El Salvador urges investors to think again

El Salvador is going all out to put an end its recent past of high levels of violence and sub-par economic growth and become a credible destination for foreign investment. The government, led by president Salvador Sánchez Cerén, has unleashed a new offensive on crime and is actively engaging international institutions such as the IMF and the Inter-American Development Bank (IDB) to set out a reform agenda to address the country’s financial distress and its chronically low competitiveness.

However, despite Mr Cerén’s leadership, the country’s highly polarised political environment has yet to find a consensus over a possible deal with the IMF, which would also give El Salvador a much-needed financial lifeline.

An optimistic stance

Betting on this consensus to finally emerge, the government has taken steps to improve El Salvador’s image among foreign investors. The push gained traction in March, when local investment promotion agency Proesa launched a new country brand to an audience of local and international investors with the aim of replicating the success of other Latin American countries, such as Colombia, that have a similarly troubled history.

“We are very optimistic of the investment climate and we are sure this is only the beginning of great and better times,” said Mr Cerén at an investment summit organised for the launch of the country brand. Its slogan, ‘El Salvador – great, like our people’, emphasises the potential of the local labour force. 

Salvadorian authorities are now committed to leveraging the potential and cost competitiveness of the country’s labour force, as well as a new set of incentives and reforms tailored towards the needs of private investors to unlock much-needed foreign investment in sectors such as manufacturing, BPO, renewable energy and infrastructure, and thus counter the inevitable fall in public spending and investment caused by the heavy shortfalls the fiscal budget is facing.

Tackling violence

Located at the heart of Central America, El Salvador has hardly been a champion of FDI. A troubled past of political and civil unrest, which culminated in a bloody civil war between 1980 and 1992 combined with a more recent problem of gang violence, left economic development on the sidelines and deterred foreign investors.

The country has achieved a certain level of institutional, social and economic stability since the end of the civil war. However, San Salvador, the capital and centre of the country’s political and economic life, remains one of the world’s most dangerous cities, according to a wide array of international studies. Security is an issue across the whole country, with businesses, as well as young people, among the most vulnerable to organised crime.

The business costs associated with crime and violence in El Salvador were second only to those of Venezuela in 2016, according to the latest World Economic Forum Global Competitiveness Report. At the same time, hundreds of thousands of people are leaving the country in search of better opportunities. More than 240,000 set off for the US in 2015 alone, according to UN data, expanding a diaspora estimated at more than 2 million, with 6 million Salvadorans still at home.

Tackling crime

The government is striving to rectify this situation. Once leader of the left-wing Farabundo Martí National Liberation Front (FMLN), Mr Cerén has intensified efforts to contain a mounting wave of gang crime, which largely originated from the US, but spread throughout the so-called northern triangle of Central America (El Salvador, Honduras and Guatemala) as thousands were deported back to their origin countries.

El Salvador's homicide rate fell by 20.7% in 2016, year on year, and by an extra 55% in the first five months of 2017 from the same period of 2016, according to government figures. These figures also show a significant decrease in extortions and car-related accidents.

If confirmed, these are promising steps for the government in its efforts to improve social security and stability, limit migration towards the US, and transform the domestic business climate.

“El Salvador is currently a stable country, a democracy, and the government is building up trust and confidence with the private sector and foreign investors, [though there is] still room to empower institutions for more efficient processes and to increase the technical and professional skills of government employees,” says Maria Alejandra Tulipano, a partner at Central American law firm Consortium Legal.  

Seven key sectors

The government’s efforts to improve the perception of the country in the eyes of foreign investors have already borne some fruit. Gross inward investment grew to $1.3bn in 2016, its highest level in the past decade, with the manufacturing and financial sectors receiving the lion’s share, according to central bank figures.

“This year we are also expecting a good year for FDI, with investments growing exponentially in sectors such as energy and telecommunications,” says economy minister Tharsis Salomón López. “Announced investment has already touched about $4bn.”

However, high levels of outward investment partly countered growing FDI on a balance-of-payment level in 2016, with net FDI standing at $373.88m in 2016, or 1.4% of GDP, down from $398.8m (1.6% of GDP) a year earlier, according to central bank figures.  

The country’s FDI potential is emerging across the seven key strategic sectors identified by Proesa – energy, agro-industry, tourism, light manufacturing, business services, aerospace, clothing and textiles.

A package of incentives made up of, among other things, 20-year purchase power agreements in US dollars (the El Salvador economy was dollarised in 2001) and five- to 10-year income tax exemption, have stirred up interest in the development of the country’s largely unexploited renewable energy sources.

In April, French operator Neoen kicked off operations at its Providencia photovoltaic power plant. With 101 megawatts ­– which required an investment of $118m financed by the IDB and French development institution Proparco – the plant stands out as the largest of its kind in Central America. A new round of renewable energy development is now around the corner as CNE, El Salvador's national energy council, awarded five new projects (four photovoltaic plants and one wind farm) largely backed by investors from the US, France, Germany and Guatemala combining some 170 megawatts of installed capacity in January.

People power

While the country's natural resources are gaining traction among investors, the competitiveness of the Salvadoran labour force is driving the development of the country’s BPO and clothing and textile sectors. Despite suffering from the brain-drain to the US, some 23,000 vocational or university graduates join the labour market every year, beefing up a labour force of about 2.9 million, 57% of which are under the age of 37.

“We are in El Salvador for the people, their skills and productivity, although there is space to make the labour market more flexible,” says Enrique Albizu, head for business development in Latin America for BPO service supplier Teleperfomance.  

Low labour and other input costs, combined with incentives granted to export-oriented companies located in one of El Salvador's 17 free economic zones, are clearly part of the equation for the BPO industry. The sector is flourishing in the country, generating about 25,000 jobs and growing by 13% in 2016, according to government figures.

From an investor’s perspective, the country has the second most convenient salary and internet costs in the whole of Central America, and the cheapest energy costs, according to Proesa figures. The same holds for the clothing and textile industry, whose exports made up about 47% of the country’s $5.3bn in exports in 2016, according to Proesa.

Perfect position

El Salvador’s attractiveness for foreign investment traces back to its key geographic location. “El Salvador is in a strategic position at the heart of Central America,” says Carmiña Moreno, head of the IDB mission in El Salvador. “It’s a key north-south transit link and we believe its geographic position is very important. We are now working to improve customs and borders procedures; that’s something that has to be improved.”

El Salvador is in the process of developing a dry canal with Honduras, connecting its Pacific port of La Union with the Honduran Atlantic port of Puerto Cortes. A key piece of the project entails a long-awaited upgrade of the La Union port, where Proesa is now looking for interested concessionaires to take charge of the infrastructure under a public-private partnership (PPP) scheme.

The government is in the process of further revising its incentives for local and foreign investment, as well as establishing a wider PPP programme, to unlock more local and foreign investment and close the gap with other countries in the region in terms of economic growth.

However, Mr Cerén and the FMLN are having to deal with an increasing polarised political environment, which is complicating the policymaking process. The country is facing financial difficulties, but a possible IMF bailout in the form of a stand-by agreement will not be made available until a shared consensus across the political spectrum over a fiscal consolidation agenda emerges.  

“El Salvador is a land of opportunities and challenges,” says Ms Tulipano. But the country must fix the challenges of internal security before investment opportunities can fully unlock investment and growth.

Costs of this report were underwritten by Proesa and the Inter-American Development Bank. Reporting and editing were carried out independently by fDi Magazine.