EL SALVADOR: A BELEAGUERED ECONOMY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00552R000200170003-8
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 23
• Document Creation Date: December 22, 2016
• Document Release Date: January 28, 2011
• Sequence Number: 3
• Publication Date: June 1, 1983
• Content Type: REPORT

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Directorate of Confident
Intelligence
El Salvador:
A Beleaguered Economy
onfidelliffir
ALA 83-10091
June 1983
Copy 3 6 8
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Directorate of Confidential
Intelligence
El Salvador:
A Beleaguered Economy
This paper was prepared bye Office of
African and Latin American Analysis. It was
coordinated with the National Intelligence
Council.
Comments and queries are welcome and may be
directed to the Chief, Middle America-Caribbean
Division, ALA,
Confidential
ALA 83-10091
June 1983
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El Salvador:
A Beleaguered Economy 25X1
Key Judgments El Salvador's economy declined for the fourth straight year in 1982,
Information available leaving it 25 percent smaller in real terms than in 1978, the last year of rel-
as of 1 May 1983 ative political stability. Hope for improved conditions, sparked by the
was used in this report.
massive popular rejection of the insurgents at the polls in March 1982, was
shortly snuffed out by a resurgence of guerrilla violence and a deepening of
world recession. Because of badly slumping export earnings, pressures on
already meager foreign exchange reserves intensified despite major foreign
assistance receipts.
Worsening political and security trends since the summer of 1982 have
undermined business confidence and have made the livelihoods of most
Salvadorans considerably more difficult. A rise in terrorist attacks,
primarily on power or transportation networks and agricultural harvests,
and uncertainty regarding government policies have discouraged the
private sector. These factors, coupled with inadequate supplies of foreign
exchange, have caused gross investment to sag-hitting a new low of
roughly 11 percent of GDP in 1982. Meanwhile, declining industrial and
agricultural output have pushed El Salvador's unemployment rate above 30
percent
We believe the outlook for the economy this year and next remains bleak,
as past key impediments to growth persist. Huge world stocks and
continued weak prices probably will prevent significant increases in foreign
coffee sales, the mainstay of Salvadoran exports. Foreign assistance flows
probably will not be appreciably higher than, and may not even match, the
$475 million level of 1982. Many industrialized countries want to avoid
appearing politically supportive of the present government in its struggle
against the insurgents and, therefore, will not contribute sizable amounts
of assistance. Finally, the guerrillas have demonstrated by their heightened
aggressiveness in recent months their capability extensively to disrupt
economic activity, especially in the eastern third of the country. Unless the
government finds a way to reduce this capability, El Salvador's economic
slide probably will continue through this year and next.
In our view, any major escalation of the insurgency, resulting in wide-
spread guerrilla control of the countryside closer to San Salvador, probably
would have a swift and disastrous effect on the economy. The effects of
such a development would be evident in-among other things-a dissolu-
tion of remaining business confidence and acceleration of capital flight. In
that event, efforts by San Salvador to pursue its struggle against the
Confidential
ALA 83-10091
June 1983
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Confidential
guerrillas, to meet emergency needs, and to prevent an economic tailspin
would require enormous foreign financial assistance, probably a multiple of
the amount presently committed. Even so, little-if any-gains could be
expected in the country's development programs.
On the other hand, we believe a significantly reduced guerrilla threat and
progress toward political democratization would rejuvenate the private
sector, but only slowly. The economy would realize some short-term gains,
such as those that could be expected from significantly reduced power
outages and lower crop losses. Landowners and businessmen also would be
encouraged to revive their investment in capital stock, but progress would
necessarily be deliberate until they were convinced that the more stable
conditions were permanent. Under these favorable circumstances, the level
of foreign financing now envisaged probably would be enough to support an
economic recovery this year and next.
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Key Judgments iii
The Passing of a Growth Era I
Crippling Blows to the Economy
2
Dashed Hopes for 1982
2
Favorable Signs Evaporate
2
Scarce Foreign Exchange and the IMF
5
Disappointing Domestic Performance
6
Prospects for 1983 and 1984
7
Scenario I-No Major Changes in Military or Political Situation
10
Scenario II-Military and Political Conditions Deteriorate Sharply
10
Scenario III-Improved Military and Political Conditions
11
A Look Beyond 1984
11
Methodological Notes on Economic Forecasts
13
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El Salvador: Economic Activity
Boundary representation is
not necessarily authoritative.
eothermal - o `~~
A >Ana~u c-,. Rio Lempa
AhuachagP n - L. (~ (i - nCabanas
Ah h :flan ~~ ~~ ~Lrbertacv~ )VC.~ v \. 1 i
S
on lqnaaan
~
.
a
.
Sonsonate .! 1 L }' SAN SALVADOR M, ueI
~'Q^
Sonsor' San V~cent~ ~~
Nueva 'San Vicente
Sa LSa{vador ; t "
Aca utla~ 2rrro, i H Zacatecoluca
i- ^ tea` ~_ J f, $ ' `~~ Us a! ~~ J La Union
~t~ ax" l San, / !e
Miguel,
9Cement
*Coffee processing
0 Food processing
Footwear and clothing
Thermal power plant
Hydroelectric plant
Ir Leather goods
Metal
1 Petroleum refining
Sugar refining
Textiles
Usulutan~
8 Vegetable oil processing
n d ur
25X1
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El Salvador:
A Beleaguered Economy
El Salvador's prolonged economic tailspin is deepen-
ing the government's already grave political and
military problems. The shrinking economy is:
? Eroding San Salvador's revenue base for covering
critical defense, land reform, and social service
needs.
? Undercutting the private sector's willingness to
persevere.
? Threatening to wear down popular support for the
government's struggle against the insurgents.
This relationship is complicated, in turn, by the
feedback of political instability on the economy,
causing its further deterioration.
Large flows of foreign assistance are essential to
break the mutually reinforcing cycle of political-
military instability and economic decline. Sluggish
foreign demand for Salvadoran exports further accen-
Table 1
El Salvador:
Gross Fixed Investment Formation
Gross Fixed Private Invest- Public Investment
Investment as a ment as a Share as a Share of
Share of GDP of Gross Fixed Gross Fixed
Investment Investment
1960
14.4
80
20
1970
11.6
79
21
1973
15.6
72
28
1975
23.0
66
34
1977
21.2
65
35
1978
23.3
70
30
1979
18.6
64
36
1980
12.4
46
54
1981
13.1
46
54
1982
11.0
49
51
tuates the country's financial needs
In this paper, we review the factors that have sapped
private-sector confidence and caused the severe eco-
nomic downturn, and we note the consequent growing
importance of foreign financial assistance. In this
regard, we suggest the magnitude of the impact of
differing political-military conditions this year and
next on foreign assistance requirements and economic
growth.
Substantial Growth but Uneven Benefits
Between 1960 and 1978, Salvadoran production ex-
panded at a relatively brisk 5.4-percent annual pace.
Growth was driven largely by hefty rises in exports of
both manufactured goods, such as textiles and metal
products, to regional markets within the newly creat-
ed Central American Common Market (CACM) and
agricultural products-coffee, cotton, and sugar-to
the United States, especially during the commodity
price booms of the 1970s. Meanwhile, gross capital
25X1
25X1
formation, mostly private investment in the industrial 25X1
sector, nearly doubled as a share of GDP, reaching 23
percent in 1978.
El Salvador's small but powerful economic oligarchy
reaped most of the gains, however, while the far more
numerous poor benefited little. Chronically high un-
employment and underemployment reflected not only
the country's overcrowded population but a highly
concentrated land ownership and use pattern that
provided only subsistence living for most landowners
and afforded hundreds of thousands of landless peas-
ants only seasonal opportunities for work. Moreover,
despite average yearly increases in per capita income
exceeding 2 percent during the period, real wages of
urban industrial and rural agricultural workers ap-
pear to have declined.
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Crippling Blows to the Economy
Beginning in 1979, El Salvador's economy was bat-
tered by a series of internal and external shocks that
resulted in a 20-percent decline in real output for the
three years ending in 1981. The most destructive
shock was the escalation of civil violence into full-
fledged insurgency. Antigovernment guerrillas de-
stroyed or damaged productive capacity and seriously
disrupted industrial, agricultural, and commercial ac-
tivity. Sagging business confidence led to the closure
of factories-especially in the labor-intensive textiles,
apparel, and metal products industries-throughout
the country, a sharp decline in private investment, and
massive capital flight. According to the US Embassy,
by 1981 the insurgents had viewed economic deterio-
ration to be a key ingredient in their strategy to
destabilize the government.
In the spring of 1980, a new military junta introduced
a series of far-reaching reforms that inadvertently
compounded the country's economic difficulties.' The
package of reforms-including land redistribution,
nationalization of banks, and establishment of govern-
ment monopolies for marketing coffee and sugar-
was intended to defuse, leftist violence and to promote
economic diversification. Because implementation of
the land reform in particular was poorly planned and
not adequately supported by government technical
and credit assistance, the reforms further set back
production of cash crops. Delays in implementing
Phase I in the land reform's early days because of
insufficient preparation enabled large estate owners to
remove considerable amounts of machinery and live-
stock. Later, indecisiveness regarding implementation
of Phase II caused widespread uncertainty about
future land ownership and has resulted in substantial
abandonment of farm operations.
Meanwhile, external developments were adding to the
economy's woes. El Salvador suffered a sharp deterio-
ration in its terms of trade with the near tripling of
the price of imported oil during 1979-81 and the
precipitous drop in the price of coffee, the commodity
that consistently had accounted for more than one-
half of the country's export earnings. Its previously
fast-growing exports of labor-intensive manufactur-
ers, such as textiles and apparel to neighboring coun-
tries, also fell off as economic activity in the region
began to falter. The resulting drop in export earnings,
coupled with increases in the net outflow of private
capital, offset by a wide margin a 15-percent average
annual rise in foreign official assistance. To minimize
the cuts in imports El Salvador was forced to accept,
the government drew down its net international re-
serves (gross reserves minus short-term obligations)
from $252 million in 1978 to $233 million in the red
by the end of 1981
Aside from the reforms, the junta began to play an
unprecedented role in managing the economy in other
ways. To shore up aggregate demand and boost
employment, the government in 1980 instituted a
major expenditure program, known as the National
Emergency.Plan. The US Embassy reported that San
Salvador hiked wage rates, expanded public construc-
tion, channeled larger sums of subsidized credit to the
private sector, and increased defense spending.
Though forced by growing inflation and balance-of-
payments deficits to shift somewhat toward austerity
in 1981, the government's preeminent position in the
economy held. In 1980 and 1981 the public sector for
the first time contributed more than one-half of fixed
investment. As an unfortunate outgrowth of the gov-
ernment's new economic activism-including the re-
forms, increased controls, and a greater commandeer-
ing of available domestic credit and foreign
exchange-the private sector became more mistrust-
ful of the government and even less willing to invest.
Favorable Signs Evaporate
A small economic turnaround appeared possible early
last year, but it never materialized. Widespread ex-
pectations for the start of world economic recovery,
higher coffee prices, and large increases in foreign
official assistance seemed to provide grounds for
optimism. More important, the insurgents were re-
pulsed militarily and rejected politically during the
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The guerrillas' campaign of sabotage, an irritant in
the early days of the insurgency, has become a
formidable source of economic disruption in El Sal-
vador. Following the failure of their 'final" offensive
in January 1981, the insurgents began to emphasize
economic targeting as a key element in their strategy
to wear down the government through prolonged
warfare.
The US Embassy estimates the direct costs of the
insurgency since its inception to be approximately
$600 million, comprised of the following:
? About 40 percent to damage and production lost in
the agricultural sector.
? Twenty percent to damage and production lost in
the industrial sector.
? Fifteen percent to damage and maintenance costs
involving economic infrastructure.
? Twenty-five percent to increased government spend-
ing requirements for defense and assistance to
displaced persons.
On the basis of other information from US officials in
San Salvador regarding trends in acreage planted to
crops and escalating guerrilla-caused power outages,
we judge that the bulk of these costs were incurred
over 1981 and 1982.
The economic sabotage has had its military and
political benefits for the guerrillas, too. Forced to
keep most of its armed forces in static positions to
protect economically productive assets as well as
civilian population centers, the government has been
unable to take the military initiative. Furthermore,
the guerrillas' ability to attack electric power systems
at will and black out sizable areas of the country for
long periods has caused substantial psychological
strain on the populace and has discredited the gov-
ernment both at home and abroad.
Approximately one-half of the direct costs of the
insurgency to the economy, according to US Embassy
reporting, has occurred in the four departments east
of the Lempa River-Usulutan, San Miguel, Mora-
zan, and La Union. The guerrillas have maintained a
dominant presence in these areas and the damage
they have done to productive assets as well as
harassment of private producers has been extensive.
Repeated sabotage of the electrical power system left
these eastern departments without power for about a
third of the year in 1982. These power outages in
addition to recurrent direct guerrilla attacks have
frequently suspended operations in cotton milling
cooperatives, coffee mills, food processing facilities,
and fertilizer plants. Insurgent attacks, extortion of 25X1
protection fees and threats to migrant workers and
truckers have discouraged the production of cotton
and other crops in the east. We believe that, largely
because of these guerrilla tactics, the acreage planted
to cotton in the region probably is less than one-half
that planted in 1979. Moreover, throughout the east,
traffic on most road systems-including the Inter-
American Highway and the Littoral Highway that
link the region with San Salvador-has been subject
to regular interdiction. US officials in San Salvador
note that the eastern region's share of GNP has fallen
by about half
Encouraged by the results of their efforts over the
past two years to undermine the Salvadoran econo-
my, the guerrillas probably will intensify their cam-
paign of sabotage this year. In recent months, they
have publicly stressed the priority they attach io 25X1
sabotaging the national economy and have announced
cash crop cultivation as a key target. The guerrillas
launched a drive in May-a traditionally critical
planting time in El Salvador-to disrupt the planting
of cotton and processing of coffee, particularly in the
east where more than one-half of the country's cotton
crop and about 20 percent of the country's coffee
crops are located. Local businessmen say the guerril-
las are forcing farmers in the region to sign letters
stating that they will not plant their crops this season
as a condition for their personal security. More than
in the past, the insurgents appear to be willing to 25X1
intimidate small farmers and peasants in addition to
larger landowners. Guerrilla activity also is increas-
ing in the central region, where major hydroelectric
power plants are located. Recent attacks on nearby
towns underscore guerrilla ambitions to damage or
destroy these heavily guarded plants.
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On 6 March 1980 the Salvadoran Government inau-
gurated a land reform program affecting roughly one-
third of the country's farmland. The land reform was
divided into three phases:
? The expropriation and redistribution of land under
Phase I, involving properties having more than 500
hectares, has been essentially completed. More than
half of the country's sugarcane and more than one-
third of its cotton are grown on these lands. At the
end of 1982, 328 properties had been acquired and
converted into farming cooperatives. About 40 of
these cooperatives have been abandoned or are
operated only sporadically because of their location
in guerrilla-infested areas. Compensation for Phase
I estates is to be paid solely in bonds with maturi-
ties ranging from 20 to 30 years.
? Phase II, which calls for the expropriation of
estates between 100 hectares and 500 hectares, has
not been implemented. These properties contain
most of the lucrative coffee-growing areas. Owners
of Phase II expropriated farms would be compen-
sated 25 percent in cash and 75 percent in bonds.
Because government officials fear that implementa-
tion of this phase would seriously hinder the
country's cash crop export earnings, it has been
shelved.
? Phase III, the land-to-tiller stage, was intended to
give peasants full title to as much as 7 hectares of
farmland that they either rented or tilled at the
time of the reform proclamation. This phase is
expected eventually to affect 178,000 hectares and
to benefit up to 150,000 families. Most of the
eligible holdings produce basic grains and cotton.
The renter or tiller must take the initiative to seek
title. Toward the end of last year, about 58,500
applications had been filed. Provisional titles had
been issued to about 60 percent of the applicants,
and 1,146 final titles had been issued. Phase III has
been a substantial budgetary burden on the govern-
ment because former owners must be pai4
50 percent cash and 50 percent in bonds.
Constituent Assembly elections in March. More than
80 percent of eligible voters went to the polls to cast
their votes despite guerrilla threats and attacks. The
massive turnout appeared to be motivated largely by a
popular backlash against guerrilla attacks on econom-
ic targets and thus on the people's livelihood
Visions of better economic times soon faded. Initial
postelection efforts to form a new national unity
government were hampered by bickering among polit-
ical and military leaders, thereby diverting attention
from the war and enabling the guerrillas to regroup,
rearm, and map new strategies. In the second half of
the year, the insurgents resumed their military initia-
tives with new vigor, sabotaging power, industrial, and
transportation facilities, as well as disrupting agricul-
tural activity. At the same time, the government's
political squabbling and inconsistent signals regarding
its commitment to the reforms stirred public doubt
about policy continuity. As reported by US Embassy
and other sources, attempts by the extreme right to
dilute the agrarian reform, though largely thwarted
by moderate elements led by President Magana,
aroused considerable anxiety among peasants
Furthermore, an unexpected deepening of world and
regional recessions devastated export earnings. Stag-
nant foreign demand and large world stocks kept the
price of coffee low and sent those of cotton and sugar
plummeting. In addition, US sugar quotas and the
International Coffee Agreement (ICA) imposed con-
straints on the volumes of these commodities that El
Salvador could sell abroad. The government's inabil-
ity to attract substantial private financing from
abroad-despite, according to US Embassy reporting,
some casting about by government leaders for a major
international bank loan-reinforced pressures on the
country's external accounts.
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Table 2
El Salvador: Balance of Payments
Million US $
Current account balance
-286
35
3
-275
-240
Trade balance
-227
105
100
-192
-160
Exports (f.o.b.)
802
1,130
1,072
794
740
Coffee
386
675
615
452
398
Cotton
98
85
83
53
52
Sugar
19
27
13
14
13
Shrimp
11
12
?13
19
24
Other
288
331
348
256
253
Imports (c.i.f.)
1,029
1,025
972
986
900
Net services and transfers b
-59
-70
-97
-83
-80
Net private capital inflows
197
-227
-487
-93
-120
Changes in reserves
38
-101
-284
-100
0
Changes in arrears
41
24
-15
Amortization on public debt
20
21
46
81
100
Foreign assistance financial
gap
147
112
205
325
475
a Estimated.
b Excluding official transfers.
Scarce Foreign Exchange and the IMF
Although foreign official financing expanded about
45 percent last year, a severe foreign exchange short-
age continued to shackle the economy. The lead in
boosting foreign assistance was taken by the United
States and the IMF, to some degree in tandem.
Assistance from the United States-which, last year,
included the largest allocation under the Caribbean
Basin Initiative jumped from $100 million in 1981
to almost $180 million. Other industrialized countries,
many of whom have been intent on maintaining
political neutrality with respect to the insurgency,
provided only minor contributions. An IMF agree-
ment concluded in July, significant as much for its
effect on Salvadoran policies as for the financing,
pledged $85 million in combined Standby/Compensa-
tory Fund Facility loans over the following year.
Nevertheless, the overall impact of the increase in
foreign official funding on the balance of payments
was largely blunted by the negative export and private
capital trends described above.
Table 3
El Salvador:
Gross Foreign Official Financing
325.0
475.0
475.0
United States
100.0
178.0
205.0
International Monetary Fund
42.5
67.5
35.0
Inter-American Development Bank 61.0
47.5
85.0
Venezuela
40.5
38.5
60.0
Others
81.0
143.5
90.0
a Estimated.
b Projected.
El Salvador managed to restrain its financing needs
and to reduce its current account deficit, but at a high
economic cost. Unable to draw further on its depleted 25X1
foreign exchange reserves, the government was forced
to cut its real imports by more than 10 percent.
To qualify for the IMF loan, San Salvador was
obliged to undertake a series of tough austerity
measures. Accordingly, the Magana administration:
? Raised interest rate ceilings.
? Shifted additional international transactions from
the undervalued official exchange rate to the paral-
lel rate determined by market forces.
? Limited central reserve bank credit.
? Tightened fiscal balances and reduced public-sector
recourse to borrowing.
These measures helped to strengthen El Salvador's
balance of payments through import disincentives and
to pare the country's large public-sector deficit.
The government succeeded in cutting the public-
sector deficit as a share of GDP-which had risen
from 2.4 percent in 1979 to 8.6 percent in 1981-to
7.5 percent last year.
At the same time, however, the measures further
depressed economic activity. Reduced expansion of
bank credit restrained the amount of domestic curren-
cy available for private and public sectors alike. With
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tax revenues slumping because of a decline in coffee
exports, the government had to slash public invest-
ment more than one-third in real terms in order
to meet IMF-mandated targets, according to US
Embassy sources.
Disappointing Domestic Performance
Together, the renewed guerrilla attacks, scarce for-
eign exchange, and government austerity caused a
5.5-percent contraction in El Salvador's real GDP last
year. IMF data indicate total public and private gross
capital formation slid to 11 percent of national output,
less than one-half of the 1978 share, as investor
confidence waned. All major sectors contributed to
the economic decline
Agricultural output, which accounts for one-fourth of
GDP and more than one-half of the country's em-
ployed labor, fell substantially. El Salvador's three
most important crops-coffee, cotton, and corn-
were hit especially hard. Coffee production was hob-
bled by a combination of inadequate maintenance of
plantations because of future land ownership uncer-
tainties, a related spread of coffee rust disease, and
depressed world demand. Guerrilla attacks and ad-
justments to the land reform were largely to blame for
reduced cotton production; in particular, the US
Embassy notes that damage last fall to more than a
dozen pesticide-spraying planes and the intimidation
of pilots involved in crop dusting probably contributed
to major losses at harvest time. Torrential rains,
closely following a severe drought, took a particularly
heavy toll on such basic crops as corn, beans, and rice.
The industrial and commercial sectors also continued
to slide. Demand for their output languished as
economic activity in neighboring CACM markets
contracted a combined 4 to 5 percent and domestic
incomes fell further. In addition, many firms were
unable to import critically needed materials and
machinery because of severe foreign exchange short-
ages.2 Finally, the insurgents obstructed industrial
activity by sabotaging power plants, factories, and
transportation facilities. The US Embassy estimated
Real GDP Growth
Percent
8
6
Gross Fixed Investment
Formation
Percent of GDP
Consumer Price Growth
Percent
International Reserves, Net
Million US $
25X1
25X1
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this situation will be tied inextricably to conditions on
three fronts: foreign markets for Salvadoran cash
crops and manufactured products, domestic military
and political stability, and the willingness of foreign
lenders and donors to extend financing. We expect
little improvement in export market conditions over
the next 18 months despite a gradual revival of world
economic activity and demand. Most important, huge
Table 4
El Salvador: Crop Production
Coffee
108
106
97
92
Cotton
82
79
57
52
Sugar
87
69
61
75
Corn
103
103
98
82
Beans
107
91
88
88
Rice
114
119
122
107
that the interruption of electric power generation
alone caused more than $60 million in direct and
indirect losses to industrial production last year.F
Based on a variety of indicators, we believe the social
and political impact of the economic slide grew
rapidly. A rise in business bankruptcies, reduced
agricultural production, and growing numbers of per-
sons displaced by the insurgency swelled the ranks of
the unemployed to more than 30 percent, according to
the US Embassy. In addition, the personal income
and living standards of most workers continued to
decline as the government held wage increases sub-
stantially below the rate of inflation. Partly due to
growing labor restiveness stemming from depressed
real wages, several leftist functionaries succeeded in
penetrating the moderate Popular Democratic Unity
(UPD}-the country's largest labor movement-and
gained important leadership positions.
We believe El Salvador's economic outlook is dim,
mainly because the country continues to face the same
debilitating low business confidence and scarce for-
eign exchange conditions, stemming from the effects
of the insurgency and a depressed world economy that
prevailed last year. In our view, attempts to overcome
world stocks, continued weak prices, and binding ICA
quotas probably will keep coffee proceeds depressed
near 1982 levels at least through the end of next year.
We, therefore, believe that military-political condi-
tions and foreign financing will be the principal
determinants of El Salvador's economic performance
in 1983 and 1984.
Because future domestic military and political devel-
opments will strongly influence the scale of El Salva-
dor's foreign financing needs, we examine these rela-
tionships under three alternative military-political
stability scenarios. Thus far, the military standoff
between government and guerrilla forces has held up
for the most part, the principal exception being the
area east of the Lempa River. So, too, has the political
accommodation agreed to by ideologically disparate
parties in the government coalition. Still, these condi-
tions remain volatile and could take on a dramatically
different complexion in a matter of months.
In each of the three scenarios investigated, we target-
ed zero growth in 1983-the best we felt possible-
and 3-percent growth in 1984 and asked what the
implicit domestic and foreign savings requirements
would be.' In view of the reluctance of many foreign
donors and lenders to supply El Salvador with new
funds, prospects for meeting the country's foreign
financing needs are highly uncertain. At the moment,
the government appears to have lined up about $475
million, all from foreign official sources.4 To the
employed in the three scenarios.
`The United States, Venezuela, and the international financial
institutions are expected to provide the dominant share. Some of
these funds, however, could be in jeopardy. The IMF may withhold
some $35 million because of El Salvador's failure to meet perform-
ance targets, particularly expected reductions in fiscal deficits and
external arrearages. Also, Venezuela may reconsider part of its $60
million of scheduled credits because of its own financial problems.
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Second Round Effects: The Insurgency and Industry
While insurgent violence has had its greatest direct
impact on the agricultural sector of the economy, it
has had an especially detrimental indirect effect on
El Salvador's industry. Political instability and dete-
riorating security have seriously eroded business
confidence and have spurred large-scale capital
flight, exceeding $1 billion since 1978 by some esti-
mates. By contributing to declines in foreign exchange
earnings and by scaring off foreign private investment
and credit, the insurgency has also reduced the
industrial sectors' access to vital foreign raw materi-
als and intermediate goods. Largely because of these
factors, private industrial investment-covering man-
ufacturing, construction, and electric power-last
year appears to have been little more than one-fourth
of the level attained in 1978 in real terms, according
to data derived from a variety of sources
Production in manufacturing and construction-the
most dynamic sectors in the economy until 1979-
has been hit especially hard by the combined effects
of the insurgency, depressed demand in both domestic
and foreign markets, and shortages of foreign ex-
change. Between 1979 and 1982 manufacturing out-
put declined more than one-third and construction
activity declined almost one-half. The share of the
manufacturing and construction sectors of GDP
dropped from 23.4 percent in 1978 to 18.8 percent in
1982. We believe industrial output in the main San
Salvadoran metropolitan area, because it is more
dependent on both foreign inputs and foreign markets,
probably has fallen as much or more than production
in eastern areas more directly under the influence of
the guerrillas.
Among the manufacturing industries,. activity in the
textile, apparel, and metal and mineral products
enterprises has slumped most sharply over the past
four years. According to the World Bank, an estimat-
ed 600 shutdowns of manufacturing firms between
1979 and 1981 were concentrated in these industries.
Moreover, employment in most of the firms that
continued to operate in that industrial group was
slashed. Because enterprises in these manufacturing
industries are more labor-intensive than most others,
the impact on rising national unemployment has been
profound.
The Salvadoran Government views revitalization of
the country's industry to be a crucial element in its
strategy to promote economic recovery and has taken
some significant steps in that direction. In December
of last year, it formed an economic recovery commit-
tee with high-level joint government private sector
membership to produce plans for projects to revive
key enterprises. At about the same time, San Salva-
dor signed a $50 million agreement with the Inter-
American Development Bank for fostering industrial
development. Still, until political and military stabil-
ity is restored, new investments in El Salvador's
industrial sectors are not likely to increase signifi-
cantly.
extent that the foreign financing gaps described in
these scenarios cannot be filled, they represent poten-
tial constraints on the attainment of the growth rates
we have targeted for the next two years. The findings
of our scenarios are intended to be suggestive, not
predictive, and a number of additional variants could
be extrapolated from them.
The military and political conditions posited for each
of the scenarios are:
political power continues to be wielded by a tenuous
coalition of disparate moderate and rightist parties.
We believe this to be by far the most likely scenario.
? Scenario II-Internal security deteriorates badly
and acrimony between moderates and rightists dis-
rupts the functionings of government. The insurgen-
cy makes major gains, leading either to a serious
deterioration in security or to a government agree-
ment to cede major power to the far left.
? Scenario I-Violence stays near last year's level,
the tactical military balance between the govern-
ment and the insurgents remains at stalemate, and
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Table 5
El Salvador: Projected Foreign Financing Gap, by Scenario
Current account balance
-315
-525
-250
Trade balance
-235
-425
-170
Exports (f.o.b.)
740
600
780
Imports (c.i.f.)
975
1,025
950
Net services and transfers b
-80
-100
-80
Net private flows
-35
-100
0
Changes in arrears
50
50
50
Amortization on public debt
125
125
125
Financial gap
525
800
425
Current account balance
-375
-800
-225
Trade balance
-300
-700
-175
Exports (f.o.b.)
800
500
900
Imports (c.i.f.)
1,100
1,200
1,075
Net services and transfers b
-75
-100
- 50
Net private flows
-25
-150
25
Changes in arrears
0
0
0
Amortization on public debt
150
150
150
Financial gap
550
1,100
350
a Scenario II is not intended as a projection but merely an illustration
of general orders of magnitude based on military-political assump-
tions offered in appendix A. Data for the autarky case mentioned in
the text are not shown here; based on a few comparable experiences
in other countries, however, we believe that imports and the financial
gap could fall in this special case as much as $100 million in 1983
and $300 million in 1984 below levels depicted in Scenario I.
b Excluding official transfers.
? Scenario III-The government gains the upper
hand militarily and all national unity political par-
ties strengthen their commitment to justice and
democracy. A weakened insurgency boosts business
confidence and possibly convinces some leftists to
join free elections. We believe Scenarios II and III
share an equally small likelihood of occurring. F_
In all the scenarios, private-sector confidence would
serve as the principal barometer for evaluating the
economic effects of political-military developments.
With a continuation of past security conditions envis-
aged under Scenario I, the private sector would play a
restrained yet important role in the country's econom-
ic affairs. In Scenario II, major intensification of
guerrilla action and/or the placement of Marxist
leaders in key government posts would probably pre-
cipitate a crumbling of most of the remaining private
sector. As a corollary, the improvement in both
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security conditions and business-government relations
in Scenario III would stimulate a major expansion of
private-sector activity.
Scenario I-No Major Changes in
Military or Political Situation
In this scenario, guerrilla forces continue to show
sizable strength and to mount frequent attacks on
economic and other targets in some areas of the
country, particularly east of the Lempa River. At the
same time, however, they prove unable to extend their
influence significantly in new areas. The national
unity government continues to resolve political differ-
ences through compromise but is handicapped in its
ability to take bold initiatives or make controversial
decisions, such as whether or when to implement the
suspended Phase II of the agrarian reform. In this
environment, few private producers would be moved
to commit significantly greater resources to the econo-
my, although those who have persevered so far would
not be likely to cut back.
For El Salvador to arrest its economic slide in 1983
and mount a 3-percent recovery in 1984, it must be
prepared to finance rising deficits on its external
current accounts. We calculate that total import
expenditures may need to be increased some 8 percent
this year and 13 percent in 1984 to restore depleted
stocks of industrial raw materials, intermediate goods,
agrochemicals, and spare parts. Meanwhile, in our
judgment, export earnings in this scenario would show
no growth this year and only a moderate rise in 1984,
primarily because of continuing depressed proceeds
from the country's two leading export commodities-
coffee and cotton. While unfavorable world market
conditions would restrain coffee exports, guerrilla
intimidation of farmers would result in declining
cotton output and export earnings.
If, as we expect, foreign private investors and lenders
remain chary of El Salvador, the burden will fall to
foreign official assistance to fill a financial gap of
$525-550 million each year. These funds will be
required to cover not only current account deficits in
the $300-400 million range but also amortization on
public debt, which we project to rise some $25 million
or more a year to $125 million in 1983 and $150
million in 1984. In addition, because of limited do-
mestic financial resources, the local currency generat-
ed from foreign assistance will contribute importantly
to the government's efforts, under IMF direction, to
meet the credit requirements of the private and public
sectors.
Currently projected foreign assistance of $475 million
in 1983 and $500 million in 1984 will not allow El
Salvador to meet the import levels consistent with our
GDP targets of zero real growth this year and
3-percent real growth next year. We believe the
import squeeze mandated by these financial shortfalls
will lead this year to a moderate decline-up to 5
percent-in national ouput. As in the past, tight
foreign exchange supplies probably will hit the manu-
facturing and construction sectors the hardest. Agri-
cultural production, although also affected, will re-
main primarily subject to the vagaries of weather and
guerrilla activity
Scenario II-Military and Political
Conditions Deteriorate Sharply
An expansion of the insurgency or an outbreak of
bitter squabbling between the rightist and moderate
factions of the government would seriously hurt the
economy and would greatly increase the amount of
foreign financing necessary to support our growth
targets. F_ -I recent military
successes have given the guerrillas some-at least
temporary-territorial gains, worldwide attention,
and a boost in morale. Should increased guerrilla
aggressiveness gather momentum and lead to major
gains in territorial control, remaining business confi-
dence would evaporate, thereby causing an accelera-
tion of capital flight and a further exodus of manage-
rial and technical talent.
Assessments of El Salvador's foreign financial needs
under conditions of an increasingly successful guerril-
la campaign could go in one of two directions that
make precise projections difficult. The leftists could
gain such a large role in policymaking that San
Salvador would opt for an autarkic approach, in
which living standards, imports, and foreign aid re-
quirements would be compressed.
If, however, the military-political situation caused a
serious deterioration in security but did not alter the
basic thrust of foreign and economic policies, foreign
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financial needs could skyrocket. A growing number of
business and factory closures would mean slumping
manufactures exports. Many rural landowners, fear-
ful of devastating financial losses, would curtail their
export cash crop operations. Moreover, shortages of
food and other consumer goods would be likely to
drive up overall import requirements. Meanwhile,
government expenditures probably would greatly out-
strip flagging revenues, reflecting not only growing
needs for defense and social services but also an
enlarged government role in keeping the economy
running.
We estimate that El Salvador, with a continuation of
existing governmental policy orientation, would re-
quire enormous foreign financial assistance to meet
our GDP growth objectives, perhaps a multiple of the
amount needed under Scenario I. At currently pro-
jected levels of foreign assistance, however, economic
activity could shrink at an annual pace exceeding 10
percent.
Scenario III-Improved Military and
Political Conditions
A reduced guerrilla threat and progress toward politi-
cal democratization probably would lead to a resusci-
tation of the private sector, although full benefits
would not be realized until after 1984. This scenario
probably would entail the government pushing a more
effective civic action program, taking the military
initiative with more successful counterinsurgency tac-
tics, and holding free and democratic elections by the
end of the year.
Some short-term economic gains might be achieved
simply by utilizing existing productive capacity more
fully. Reduced risk of terrorist attacks would enable
farm owners to attain substantially greater crop har-
vests. In addition, enhanced government protection of
electric power facilities in and around the eastern city
of San Miguel, the country's third-largest industrial
center, probably would permit significant increases in
industrial production. We calculate that rising output
of cash crops and manufactured goods might spur an
expansion of export earnings amounting to some $50
million in 1983 and much more in 1984.
We believe an expansion of private capital formation
also would occur, but more slowly. Domestic and
foreign businessmen would be likely to proceed cau-
tiously until they were convinced that the improved
military and political conditions would endure. At the
same time, however, the public sector might be in
better financial position to contribute to economic
recovery as a result of diminished defense needs and
substantially higher export tax revenues. Under these
favorable circumstances, we calculate that the flow of
foreign financial assistance now envisaged through
the end of 1984 would appear to be sufficient to
permit zero growth this year and probably more than
enough to support 3-percent growth next year
We believe El Salvador has no chance of returning to
past rapid growth rates until it restores political and
military stability. Even then, a joint effort by the
government and the private sector to recreate a
foundation for sustained growth probably would be
essential. The government will need to attach high
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priority to the rebuilding of damaged roads, railways,
bridges, and power facilities. To promote higher effi-
ciency, San Salvador must also relax controls over
trade, interest, and prices, as well as assure ample
allocations of foreign exchange and domestic credit to
the private sector. Private enterprises must modernize
equipment, rebuild diminished stocks of materials,
and strengthen their financial structures. Partly be-
cause foreign investors and commercial bankers will 25X1
respond only gradually to improved political and
economic conditions, foreign assistance will probably
continue to play an important role for some time.
El Salvador, in our view, also will need to give greater 25X1
emphasis to developing and diversifying its industrial
sector, considering its limited agricultural land and its
large and rapidly growing population. In particular, a
major increase in output of labor-intensive manufac-
tures for export to non-CACM markets could contrib-
ute importantly to the generation of employment and
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foreign exchange. We doubt that El Salvador can
count on continued, rapidly expanding foreign mar-
kets for its cash crops to meet its large foreign
exchange needs.
Still, agriculture will continue to be important, espe-
cially for absorbing the country's rural unemployment
and for providing inputs to major coffee and food
processing industries. Accordingly, San Salvador
could raise farm output to or above peak levels of
1979 without difficulty by resolving the outstanding
agrarian reform problems, expanding irrigation, and
increasing fertilizer applications. Making a clear deci-
sion either to expedite implementation of the agrarian
reform's Phase II-which contains major areas of
coffee and cotton farmland-or abandon it altogether
would by itself stimulate increased production by
dissipating uncertainty.
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Appendix
Methodological Notes on Economic
Forecasts
The compilation of historical data and estimates of
projected trends contained in this assessment draws
on official Salvadoran statistics and a variety of other
information and analytical sources, most notably US
Embassy reporting and publications of the Interna-
tional Monetary Fund (IMF) and World Bank. We
chose the broadly accepted IMF definitional formats
in instances when differences arose between the Fund
and San Salvador about data interpretation and pres-
entation, particularly regarding external accounts.
Furthermore, our scenario forecasts were based on
certain assumptions regarding future world economic
trends, including oil prices, world and regional eco-
nomic growth, and commodity prices. These data
projections were derived from CIA-constructed esti-
mates.
Financial Gap Analysis
Our projections for foreign financing requirements for
1983-84 were calculated as the amount of funds
needed to close projected foreign exchange gaps asso-
ciated with certain economic growth tracks under
three varying military and political stability scenarios.
This financial gap was calculated as:
FG = (I - E + ST) + A + P
where FG equals foreign financing gap, I equals
import expenditures, E equals export earnings, ST
equals net outflows of services and transfers, A equals
amortization of medium- and long-term public debt,
and P equals net flows of private capital, including
Exports were calculated as the product of projected
volume and international commodity prices. The pro-
jected volume of agricultural exports-predominantly
coffee and cotton-was determined according to the
expected impact of international quotas (coffee) and
the insurgency (cotton). Commodity prices for 1983
and 1984 were estimated using the Box/Jenkins
statistical analysis, employing the latest information
regarding stocks and evolving market conditions. In
general, coffee prices are expected to remain relative-
ly constant over both years while cotton prices are
projected to fall slightly in 1983 followed by a mild
recovery in 1984. Projections of Salvadoran manufac-
tures exports reflect our judgment that CACM coun-
tries, beset by financial problems of their own, proba-
bly will not absorb substantially greater amounts of
Salvadoran goods through 1984.
Net Services and Transfers consisted primarily of
known and anticipated interest obligations on foreign
debt, profit remittances, and direct grants.
25X1
25X1.
Imports took into account anticipated needs of both
the producing sectors and the consuming population
in 1983 and 1984. Accordingly, we estimated the
amounts of foreign productive inputs required to
sustain zero growth this year and 3-percent growth
next year as well as what we believed to be the
minimum politically acceptable level of nonproductive
imports. For this purpose, we disaggregated Salvador-
an imports into the following five broad producer-
related and consumer-related categories: food, other
consumer goods, fuel, raw materials and intermediate
goods, and capital goods. Our analysis led to these
judgments:
? Pressure for increases in food imports will be high in
view of recent large losses of domestic basic grain
output.
? Little increase in imports of other consumer goods
appears necessary. Though cut considerably below
pre-1979 levels, this category of goods has not been 25X1
pared to the bone.
? Fuel import costs can continue to be held down as a
result of the development of hydroelectric and geo-
thermal resources and declining oil prices.
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Table 6
El Salvador: Import Volume, by Category
Other
Consumer
Goods
Raw and
Intermediate
Goods
Capital
Goods
1974
97
96
89
126
110
1975
111
96
80
99
144
1976
110
103
80
124
185
1977
128
168
101
143
214
1978
158
163
107
141
227
1979
138
153
119
129
164
1980
175
126
97
105
76
1981
175
1982 a
179
? Imports of raw materials and intermediate goods
will need to be substantially increased to replenish
seriously depleted inventories.
? Moderate increases in capital goods imports-to
1980 and 1981 levels-probably are needed simply
to provide essential replacement equipment and
spare parts.
Amortization included scheduled repayments of me-
dium- and long-term debt of the government, govern-
ment-guaranteed, or of the Central Reserve Bank.
Comparable data for private debt do not exist. The
bulk of the amortization on private debt is for short-
term loans, much of which characteristically has been
rolled over in recent years.
Net Private Flows encompassed all private flows on
capital account, including investments as well as
short-, medium-, and long-term credits. Since 1978,
capital flight has weighed heavily in the totals. Be-
cause substantial flows of private capital have not
been traceable through the international banking
networks, San Salvador has been compelled to lump
"errors and omissions" in with this category of trans-
actions.
Under Scenario I, the principal change from 1982 in
El Salvador's balance of payments would occur in its
imports. We believe the country would have to boost
its import expenditures roughly 8 percent in 1983 and
13 percent in 1984 to meet our specified GDP growth
targets. Of these increases, we expect rising import
prices in each year will account for 4 to 5 percentage
points, comparable to the price pressures experienced
in 1982. Approximately two-thirds of import bill
increases over the two years would consist of pur-
chases of foreign raw materials and intermediate
goods. Based on an evaluation of historical import
data for this category, it appears that a rise of this
magnitude would be in order to bring national inven-
tories up to levels more closely in line with normal
stock-industrial output relationships. The remainder
of El Salvador's rise in imports, according to our
analysis, would be divided mainly between food and
capital goods procurement.
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If military and political conditions slip considerably as
suggested in Scenario II, it would be impossible to
specify the economic impact. A far-leftist accession to
political power could result in El Salvador's dimin-
ished dependence on foreign financing and a substan-
tial fall in economic activity. Based on experiences in
Cuba following Castro's seizure of power and in
South Vietnam following its conquest by North Viet-
nam, we believe foreign financing could be cut as
much as $300 million below the amounts shown in
Scenario I. If the Salvadoran Government persists in
its struggle against the insurgents, it will likely look to
increased foreign financing to prop the economy. How
much would be needed, however, would inevitably
depend on just how badly military and political
conditions worsen.
Nonetheless, we believe it would be useful to suggest
some orders of magnitude under somewhat conserva-
tive "deterioration" assumptions. The impact of con-
ditions under this scenario would be felt on exports,
imports (beyond those described under the first sce-
nario), and net private capital flows. If we were to
assume that the direct damage inflicted on El Salva-
dor's ability to produce would be three times that
wrought in 1982, we could probably make the follow-
ing claims:
? Export earnings probably could be expected to fall
some $100 million or more a year. Cash crops,
cultivated and harvested in the least secure outlying
areas, would be especially vulnerable to destruction.
? Emergency needs, particularly for food, could swell
the country's import bill up to $50 million a year.
? Although most domestic capital that would be
inclined to leave the country has already left, re-
newed capital flight would probably accelerate to
more than $100 million a year.
We have distinguished Scenario III from the other
scenarios primarily by its higher exports. For exam-
ple, without significant guerrilla harassment, farmers
probably could raise their exports of cotton and sugar
substantially. Moreover, a more stable political envi-
ronment in El Salvador would be conducive to an
increase in industrial production for export markets.
Some reduction in imports may be possible also, as
fewer materials, parts, and equipment would be need-
ed to replace capital stock damaged by the guerrillas.
Foreign private investors and lenders would once
again begin to take a strong interest in El Salvador,
but the major effects probably would not be evident
until after 1984.
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