
were still years away from retirement to join the new system, but 
provided them transfer certificates as credits for contributions 
made under the old system.  In all, the government issued about $850 
million in 15-year certificates, payable to retirees with 3.4 
percent annual interest through the new pension fund 
administrators. 
 
¶3.  These two transition costs--payments due to retirees under the 
old system and debt incurred by issuing transfer certificates--are a 
significant burden on the government budget.  In 2006, these costs 
were expected to reach $400 million, about 12 percent of the total 
budget, or 2.2 percent of GDP.  Reluctant to raise taxes, in 2006 
and in previous years the government financed pension costs with 
bonds sold on local and international markets; in 2006, the 
government raised $625 million. 
 
¶4.  The current composition of the Legislative Assembly makes it 
unlikely that the government can continue to cover pension costs by 
issuing debt.  Although budget expenditures require only a simple 
majority for approval, financing a fiscal deficit with international 
loans or bonds requires a qualified majority (56 of 84 votes).  In 
years past, getting that qualified majority meant convincing a 
handful of FMLN deputies to break ranks--a difficult but achievable 
task.  Since March 2006 elections, with the FMLN legislative faction 
now under the firm control of hard-line communists, getting 
legislators to cross the aisle has become next to impossible (see 
reftel).  In response, the government has found a financial solution 
to this political problem. 
 
New Reforms Bypass FMLN . . . 
----------------------------- 
¶5.  On September 7, the Legislative Assembly approved with a simple 
majority the creation of a trust that will assume the government 
pension liabilities created when the system was privatized in 1996. 
The trust fund, not the government directly, will finance the legacy 
costs of the old pension system, thereby obviating the need to seek 
a qualified majority from the Legislative Assembly. 
 
¶6.  Administered by the state-owned Multisectoral Investment Bank 
(BMI), the trust will issue public securities that, based on 
additional reforms passed September 14, the private pension fund 
managers must buy.  These new securities, issued with a 25-year 
term, will pay interest at LIBOR 180 plus 75 basis points. 
According to Pension Fund Superintendent Francisco Sorto, in 2007 
the trust will issue about $1.5 billion worth of these new 
securities to buy back $850 million in old transfer securities and 
cover about $420 million in new pension obligations, leaving the 
trust with about $230 million in capital.  Although not technically 
sovereign debt, the government is betting that investors will see 
the government's obligation under the 1996 reform to pay pension 
costs as an implicit guarantee.  [Note: In the debate leading up to 
the September 14 reform, a proposal to allow the pension funds to 
buy foreign securities (up to 10 percent of the fund value) was 
derailed by PCN deputies backed by owners of the local stock 
exchange.  End note.] 
 
¶7.  In addition to political breathing room, the reform--essentially 
a refinancing exercise--eases the government's immediate fiscal 
burden.  In 2007, the government's pension costs were to have 
reached $420 million, 2.1 percent of GDP.  With the reform, costs 
for 2007 will fall to only $60 million, 0.3 percent of GDP.  Over 
the long term, as yearly payments on the 25-year bonds add up, 
pension costs will increase and peak at 1.8 percent of GDP in 2018. 
Looking to take advantage of the reform early, Technical Secretary 
Eduardo Zablah announced on September 19 that the trust would be 
established in October 2006, freeing up for other capital projects 
an estimated $96.5 million that had been budgeted in 2006 for 
pension costs. 
 
. . . But at a Cost 
------------------- 
¶8.  This financial (and political) re-engineering is not without 
detractors.  Alvaro Trigueros, a macroeconomist at prominent think 
tank FUSADES, warns that the pension reform increases the present 
value of the debt by $100 million (in other words, the sum of all 
future pension-related debt payments after the reform is $100 
million higher than before).  On the political side, some worry that 
by removing the FMLN's one legislative bargaining chip (approval of 
international financing), the left may further intensify its efforts 
to exercise power through often-violent street demonstrations. 
Meanwhile, FMLN deputies have said they will file a constitutional 
challenge against the reform in the Supreme Court. 
 
Comment 
------- 
¶9.  Government officials say the FMLN's obstructionist negotiating 
strategy on approving government debt left them with no choice but 
to create a trust to manage pension obligations.  In coming to that 
conclusion, and with an eye toward ARENA's 2009 face-off with the 
FMLN, tax increases were not on the table.  In the end, the 
government pushed-off the fiscal reform that should have accompanied 
the 1996 pension reforms for another ten years or so, gambling that 
by then political winds will have shifted to make raising taxes 
possible.  End comment. 
 
Barclay