From: rich@pencil.cs.missouri.edu (Rich Winkel)
Subject: El Salvador: Proceso 528: Economy
Followup-To: alt.activism.d
Originator: rich@pencil.cs.missouri.edu
Organization: PACH
Date: Sun, 6 Sep 1992 21:43:36 GMT

/** reg.elsalvador: 165.0 **/
** Topic: Proceso 528: Economy **
** Written 11:39 am  Sep  5, 1992 by cidai@huracan.cr in cdp:reg.elsalvador **
From: cidai@huracan.cr (Centro de Informacion Documentacion y Apoyo a la Invest. - UCAJSC)
Subject: Proceso 528: Economy

Center for Information, Documentation and Research Support (CIDAI)
Central American University (UCA)
San Salvador, El Salvador
 
PROCESO 528
September 2, 1992
 
ECONOMY:
Inconsistent economic measures
 
     One of the most important aspects of the government's economic
stabilization measures is reducing the rate of inflation.
Nevertheless, in an attempt to reduce the budget gap -another major
component of the stabilization strategy- measures have been adopted
which will inevitably provoke higher prices. Concretely, the
implementation of the Value-Added Tax (VAT), along with increased
electricity and transportation rates, will have a considerable
impact on prices and family budgets. In this context, the Central
Reserve Bank has announced that it will release $20 million into
the exchange market in order to stop the increasing exchange rate
and, thereby, help slow price increases.
     These economic policies reflect inconsistencies which could
slow down attempts to reduce inflation, stabilize the foreign trade
sector and reduce poverty. The measures contained in the different
policies are not sufficiently coherent among themselves to
guarantee that the goals of economic stabilization can be achieved
simultaneously.
     It is obvious that the new VAT and higher electricity and
transportation rates will speed up inflation. In an attempt to
reduce the budget gap, the government has shown itself willing to
sacrifice part of the goals it won in the area of price stability.
In addition, containing inflation is being attempted through market
forces such as injecting dollars into the market, although this
only means postponing the adjustment in the exchange rate necessary
to reduce the trade deficit.
 
Contradictions in the stabilization measures
 
     Since taking power, ARENA has been incapable of achieving much
progress toward reducing the budget gap. The consolidated deficit
of the central government for 1989-1991 was 4.4% of the GNP, while
during the 1985-88 period (before ARENA's economic program went
into effect) it was about 3.4% of the GNP. Furthermore, according
to official figures, the rate of price increases has slowed during
the current administration. Between 1990 and 1991, the inflation
rate dropped from 19.3% to 9.8%.
     Nonetheless, attempts to close the budget gap by creating
taxes which force them up, although making it possible to stabilize
public finances, will eventually produce negative progress in
efforts to stabilize prices. Additionally, the recent tax reforms
only reproduce the regressive character of the nation's tax
structure (cf. Proceso 526), and this will have further harmful
effects on the most disadvantaged sectors.
     With regard to the exchange rate, it must be noted that, as we
can see in Table 1, it has gone up by 2.6% over the last few
months. However, the greatest jump occurred in the last half of
June, in the case of markets run by exchange houses and commercial
banks, and between July 2 and 3 for the Central Reserve Bank. It is
clear that pressures to increase the exchange rate were felt first
in the marketplace and then in the Central Reserve Bank, where the
rate shot up even higher, from 8.30:1 to 8.41:1 between July 2
and 3.
     This suggests that the foreign exchange market is mostly
determined by the market consisting of exchange houses and
commercial banks; the Central Bank, given the tendencies of the
market, appears to play a secondary role with little effect on
determining exchange rates. Evidence of this is the Bank's need to
intervene in the market by offering $20 million for sale, with the
hope of stabilizing the exchange rate at 8.52:1.
     The reasons given by the Central Bank for releasing these
funds are related to the need to guarantee a stable exchange rate
for the importation of medicines, other essential products and
agricultural-industrial inputs. Here the government appears to be
at a crossroads, for the measure denotes its unwillingness to
permit higher exchange rates leading to greater inflation.
Nevertheless, the government's Development Plan establishes that
one of the ways to stabilize prices is through the foreign trade
sector, for which a higher exchange rate would be necessary in
order to make Salvadoran exports more competitive.
 
TABLE 1
EXCHANGE RATES IN COLONES PER DOLLAR
 
-----------------------------------------------------------------
         June                    July                    August   
       1    15    22    30      2    3     15    28     10   20
-----------------------------------------------------------------
CRB  8.22  8.23  8.25  8.30   8.30  8.41  8.44  8.43   8.43  8.44
EH   8.23  8.26  8.32  8.41   8.43  8.44  8.45  8.44   8.45  8.48
CB   8.24  8.25  8.29  8.38   8.41  8.42  8.43  8.42   8.43  8.45
-----------------------------------------------------------------
Source: Central Reserve Bank.
CRB: Central Reserve Bank
EH: Exchange Houses 
CB: Commercial Banks
 
     A higher exchange rate could produce much higher prices. This
can be inferred from the figures provided by Tables 1 and 2, which
show an increase in June-July exchange rates simultaneous with a
rising Consumer Price Index, which showed the highest rates of the
year. On this point, the government seems to be more favorably
inclined toward controlling prices than toward reducing the trade
deficit.
 
TABLE 2
CONSUMER PRICE INDEX (base 1978=100)
-----------------------------------------------------------------
                    Jan   Feb    Mar    Apr    May    Jun    Jul
-----------------------------------------------------------------
General Index      860.1  862.4  868.2  877.3  881.2  891.6  909
Annual variation     8.4    8.3    7.5    8.1    6.7    7.1  6.6
Period variation     0.6    0.3    0.7    1.0    0.4    1.2  1.9
-----------------------------------------------------------------
Source: FUSADES. Weekly Economic Report No. 34, 1992.
 
     This scenario depicts a lack of concern (or at least a lack of
attention) about stabilizing the foreign trade sector. The
extraordinary current influx of foreign exchange in the form of
family remittances, loans and donations is what is allowing the
government to maintain the exchange rate stable, which is important
in controlling the rhythm of inflation. Yet this is what makes the
government neglect the need to promote a diversified productive
structure which is capable of expanding exports. This contradiction
could become extremely harmful once foreign resources trickle off.
 
Other recent tax reforms
 
     Other tax measures have been implemented which equally
contribute to accelerated inflation and reflect contradictions in
government economic policies.
     In the first place, tariffs on powdered milk imports have gone
up; in the second place, specific taxes on domestic beer and
cigarettes have been reduced. In the first case, the reason given
was the need to protect the local dairy industry from foreign
competition, but the fact is that the measure made powdered milk
more expensive and thereby increased the price index for basic
foods. In the second case, the purpose was to pass legislation
favoring domestic industries in order to help them overcome their
unequal footing in competition with their counterparts overseas.
However, it is significant that the measure renounced the
possibility of obtaining greater tax revenues from beer and
cigarettes precisely at a time when other reforms aimed at
increasing revenues are going into effect.
 
Final Considerations
 
     The goal of stabilizing prices is in danger with these new
fiscal and tariff measures, while stabilizing the foreign trade
sector continues to be postponed in order to contain inflation.
     The inconsistency seen in the government's economic
stabilization measures endanger any progress made to date. The most
recent measures show that, in the government's current economic
strategy, economic stabilization in the public and foreign trade
sectors requires sacrificing the only achievement truly made to
date: reduced inflation.
     The measures carried out so far are irreversible, and
therefore other policies to redirect the economy must conform to
the needs inherent in the current stage of stabilization. There is
a particular need to address the negative effects on the poor of
the tax reforms and the increased exchange rate required by the
stabilization of the foreign sector. In this context, the
government must begin implementing not only social compensation
programs, but also a strategy to generate income among the most
disadvantaged sectors which is, at the same time, consistent with
the transformation of the productive structure. To this end, it is
key that stabilization measures and policies for redirecting the
economy be closely linked.
     Compensating the new price increases will be easier and more
effective if efforts are made to involve the most disadvantaged in
those productive sectors defined as a priority in transforming the
nation's productive structure. This would favor economic
stabilization in all its aspects, as well as economic growth and
the war on poverty.
 

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