VZCZCXYZ0001
RR RUEHWEB

DE RUEHSN #0479/01 1092214
ZNR UUUUU ZZH
R 182214Z APR 08
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC 9352
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SAN SALVADOR 000479 
 
SIPDIS 
 
STATE PASS USAID/LAC 
STATE ALSO PASS USTR 
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON ETRD EINV ES
SUBJECT: INFLATION IN EL SALVADOR: PERCEPTION VS. REALITY 
 
 
¶1. Summary. Officially, El Salvador has the lowest annual inflation 
rate in Central America, but public perception is the cost of living 
is rising dramatically.  El Salvador's Consumer Price Index (CPI) is 
based on 17-year-old consumer data, and critics believe that it 
understates actual inflation.  Although the overall trend in 
inflation is likely still sound, economists agree that El Salvador 
starts from the highest base prices in the region, so even low 
inflation has a big effect on consumer confidence.  In the run-up to 
2009 elections, public perception of inflation is likely to drive 
additional populist economic policies with negative long-term 
effects.  End Summary. 
 
Inflation Today 
--------------- 
 
¶2. The official inflation rate in El Salvador remains the lowest in 
Central America, at 4.9% in 2007.  The average annual inflation rate 
from January 2000-February 2008 was 3.5%, compared to 7.2% for 
Guatemala, 8.2% for Honduras, 8.5% for Nicaragua, and 11% for Costa 
Rica.  In March 2008, El Salvador's inflation rate rose to 6%. 
 
¶3. Public perception of inflation, however, is far different.  In a 
recent poll conducted by national newspaper "La Prensa Grafica," 84 
percent of Salvadorans think that the cost of living in the country 
is bad or very bad.  Complaints about the rising cost of living are 
commonplace, and increases in the price of gasoline and the price of 
beans make the front page of the national press. 
 
Official Measures of Inflation 
------------------------------ 
 
¶4. The Census and Statistics General Directorate of the Ministry of 
Economy (DIGESTYC) compiles the official consumer price index (CPI). 
According to Miguel Angel Corleto, director of DIGESTYC, The CPI 
uses a market basket based on a 1990-1991 Expenditures & Income 
Survey, with a base of December 1992.  This basket is composed of 
241 goods and services which reflect the average patterns of 
consumption of an urban household of 3.9 members.  In this index, 
foods and beverages have a weight of 33.49%, while transportation 
has a weight of 10.35%. 
 
¶5. With the assistance of the Swedish Agency for International 
Development, DIGESTYC is developing a new CPI based on the 
Expenditures and Income Survey of 2005-2006. DIGESTYC began 
internally tracking the new CPI in September 2007 and will replace 
the current CPI in January 2009.  According to DIGESTYC, the new CPI 
is a higher quality index with improved geographical coverage and 
content. The index will maintain the same number of goods and 
services (241), but the specific goods and services are updated to 
reflect current consumption.  For example, it drops black & white 
TVs and wax candles and adds cell phones and cable TV service. 
According to DIGESTYC, the results of the current and the new CPIs 
are similar, demonstrating the same overall trends. 
 
¶6. DIGESTYC also tracks a "basic basket" for both urban and rural 
areas.  The basic basket is based on a nutritionist's assessment of 
the minimum caloric and nutritional requirements for an urban or a 
rural Salvadoran family.  These nutritional requirements are then 
matched up against "typical" food products, which form the basic 
basket.  Because the basic basket is derived from nutritional 
requirements rather than consumption surveys, it does not 
necessarily reflect actual consumption or goods purchased. 
Regardless, the basic basket is widely cited as a measure for cost 
of living, especially for the poor. 
 
Criticisms & Causes 
------------------- 
 
¶7.  The most common criticism of the CPI is that it is a dated 
measurement that doesn't reflect El Salvador today.  According to 
Dr. Roberto Rubio, head of the moderate-left NGO Foundation for 
Development (FUNDE), the current CPI is too dated in both its 
products and in the weight given to different parts of the basket. 
 
Armando Flores, director of the private Consumer Defense Center 
(CDC), goes one step further, arguing that national statistics are 
fundamentally flawed and therefore the official inflation rate is 
questionable.  Using their own measure, the CDC estimated that the 
price of the rural basic basket increased by 27% and the urban basic 
basket increased by 25% between May 2004 and January 2008, and 
difference between rural and urban appears to be gowing in 2008. 
Prices of key staples greatly inceased during 2007. For example, 
the price of beas increased by 68%, the price of rice by 56.2%, and 
the price of corn by 37.5%.  Flores noted that te current rural 
minimum salary only covers aroun 72% of the rural basic basket, 
while the urban inimum salary covers around 120% of the basic 
baket.  According to World Food Program estimates, the actual 
 
calorie intake of an average meal in rural El Salvador today is 
roughly 60% of what it was in May 2006, leading to increased 
under-nourishment. 
 
¶8. According to Alvaro Trigueros Arguello, Macroeconomic Section 
Manager, and Rafael Pleitez Chaves, Social Section Manager at the 
Salvadoran Foundation for Economic and Social Development (FUSADES), 
El Salvador's most prominent think tank, DIGESTYC's figures are 
good, but the cumulative effect of inflation has taken a toll on 
people's pocketbooks.  Arguello noted that, by official measures, 
the cost of living has gone up 19.5% over the last four years, so 
public perception is not necessarily inconsistent with official 
figures.  According to FUSADES public opinion research, there is 
also a strong correlation between higher gasoline prices and lower 
consumer confidence. 
 
¶9. Former Finance Minister Manuel Enrique Hinds also attributed most 
of El Salvador's inflation to external factors, primarily world 
commodity prices.  He saw a strong correlation between the U.S. 
current account deficit and commodity prices, which he thought would 
correct as the current account deficit fell.  Nevertheless, Hinds 
expected commodity prices to remain high for at least 2 to 5 years. 
In his view, rising food prices were the biggest single threat to El 
Salvador's economy, but there was "nothing" the government or other 
actors could do. 
 
¶10. DIGESTYC, Rubio, and Flores all agreed that one reason 
Salvadorans perceive inflation to be high is that El Salvador starts 
from the highest prices in the region.  A 5% increase in prices in 
El Salvador will therefore be felt a lot more than a 10% increase in 
neighboring Honduras, where most prices are lower.  Rubio and Flores 
both blame the lack of competition in El Salvador, especially an 
oligopolistic market in several sectors (air transportation, cement, 
flour, and beer), for the higher prices.  DIGESTYC attributed the 
higher prices to the need for El Salvador to import most of its 
products. 
 
¶11. Many in the public blame dollarization for higher prices.  Rubio 
said that the higher initial prices in El Salvador have been more 
noticeable since dollarization, which is why people associate higher 
prices with dollarization.  Beyond some "rounding" when prices were 
dollarized in January 2001, however, none of the think tanks or 
economists attributed inflation to dollarization. 
 
¶12. FUSADES has been developing a theoretical model that tries to 
explain the relationship between inflation rate, exchange 
rate/dollarization, and remittances.  Looking at the last seven 
years, they found that inflation is primarily a function of three 
factors: "imported" inflation from the U.S., oil prices, and 
remittances.  According to their model, the growth of remittances 
explains a major part of the changes in the inflation rate in El 
Salvador, and as the rate of remittance growth decreases, El 
Salvador's inflation rate should converge with the U.S. inflation 
rate. 
 
Comment 
------- 
 
¶13.  El Salvador's official inflation rate is based on a dated CPI, 
and the actual inflation rate is likely somewhat higher than 
official statistics.  Nevertheless, under a new measure, El 
Salvador's inflation rate should still be the lowest in the region. 
As a dollarized economy, El Salvador avoids politically motivated, 
inflationary monetary policy, a fact noted by economists on both the 
left and right.  Likewise, the main factors driving inflation - 
higher international oil and food prices - affect the entire region. 
 El Salvador does, however, have among the highest prices in the 
region on many goods, and so even a small increase in inflation is 
noticed by the public.  Further, consumer take little solace in 
knowing that prices they are paying may be going up slower than 
prices in neighboring countries.  What they tend to focus on is that 
prices are going up, and in certain instances way up. 
 
¶14.  Public perception of the cost of living is unlikely to change 
in the near future, and the real risk is that this will lead the 
government to implement unsound economic policies in an effort to 
"do something" before January and March 2009 elections.  President 
Saca's description of a "perfect storm" of slower U.S. growth and 
high energy and food prices could presage further government 
intervention.  Already the government has adopted some price 
controls/price freezes in sectors like electricity and introduced 
untargeted transportation subsidies that economists across the 
political spectrum deride.  In the longer term, these policies 
distort the market and may have a negative effect on foreign 
investment.  If food and oil prices continue to rise, it is probable 
that we will see additional, politically motivated economic policies 
trying to shore up consumer confidence and ARENA's electoral 
prospects. 
 
Butler