Country Report El Salvador 1st Quarter 2015

Update Country Report El Salvador 30 Dec 2014

Latin America — Key issues in 2015

The outlook for Latin America in 2015 appears fairly subdued as the region continues to struggle to emerge from a period of below-average growth against the backdrop of the continuously disappointing economic performances of Brazil and Mexico, outright contractions in Argentina and Venezuela, and the deceleration of previously very dynamic, commodities-driven economies, such as Peru and Chile. After growing at an average 2.7% in 2012-13, regional GDP decelerated to an estimated 1.5% in 2014, the worst performance since 2009 for Latin America. We expect growth to pick up slightly in 2015, to 2.6%, setting the scene for a more solid performance in 2016-19 (with annual average growth of 3.3%), amid resilient domestic demand, some progress in structural reforms and increased investment, as well as a more positive external outlook. However, this will be well below post-crisis highs of over 5% in 2010-11 and a host of external and domestic challenges will continue to test the resilience of the region in the short term.

Panama, the Dominican Republic and Peru will post Latin America's best performances in 2015 (with growth of 5.5%, 4.8% and 4.5%, respectively) while Venezuela, Argentina and Brazil will lag behind (a 1.8% contraction, and growth of only 0.3% and 0.8%, respectively), constraining regional growth. The outlook for Nicaragua, Bolivia, Paraguay and Costa Rica is also quite positive, with forecast growth rates above 4%. Mexico (3.3%) will post a better performance than Brazil and its medium-to-long-term prospects appear fairly solid, provided the ambitious growth-enhancing structural reforms adopted in 2013-14 are fully implemented, but risks abound for the country on the political front.

Despite a better performance expected by the region in 2015 and its increased resilience to external shocks than in the recent past, against the backdrop of better macroeconomic fundamentals and copious international reserves (an estimated US$882.9bn in 2014), a number of external and domestic factors weigh on the outlook, as follows.

Monetary-policy normalisation in the US

After a painfully slow recovery, the US economy appears to be going from strength to strength, amid booming consumer demands, accelerating job creation, improving business confidence and increased public investment. We forecast growth to pick up to 3.3% in 2015, from 2.2% this year. As Japan and the euro zone introduce new stimulus measures to shore up their economies, the Federal Reserve (the Fed, the US central bank) is preparing to raise interest rates, after having completed the tapering of its massive bond-buying programme in October. This has the potential to draw some capital away from Latin America, stoking renewed volatility in international capital markets. Tighter global-financing conditions and increased attractiveness of the US and other OECD economies will make for a more challenging environment for attracting investment and financing, with the region's competitiveness shortcomings increasingly under scrutiny from potential investors.

Euro zone faces continuing economic woes

The Euro zone, one of Latin America's main trading and investment partners, remains mired in slow growth (with unemployment falling to an extent, but still high, at over 11%), amid continuously elevated debt levels, strained budgets and sour political mood. The Russia-Ukraine crisis has also damaged investor sentiment in Northern European economies, including Germany. Although economies in the periphery, like Spain, are doing better, they are too small to fully offset weaknesses in Italy, France and Germany. GDP expanded by an anaemic 0.8% this year and will remain subdued, at 1.1% in 2015, affecting Latin America via muted trade, credit, tourism and investment.

China's new growth paradigm and weaker commodities prices

Growth in China will continue to decelerate in 2015, to 7.1% from an estimated 7.3% this year, amid the government's efforts to clamp down on rising levels of debt and reckless bank lending and to shift to a more balanced growth model, based on household consumption, rather than exports and investment. GDP growth will slow further in the forecast period, falling to a record 5.5% low in 2019. China is an increasingly key market and source of foreign direct investment (FDI) and financing for Latin America, and its weaker pace of expansion will continue to reduce, in particular, tailwinds enjoyed by South American commodity exporters in 2003-11. Although we do not envisage a complete collapse in commodity prices-these will continue to be supported by infrastructure-related demand in many emerging markets-commodities exporters in the region and beyond will no longer enjoy the cumulative annual gains in terms of trade experienced in recent years. This will strengthen the case for domestic reforms to boost productivity as a way to ensure sustained growth going forward. Although a boost for oil importers, the recent slump in oil prices, if prolonged, will also pose significant challenges for oil exporters in the region, in particular Venezuela, which is already struggling with severe domestic macroeconomic distortions.

Only slow progress on structural reforms

Latin America has consistently underperformed in comparison with other emerging economies in the recent past, in terms of its growth rate and potential, and our forecasts are for it to continue to do so, especially given the end of the commodities boom. This partly reflects Latin America's reduced scope for catch-up with developed-country income levels, but also the region's entrenched structural-competitiveness flaws, which constrain productivity and growth rates.

Reforms to broaden the tax base, notably by tackling widespread informality, are needed to boost government revenue, and tax systems could do with some simplification. According to the OECD, tax revenue in Latin America totalled 20.7% of GDP in 2012, up from 13.9% in 1990, but this was still low compared with the OECD average of 34.6%. The region also remains over-reliant on indirect taxes-which are especially regressive and inimical to the strengthening of domestic markets in a region with high poverty rates-and on commodity exports, which leave the public finances exposed to external shocks. A further liberalisation of the factors markets (notably by improving competition in the goods and services markets and increasing the flexibility of labour markets) will also increase the region's attractiveness to foreign investors. Poor infrastructure also remains a crucial bottleneck for regional growth, with public investment in infrastructure never having recovered from the substantial cuts made under the stabilisation programmes of the 1990s, and public-private partnerships (PPPs) not completely making up for the resulting infrastructure-financing gap.

The quality of education also remains a concern, as highlighted by the OECD's most recent Programme for International Student Assessment (PISA) survey. Progress on competitiveness-enhancing reforms has been piecemeal so far, amid a lack of political appetite in fragmented legislatures and little incentive to improve fundamentals amid exceptionally favourable external conditions (high commodities prices and unprecedented international liquidity). While Mexico has adopted a comprehensive structural-reform package in 2013, most countries have lagged behind on competitiveness reforms. We expect advances in reinforcing competitiveness fundamentals to gather some momentum in the forecast period, driven by an increasingly pressing need to boost the region's attractiveness against the backdrop of increased competition for investment, and demands for better services and more efficient governments from an increasingly vocal civil society.

Social unrest to trouble political outlook

Social unrest will continue to simmer-and occasionally boil over-in the region, amid growing frustration over governance flaws and poor government effectiveness, as well as concerns around projects involving natural resources, particularly in the Andes and Central America. Widespread corruption, in particular, will remain a major grievance for citizens in the region. According to the Corruption Perceptions Index 2014, recently released by anti-corruption watchdog, Transparency International, 18 of the 29 Latin American countries covered in its sample of 175 economies are placed in the bottom half of the rankings, with only Barbados and Uruguay (tied at 17th) making the top 20. While the index highlights Venezuela, Haiti (tied at 161st) and Paraguay (150th) as the regional laggards, perceptions of high corruption also plague regional giants such as Mexico (103rd) and, to a lesser extent, Brazil (69th). Mexico, notably, is currently facing a major political crisis following the disappearance (and presumed murder) of 43 students on September 26th, in the city of Iguala, Guerrero state. Evidence that municipal police had kidnapped the students and handed them over to a local drug cartel, known as Guerreros Unidos, were met with widespread outrage and provoked some of the largest protests seen in generations in Mexico, demanding that the president, Enrique Peña Nieto, step down. The crisis has also been exacerbated by a major scandal involving the first lady, and a US$7m home transferred to her by a media giant, Televisa, in 2010 and registered under a company associated with a Chinese-led consortium that was awarded a now-cancelled tender to build a high-speed railway. The events have highlighted the severity of institutional flaws at local and state level in Mexico and the presentation of a new ten-point security policy by Mr Peña Nieto has failed to quell social unrest. It is unlikely that the crisis will be defused without a major shake-up of the cabinet and a credible strategy for combating corruption in 2015.

Other episodes of social mobilisation have taken place in Brazil, Venezuela, Peru and Argentina during the course of 2014, exposing a wider crisis of representation and decreasing trust in the political class. Social conflicts over control and use of natural resources, as well as a backlash against mining activities and foreign investors' involvement, have also continued across the region, amid concerns of the rural poor and indigenous communities over how extractive projects will affect their livelihoods and the environment.

Levels of crime and violence to remain high

Latin America is likely to remain among the most violent regions in the world; it had an average of 25 murders per 100,000 population in 2012, compared with a global average of 6.2 per 100,000 according to the UN Office on Drugs and Crime's (UNODC) latest data. Crime will be particularly concerning in Mexico, Central America and the Caribbean, with drug-trafficking the central element. Given that hardline security policies have not always yielded the desired results, the debate on different or additional courses of action is likely to continue. This will include a focus on prevention, but also drug decriminalisation, following the lead of Uruguay. Persistently high crime rates will continue to discourage private investment, increase business-operating costs, and divert government expenditure from other social and economic needs. Inadequate domestic police forces and judicial institutions will struggle to contain the crime epidemic, and this will continue to fuel state corruption and undermine trust in democratic governance.

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