Dollarization on El Salvador

1
Dollarization on El Salvador

• Team Members
• Nixon Orellana
• Mike Scott

2
Introduction

• In 2001 El Salvador engaged in full dollarization
  to enhance its economic reform process the set of
  previous structural reforms put in place to
  support economic stability and thus attract
  foreign investors
• The expected benefits of full dollarization
  include the elimination of exchange rate risk,
  contributing to the decline of the country risk
  premium and interest rates, as well as the
  reduction of the inflation rate and inflationary
  expectations. These outcomes are expected to
  encourage foreign investment and a stable capital
  flow.

3
EL SALVADOR AT THE BEGINNING OF THE TWENTY-FIRST
CENTURY

• Since signing the Peace Accords in 1992 to end a
  12-year civil war
  
• El Salvador has moved steadily toward the
  implementation of neoliberal economic policies by
  privatizing the banking system,
  telecommunications, public pensions, and
  electrical services

4
EL SALVADOR AT THE BEGINNING OF THE TWENTY-FIRST
CENTURY

• Lowering import tariffs eliminating most price
  controls and attempting to attract foreign
  investment through infrastructure improvements
  and greater enforcement of intellectual property
  rights (U.S. Department of State 2002, 6-11).

5
EL SALVADOR AT THE BEGINNING OF THE TWENTY-FIRST
CENTURY

• On a macroeconomic scale
• Inflation has averaged only 5 percent since 1992
  
  
• total external debt was manageable, at about 23
  percent of GDP in 2001
  

6
EL SALVADOR AT THE BEGINNING OF THE TWENTY-FIRST
CENTURY

• 1.5 million Salvadorans (immigrants)
• 1.6 billion, or 60 percent, of El Salvador's
  exports annually.
  
• imports from the United States are about 2.1
  billion, resulting in a rather large trade
  deficit
  

7
EL SALVADOR AT THE BEGINNING OF THE TWENTY-FIRST
CENTURY
8
EL SALVADOR AT THE BEGINNING OF THE TWENTY-FIRST
CENTURY
9
Economics

• GDP Remitance reached the hefty sum of 1.9
  billion in 2001 (U.S. Department of State 2002,
  7). This is equivalent to almost 15 percent of
  GDP. This flow of dollars has spawned the popular
  expression in El Salvador, "our greatest export
  is our people."

10
Economics

• The Salvadoran economy is dominated by the
  service sector, which amounts to 50 percent of
  GDP, while the agricultural sector produces 24
  percent of GDP and the industrial sector only 20
  percent of GDP.
• Growth of real GDP has been slow but steady
  during the decade, ranging from 2.1 to 4.2
  percent annually (U.S. Department of State 2002,
  6).

11
Economics
12
Economics
13
Economics
14
Politics and Society
15
Politics and Society
16
El Salvador At a Glance

• Smallest country (third largest economy)
• About the size of Massachusetts
• Represents 1 of 7 independent nations
• (officially dollarized)
• 50 of population poverty line

17
Reasons for Dollarization

• Lower Interest Rates
• Decrease Inflation
• Increase foreign investment
• (other reasons)
• Next logical step (colon pegged since 93)
• Economy closely linked with U.S.
• (total exports remittances)

18
Real GDP Growth
19
What happened to economic growth?

• El Salvador faced several shocks
• Two earthquakes
• Declining international coffee prices
• Increasing oil prices
• Slowdown of U.S. economy
• Result Dampened economic growth
• expected benefits from dollarization

20
Growth Indicators

Since 2001

GDP

Exports 3 (versus 17.5 in 2000)

Foreign Direct Investment slow

-- Fixed Capital Formation 1

21
Benefits of dollarization

• Lending interest rates decreased
• 11 (2000)
• 6.3 (2004)
• Remittance inflows increased
• 2.55 billion (16 of GDP) in 04
• Inflation decreased
• 7.8 (1992-2000)
• 3 Since 2001

22
(No Transcript)
23
(No Transcript)
24
Interest Rates
25
Interest Rates
26
Downside of dollarization

• Forfeits control of money supply
• (cant finance fiscal deficit with
  seigniorage)
  
• -- limits Fiscal Policys ability to respond
• to negative shocks
• Restricts Monetary Authoritys role as
• Lender of Last Resort
• Result no safety net to stimulate growth

27
Twin Challenges

• Rising U.S. interest rates
• (--decreases C increases I)
• Greater competition from non-dollarized trading
  partners
  

28
Recommendations Challenges

• Improve education/worker training
• Provide more private investment in basic
  infrastructure programs.
  
• Raise productivity
• Lower costs