VZCZCXRO8803
RR RUEHLMC
DE RUEHSN #0131/01 0252138
ZNR UUUUU ZZH
R 252138Z JAN 07
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC 4976
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP

UNCLAS SECTION 01 OF 03 SAN SALVADOR 000131 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USAID/LAC 
STATE ALSO PASS USTR 
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN 
3134/ITA/USFCS/OIO/WH/PKESHISHIAN/BARTHUR 
 
E.O. 12958: N/A 
TAGS: ECON ETRD EINV ES
SUBJECT: SALVADORAN ECONOMY SHOWS SIGNS OF LIFE 
 
REFS: A) 06 SAN SALVADOR 2996; B) 06 SAN SALVADOR 2871; C) 06 SAN 
 
SALVADOR 2756; D) 06 SAN SALVADOR 2543; E) 06 SAN SALVADOR 2475; F) 
06 SAN SALVADOR 1131; G) 06 SAN SALVADOR 402; H) 06 SAN SALVADOR 
353; I) 06 SAN SALVADOR 95; J) 05 SAN SALVADOR 113 
 
Summary 
------- 
¶1.  (SBU) The Salvadoran economy grew 4.2 percent in 2006, ending a 
six-year streak of anemic economic growth.  President Saca has 
expanded on the sound economic policy of his predecessors to 
implement a sectoral growth strategy that positions El Salvador as a 
logistics hub in the medium term, with agriculture, tourism, and 
full-package apparel assembly (maquila) pushing growth in the short 
term.  He has expanded social services through the creation of 
FOSALUD, a network of public health clinics, and Red Solidaria, a 
poverty alleviation program.  Both CAFTA-DR implementation and the 
recently approved MCC compact are also important components of 
Saca's strategy on economic and social issues.  However, maintaining 
economic growth and alleviating poverty in the run-up to 2009 
elections will require new investment, which in years past has been 
deterred by the security situation as well as regulatory and 
competition issues, El Salvador's limited domestic market, and a 
lack of small business financing.  End summary. 
 
GDP up 4.2 Percent in 2006 
-------------------------- 
¶2.  (U) Showing signs of life after six years of growth that never 
exceeded 2.8 percent and was as low as 1.7 percent, the Salvadoran 
economy grew 4.2 percent in 2006, according to the Central Bank. 
The agricultural sector led the way in 2006, growing 7.1 percent. 
Other leading sectors were transportation and communication, which 
grew 5.3 percent, and services, which grew 4.9 percent.  Industry 
and manufacturing grew 3.2 percent in 2006 according to the Central 
Bank, despite a 10.1 percent contraction in the apparel assembly 
(maquila) subsector.  For 2007, the Saca Administration projects 
growth of 4.5 percent.  Meanwhile, the results of a Ministry of 
Economy household survey released in December 2006 suggest that 
there has been little recent progress on poverty alleviation, with 
35.2 percent of households living in poverty, up from 34.6 percent 
in 2004.  Overall, there has been good progress on poverty 
alleviation since the Peace Accords were signed in 1992, when the 
poverty rate was 58.7 percent 
 
¶3.  (U) Annual inflation in 2006 was only 4.3 percent, thanks to 
dollarization and fiscal discipline that kept the government deficit 
at 2.7 percent of GDP.  Interest rates also remained low, with banks 
lending at an average of 7.6 percent annual interest for a one-year 
period.  Remittances continued to grow in 2006, increasing to $3.3 
billion from $2.8 billion the previous year.  Imports were up 13.1 
percent for the first 11 months of 2006, reflecting higher fuel 
prices as well as increased imports of consumer goods.  Exports, 
meanwhile, grew 4.3 percent over the same period. 
 
Saca Making Good on Economic Agenda 
----------------------------------- 
¶4.  (U) In a marked departure from the strictly laissez-faire 
economic policies of his ARENA predecessors, after taking office in 
June 2004 President Saca announced an economic growth strategy that 
bet on El Salvador becoming a logistics hub in the medium term, with 
agriculture, tourism, and full-package apparel assembly (maquila) 
pushing growth in the short term.  He also continued the efforts of 
previous governments to facilitate private-sector-led growth, 
especially through CAFTA-DR implementation. 
 
¶5.  (U) The Saca Administration has made considerable progress in 
carrying out that agenda.  Infrastructure improvements to become a 
logistics hub are already underway, including construction of a $169 
million port in La Union that can handle post-Panamax ships; 
construction will be completed in 2009.  There are also plans to 
build a new cargo facility at Compalapa airport that would build on 
TACA's already large passenger hub and cement El Salvador's 
leadership in regional aviation.  Another important infrastructure 
improvement is the road funded by the Millennium Challenge 
Corporation (MCC) to be built across the northern part of the 
country.  Customs officials are also moving forward with USAID 
funded CAFTA-DR reforms to speed cargo handling (Ref. G). 
 
¶6.  (U) Growth in the agricultural sector has benefited from a 
Ministry of Agriculture program to provide farmers with improved 
seeds for basic grains, but more important factors in 2006 were good 
weather, higher prices for sugar and coffee, and expanded 
cultivation of fresh fruits and vegetables.  Tourism, meanwhile has 
received a boost from a new tax exemption for investments in that 
sector (Ref. I).  The private sector has responded by adding nearly 
 
SAN SALVAD 00000131  002 OF 003 
 
 
1,000 new hotel rooms, and the Tourism Ministry reports that tourist 
spending is up 37 percent.  Apparel assembly (maquila) has not fared 
as well, however, and exports have fallen 10.8 percent during the 
first 11 months of 2006 compared to 2005, due in part to sourcing 
difficulties triggered by CAFTA-DR's staggered entry into force but 
also due to increased competition from China (Ref. E). 
 
¶7.  (U) CAFTA-DR entered into force for El Salvador and the United 
States on March 1, 2006.  The Saca Administration views the 
agreement, and its open-market trade policy, as a critical element 
of El Salvador's economic growth strategy.  The agreement has been 
important to maintaining apparel assembly (maquila) investment in 
the face of Chinese competition, and it is already paying dividends 
for exporters of processed foods, sugar, and ethyl alcohol (Ref. D). 
 Officials at El Salvador's export promotion agency, EXPORTA, are 
confident investors will take advantage of opportunities in other 
sectors within the next few years.  Perhaps as important as the 
trade benefits are the opportunities for institutional 
strengthening, especially in the area of investment dispute 
resolution, intellectual property rights, customs administration, 
and labor and environmental law enforcement. 
 
Follow Through on Social Agenda as well 
--------------------------------------- 
¶8.  (U) After taking office, President Saca promised an expansion of 
social programs, signaling a more direct role for the government in 
poverty alleviation efforts.  To a large extent he has followed 
through on that promise.  Three initiatives stand out--FOSALUD, Red 
Solidaria, and the MCA Compact.  FOSALUD, the Solidarity Fund for 
Health, was launched in December 2004 to extend basic healthcare 
services to underserved populations and ease overcrowding in 
national hospitals (Ref. J).  Funded by a sin tax that raised about 
$20 million in 2005 and as much again in 2006, FOSALUD has opened 
105 clinics to date. 
 
¶9.  (U) Red Solidaria, the Solidarity Network, is a poverty 
alleviation program launched in March 2005 to provide assistance in 
the poorest 32 municipalities in El Salvador, all of which have 
poverty rates of above 50 percent (Ref. F).  Families participate in 
public health programs and enroll their children in school in 
exchange for direct monetary support of $15-20 month.  Red Solidaria 
is also improving basic infrastructure such as water, roads, 
electricity, and housing.  The final component includes projects to 
improve agricultural productivity and to support microfinancing. 
Although funding has been in question thanks to ostensible FMLN 
concern that a World Bank loan in support of the effort would 
further indebt the government (Ref. C), Red Solidaria has now begun 
working in all 32 targeted municipalities, providing support to an 
estimated 24,000 families. 
 
¶10.  (U) Early in his term, President Saca recognized the 
significant role the MCC could play in developing El Salvador's 
northern zone.  On November 29, 2006, the Government of El Salvador 
and the Millennium signed a five-year, $461 million compact that 
seeks to stimulate economic growth and reduce poverty in the 
country's northern region.  The 291 kilometer northern road is the 
focus of most headlines, but MCC will also build 240 kilometers in 
connecting roads and support rural electrification, water 
sanitation, vocational training, and business development (Ref. A). 
 
 
Comment: Challenges and Opportunities 
------------------------------------- 
¶11.  (U) President Saca has expanded on the sound economic policy of 
his predecessors to implement a sectoral growth strategy and expand 
social services--while maintaining fiscal discipline.  This year's 
4.2 percent growth suggests that strategy is paying off, but El 
Salvador needs new investment to maintain this positive momentum and 
ensure that the benefits of growth are broadly distributed to 
address poverty.  In 2006, there was negligible foreign investment 
inflow--the only exception was a Guatemalan bank's purchase of Banco 
Americano, a failing local bank.  Gross capital formation, a 
measurement of overall investment, was only 15.2 percent in 2005, 
the lowest in the region. 
 
¶12.  (SBU) Several factors explain the lack of investment in El 
Salvador.  Violent crime, which President Saca appears ready to 
address, is the most significant deterrent to new investment, and it 
poses enormous costs for businesses already in operation (Ref. H). 
One large U.S. investor may open a plant that would employ up to 
6,000 Salvadorans, but the firm has lingering concerns about 
security.  Ongoing regulatory uncertainty in the electricity sector 
and recent calls for price controls in fuel distribution also deter 
investment. 
 
SAN SALVAD 00000131  003.2 OF 003 
 
 
 
¶13.  (SBU) The small size of the Salvadoran economy and 
anticompetitive practices in some sectors are other factors that 
hinder investment.  Outside of commercial and residential real 
estate developments that seek to tap into remittances, local 
investors are looking beyond El Salvador for new opportunities. 
Finally, a lack of credit for small businesses also hinders 
investment.  The banking sector continues to undergo significant 
restructuring as multinationals acquire local banks.  We are hopeful 
that these new banks will bring with them new approaches to dealing 
with small businesses and also push forward pending legislation to 
modernize the regulation of the financial sector (Ref. B).  Dealing 
with some or all of these constraints on investment will be key to 
achieving 4.5 percent growth for 2007 and making additional progress 
on poverty alleviation, especially before the 2009 elections.  End 
comment. 
 
Butler