VZCZCXYZ0000
PP RUEHWEB

DE RUEHSN #0861/01 2001357
ZNR UUUUU ZZH
P 181357Z JUL 08
FM AMEMBASSY SAN SALVADOR
TO RUEHC/SECSTATE WASHDC PRIORITY 9818
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC

UNCLAS SAN SALVADOR 000861 
 
SENSITIVE 
SIPDIS 
 
DEPT PLEASE PASS AID/LAC, USTR 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV IBRD ES
SUBJECT: EL SALVADOR SEEKS DEBT RESTRUCTURING LOAN, NEW TAX 
REVENUES 
 
REF: A. 06 SAN SALVADOR 2351 
     ¶B. 07 SAN SALVADOR 1185 
     ¶C. 07 SAN SALVADOR 2431 
     ¶D. 07 SAN SALVADOR 2383 
 
¶1. (SBU) SUMMARY. According to a senior Ministry of Finance 
official, the Government of El Salvador (GOES) is privately 
pursuing $1.2 billion in new World Bank loans to restructure 
existing debt, prevent a fiscal crisis in 2011, and free new 
money for social spending.  The Ministry of Finance is also 
struggling to make up budget shortfalls of over $100 million 
caused by commodity price-driven subsidies.  New taxes and 
government austerity measures are expected to raise $65-70 
million, while the budget deficit is expected to increase by 
0.4-0.5% of GDP.  Separately, the state-owned hydroelectric 
authority is exploring issuing new debt to cover a projected 
$100 million shortfall caused by its electricity subsidies. 
The economic pressures are weighing heavily on the incumbent, 
pro-U.S. ARENA government that is trying hard to get 
reelected but sometimes loses its way in the process.  END 
SUMMARY. 
 
DEBT RESTRUCTURING 
------------------ 
 
¶2. (SBU) On July 14, Manuel Rosales, Advisor to the Minister 
of Finance, told Econoff that the Government of El Salvador 
(GOES) hopes to pursue $1.2 billion in loans from the World 
Bank to restructure its existing debts.  (NOTE.  El Salvador 
faces a potential fiscal crisis in 2011, when an 
approximately $650 million Eurobond comes due.) 
 
¶3. (SBU) The GOES has been privately negotiating with the 
World Bank, after previous approaches to the Inter-American 
Development Bank (IDB) and the Central American Bank for 
Economic Integration (CABEI) did not provide adequate debt 
relief.  El Salvador would receive two tranches of loans - 
$550 million to be used to pay off existing, higher interest 
debt from the IDB and other sources, and $650 million to pay 
off the 2011 Eurobond.  Minister of Finance Handal was 
briefing President Saca on the proposal the morning of July 
14, and Hacienda will not discuss the proposal publicly until 
they get the go-ahead from President Saca. 
 
¶4. (SBU) Rosales said the World Bank offered 30-year loans at 
LIBOR plus 5 basis points.  The loans include a 5-10 year 
grace period and an initial commission of 0.25%, with no 
additional commissions.  Rosales estimated that the GOES 
would save $75 million per year in 2009 and 2010 in debt 
service payments, money which could be used to finance new 
social programs.  Overall, the World Bank loans would smooth 
El Salvador's debt payments into a gradual, declining curve. 
Under the current situation, El Salvador faces three massive 
spikes from 2011, 2025, and 2036 Eurobonds. 
 
¶5. (SBU) World Bank staff told Rosales that the leftist 
opposition FMLN had approached the Bank earlier this year, 
during Presidential Candidate Mauricio Funes's visit to 
Washington, to talk about debt issues.  (NOTE: ARENA 
Presidential Candidate Rodrigo Avila is scheduled to meet 
with the World Bank during his July 16-18 visit to 
Washington.  END NOTE.)  Rosales stated that the World Bank 
would initially approach the FMLN deputies about the 
proposal, and it could be presented to the Assembly in 
mid-August.  In Rosales' view, the FMLN is "so confident that 
it will win the (March 2009) election" that it would vote for 
the proposal to ensure a strong fiscal position for its 
government.  (NOTE. New debt issuance requires a 
super-majority -- 2/3 approval -- vote in the Assembly.  The 
FMLN has opposed any new debt for the last two years, and 
some of its votes are needed to obtain that super-majority. 
END NOTE.) 
 
¶6. (SBU) Rosales "had been burned by the FMLN before" on debt 
issues, however, so the Ministry would continue to plan for 
alternatives.  If the Assembly should fail to approve this 
new loan, Rosales stated that the 2011 fiscal situation was 
not as dire as some, such as Citibank, had forecast. 
According to his projections, El Salvador should run a $100 
million surplus in the 2010 budget and a $150 million surplus 
in the 2011 budget, so the next government would only need to 
come up with $400 million to cover the 2011 Eurobond debt. 
Should no new debt be issued, he speculated, the most likely 
solution was a trust, similar to what had been established 
for the government pension fund (reftel A), and for other 
government expenditures such as education and security 
(reftel B). 
 
 
BUDGET PROBLEMS: SUBSIDIES REQUIRE NEW REVENUE 
--------------------------------------------- - 
 
¶7. (SBU) According to Rosales, tax receipts have been growing 
better than expected in 2008, but not fast enough to meet 
budget projections.  Conversely, a few policy changes have 
contributed to a drop in revenues.  First, the GOES had 
created new income tax deductions for health and education 
expenses, which caused the bulk of the decline. Second, to 
combat higher oil prices, the 1% tariff on oil imports had 
been cut to zero.  (NOTE.  However, in a move criticized by 
everyone except those receiving the subsidy, the GOES did 
impose a $0.10 per gallon tax on gasoline to pay for bus 
transportation company subsidies and is about to grant them 
another subsidy.  Reftel C.  END NOTE.)  Finally, after the 
bread bakers' protest earlier in the year, the import duties 
on wheat and flour had been cut from 10% to zero. 
 
¶8. (SBU) Rosales expected tax revenues to decline later in 
the year, however, as higher energy and food prices drive 
more consumers to shop in the informal economy, where 
value-added taxes (VAT) are seldom collected.  The tax 
authorities were stepping up enforcement, but the informal 
sector is large and disperse enough where this would have 
minimal effect.  Rosales also noted that revenues from the 
$0.20 per gallon gasoline tax, which goes to a dedicated fund 
for roads, was already down 6% for the year, as gasoline 
consumption has declined due to the high prices. 
 
¶9. (SBU) At the same time, Rosales said energy and commodity 
prices were driving up the cost of government subsidies.  At 
$140 per barrel for oil, the GOES' propane gas subsidy would 
cost an estimated $175 million.  Rosales said that the 2008 
budget had used an International Monetary Fund (IMF) estimate 
of $70 per barrel.  Similarly, the electricity subsidy for 
families who use less than 99 kilowatts per month will cost 
at least $60 million at current prices.  Separately, the 
state-owned Hydroelectric Executive Commission of Rio Lempa 
(CEL), requires at least an additional $100 million to meet 
its energy subsidy obligations (reftel D).  Overall, Rosales 
projected that El Salvador would run a deficit of 2.3%-2.4% 
of GDP for 2007, up from the budget projection of 1.9%. 
 
¶10. (SBU) The Ministry of Hacienda (Finance) was looking to 
make up the budget shortfall through a series of new 
measures.  First, the minister had instructed the Directors 
of Taxation and Customs to develop an plan to increase 
collection (Rosales had no specifics).  Second, President 
Saca had ordered all ministries to adopt an austerity 
program, which Rosales estimated would save $15 million. 
Third, the Assembly had approved a tax "amnesty," where 
penalties and interest for non-payment would be waived. 
Rosales said the previous amnesty was successful, and they 
expected at least $25 million in new tax payments from this 
one.  (NOTE. The GOES last offered an amnesty in 2004, 
shortly before the 2005 Presidential election.  END NOTE.) 
Finally, Rosales estimated that a $0.04 tax on telephone 
calls originating outside El Salvador, which has passed the 
Assembly but not yet entered into force, would raise $25-30 
million, which would directly fund the electricity subsidy. 
According to the draft law, the new telephone tax is to fund 
new social programs. 
 
¶11. (SBU) Rosales said CEL was seeking loans to cover its 
$100 million shortfall. CEL was applying for a $40 million 
loan from Central American Bank for Economic Integration 
(CABEI), and the state-owned Multisector Investment Bank 
(BMI) is investigating an international bond offering to 
raise the other $60 million.  Rosales did not specify whether 
the GOES would seek legislative approval for this new debt or 
establish a new trust. 
 
COMMENT 
------- 
 
¶12. (SBU) El Salvador faces many financial pressures: rising 
rates of inflation (9% in the first six months of the year 
versus 4.7% in 2007), slower remittance growth (about 6% 
versus double digit growth in previous years), and no short 
term end in sight to high food and fuel prices.  Its 
escalating subsidy costs combined with a slowdown in the 
economy (reduced growth projections from 5% to 3.5-4% growth) 
and more movement into the informal sector and concomitant 
reductions in fiscal revenue also spell trouble for the 
incumbent ARENA administration. 
 
¶13. (SBU) El Salvador has elections in January and March 
¶2009.  We will have a better indication of where the FMLN 
stands when it releases its fiscal and economic plan in 
mid-to-late August.  Though they have indicated a renewed 
willingness to consider multilateral financial institution 
loans, the FMLN's commitment to new loans is by no means 
assured.  Several prominent macroeconomists have described 
the 2011 debt crisis as a "political problem," not an 
economic one, but unless the two parties are able to reach 
some accommodation, it will have serious economic 
consequences for the country. 
 
¶14. (SBU) ARENA's steadfast refusal to target or reduce 
subsidies forces it to look for additional funds to pay for 
them, with the tax on incoming long distance calls only the 
latest example.  This short-sighted approach hurts El 
Salvador's long-term competitiveness and business climate, 
and the GOES risks complaints filed against it under 
CAFTA-DR.  In their preoccupation to get ARENA re-elected, 
the Saca administration is laying aside some of the good 
economic policies that helped ARENA get elected the previous 
four times. 
GLAZER