News Column

Fitch: El Salvador Tax Move a Limited Positive; FRF Still Key

August 1, 2014



NEW YORK--(BUSINESS WIRE)-- Tax legislation passed by El Salvador's parliament on Thursday demonstrates the authorities' ability to implement tax reform, but it will have a limited and delayed fiscal impact, Fitch Ratings says. The proposed fiscal responsibility framework (FRF), which has not yet been approved by the legislature, will be of greater significance.

The reform creates a minimum corporate income tax equivalent to 1% of net assets, repeals an exemption for newspapers and introduces a tax on financial transactions. When fully implemented in fiscal 2016, it is expected to add around 0.4% of GDP to total tax collection, which is at the lower end of preliminary estimates as the reform did not include taxes on luxury real state previously under discussion. There is also a risk that a financial tax will damage growth and financial intermediation, especially if it is passed on to consumers.

The authorities' ability to increase tax revenue via reforms and collection enhancements (the tax burden rose to 15.4% of GDP last year from 12.6% in 2009) despite low economic growth is an acknowledged ratings strength. But we did not expect the latest reform to yield large, extra revenues, and expenditure growth has driven larger fiscal deficits in recent years. A more meaningful initiative is the FRF, which aims at improving El Salvador's fiscal position and debt dynamics over the medium term. There is no clear timeline for the discussion of the FRF that was expected to be dealt with in tandem with the tax reform.

In addition to a further increase in the tax burden to 17% of GDP, the FRF's original goals included achieving primary balances and limiting current expenditure and wages, and reducing nonfinancial public sector debt. However, the plan sees most consolidation coming after 2017. Without substantial pickup in economic growth or more front-loaded consolidation, we see little prospect of debt dynamics stabilizing in the near term, and public debt could rise to 65% of GDP by 2016, approaching twice the 'BB' category median of 35%. Implementation risk remains high, and the abstention of the main opposition party from yesterday's vote on tax reform shows that the political consensus supporting consolidation may not be firm.

We affirmed El Salvador's 'BB-'/Negative sovereign rating last month. For our full assessment, see the Full Rating Report, available at www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

Applicable Criteria and Related Research:

El Salvador

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Fitch Ratings

Santiago Mosquera

Director

Latin America

+1 212 908-0271

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY

or

Mark Brown

Senior Director

Fitch Wire

+44 20 3530 1588

or

Media Relations:

Elizabeth Fogerty, +1-212-908-0526 (New York)

elizabeth.fogerty@fitchratings.com


Source: Fitch Ratings


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