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El Salvador-Direct Foreign Investment and External Debt

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El Salvador Index

Foreign capital, especially from the United States, played a crucial historic role in El Salvador's economic development. In the early decades of the twentieth century, foreign capital (primarily British, American, and Canadian) contributed to the development of a mining sector that produced gold and silver for external markets. Investment from these countries also spurred the development of the Salvadoran railroad and electrical systems. Between 1930 and 1950, direct investment increased for the processing of agricultural commodities and for the service sector.

The amount of foreign capital flowing into the Salvadoran economy during the 1960s and 1970s paralleled the rise and decline of the CACM. During the 1960s, foreign capital supported the development of import substitution industries, such as Alcoa's 1963 joint venture to produce semi-finished products from imported industrial extrusion ingot and Lenox's 1964 investment to produce plastic products. The strong performance of the CACM during the 1960s attracted direct foreign investment. Between 1963 and 1968, the stock of direct foreign investment increased from US$43 million to US$110 million. Between 1968 and 1978, however--the period of the CACM's decline--direct foreign investment increased to only US$124 million. In the 1970s, a larger share of direct foreign investment went to industries with low value added, like those in the industrial free zone, rather than toward import substitution industries. Until 1979 foreign capital played an important role in El Salvador's most dynamic industries, with the exception of brewing and cement. During the 1980s, capital inflows slowed in response to the country's political and economic instability. Between 1980 and 1984, foreign direct capital flowed in at a rate of about US$7 million per year.

Increased foreign investment, particularly in export-oriented industries, was an economic goal of the Duarte administration. Although the instability engendered by the civil conflict militated against it, the export promotion law of 1986 sought to attract more foreign capital by granting a ten-year (renewable for an additional ten-year period) exemption from most import duties on inputs for industries that exported at least 25 percent of their production. These industries were also exempted from all revenue and net worth taxes. In an effort to simplify the often frustrating procedure of registering foreign firms with the government, a central documentation center was established to address the needs of export-oriented firms.

Salvadoran external debt was mostly a result of extensive government borrowing after 1979, which increased the government's indebtedness from US$88 million in 1970 to US$1.5 billion in 1987. The private sector owed US$120 million to foreign creditors in 1987. El Salvador's total external debt of approximately US$1.7 billion represented less than half of the country's estimated 1987 GDP. As a share of exports, debt service rose to 37 percent from 33 percent in 1986, slightly below the debt service of other large debtor countries such as Brazil, Mexico, and Argentina. On a per capita basis, El Salvador's debt was well below that of Costa Rica, Mexico, Argentina, and Brazil.

Of the country's total 1987 debt service of US$182 million, about US$113 million went toward principal, while only US$64 million went toward interest payments. Low interest payments reflected the favorable terms associated with El Salvador's external debt. The average interest rate on the debt in 1987 was 3.1 percent, and the average maturity was thirty-nine years, with an average 8.6-year interest-free grace period. Thus, relative to other heavily indebted countries, El Salvador's external debt represented less of an obstacle to economic development. Over 90 percent of the Salvadoran debt was held by nonprivate lenders and was publicly guaranteed. Almost half of the public debt was bilateral, most of it held by the United States government. Other factors, such as the civil conflict, deteriorating terms of trade, and an antagonistic relationship between the private sector and the Duarte administration, have more adversely affected the country's economy than has the government's indebtedness.

In addition to multilateral aid from the World Bank (see Glossary) and bilateral aid, El Salvador made use of US$43 million of its IMF credit in 1987. To qualify for this credit, the government initiated a short-term structural adjustment program with limitations on credit and public sector spending and the adoption of monetary targets, unification of the exchange rate regime, the creation of new export promotion incentives, and the formation of an external debt management committee to ensure that autonomous and semiautonomous institutions did not accumulate external debt too rapidly.

Future economic development in El Salvador seemed in the late 1980s to be highly dependent on political factors. The lingering instability caused by the civil conflict inhibited investment, damaged the infrastructure, denied secure access to certain parts of the country, and forced the government to allocate an abnormally high percentage of its budget to the military. Even a complete cessation of hostilities, however, would be unlikely to lead to complete recovery in the short term, given the structural shortcomings of the economy.

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The lack of broad, accurate, and up-to-date government statistics from El Salvador is compensated for to some extent by the working relationships established in the late 1980s between the Salvadoran government and the IMF and the United States Department of State, particularly AID. Several Department of State reports compiled by the embassy staff in San Salvador provide an overview of the economy. Because Salvadoran statistical reporting to the IMF was required by the stabilization packages implemented in the mid-1980s, the IMF has reliable statistics for the country. A good source for both economic and political reporting is the quarterly Country Profile: Guatemala, El Salvador, Honduras produced in London by the Economist Intelligence Unit. A more historical perspective on the economy is provided by Marc W. Herold's article "Finanzekapital in El Salvador, 1900-80," as well as by David Browings's El Salvador: Landscape and Society. (For further information and complete citations, see Bibliography.)

Data as of November 1988

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