SECTION VII - INVESTMENT CLIMATE A1. Openness to Foreign Investment -- El Salvador seeks Foreign Investment El Salvador's open investment climate is built upon the commitment of President Calderon-Sol and former President Alfredo Cristiani to the free market. The signing of the Chapultepec Peace Accords in January, 1992, that ended twelve years of civil strife in El Salvador, as well as the privatization of banks and savings and loan associations, have contributed to an improved investment climate for foreign and local investors. The economic outlook for 1994 is for real economic growth of 5.5 percent of GDP, inflation of ten percent, and a stable currency. The economic expansion is broad based, with the construction and service industry the stellar sectors. For savvy investors, especially those in shared-production schemes, El Salvador and its hard-working people represent a promising investment opportunity. The Salvadoran Government welcomes foreign investment; companies from the United States, Canada, Korea, Taiwan, and Mexico have made recent investments here with favorable results. The legislation governing foreign investment in El Salvador includes: A) the 1990 export reactivation law; and B) the 1988 foreign investment promotion and guarantee law. The 1988 foreign investment and promotion law is a very comprehensive statute. To investors who register with the Ministry of Economy this law provides: -- Unrestricted remittance of net profits for investors in industrial activities. -- Remittance of net profits up to fifty percent of the registered foreign capital per year for investors in commercial and service activities. In practice, however, there is free convertibility of capital. -- Unrestricted remittance of funds obtained from the liquidation of a business in proportion to the foreign funds invested. -- Unrestricted remittance royalties and fees for use of foreign patents, trademarks, technical assistance and other similar services. -- Foreign investors may hold dollar accounts in El Salvador and may use these accounts to obtain local financing. El Salvador's export promotion and free zones are for investors totally engaged in export-oriented operations. Those firms located in export processing zones or bonded warehouses that export 100 percent of their production outside the Central American market, including drawback/assembly operations, can enjoy the following benefits: -- Up to 20 years income tax exemption -- Duty free importation of machinery, equipment, tools, spare parts, furniture, and other products necessary for the operation. -- Duty free importation of raw materials, semi-manufactured, and intermediate products. -- Duty free importation of fuels and lubricants Under the export reactivation law that was signed in April, 1990, firms not located in free zones and exporting less than one hundred percent of their production may apply for tax rebates of six percent of the FOB value of these exports. However, it should be noted that the paperwork to obtain this rebate is cumbersome. There are no expropriation cases pending in El Salvador. The one pending case involved an electric utility and was successfully resolved in March 1993. The GOES is in the process of setting up a one-stop office for foreign investment. This office will be within the Ministry of Economy, where investors now register their investments. This registration process is non- discriminatory and is generally not regarded as an impediment to investment. To the best of our knowledge, the only investment that has been turned down in the past few years was a proposal to build a giant tire burning facility that would have allegedly caused environmental problems. The GOES has recently passed legislation that will allow private companies to provide telephone and mail services. There are provisions for privately owned electricity generating facilities to sell electricity to CEL, the government electricity company. It is not necessary to have a local partner in El Salvador. Some maquila operations have one hundred percent foreign ownership. Three multinational oil companies operate in El Salvador, and two of these companies own a small refinery. One U.S. bank has an office in El Salvador. The banking law has been modified to encourage other foreign banks to enter the country. During the Cristiani Administration the bank privatization program took place. Today only one bank remains in government hands. Looking at possible upcoming privatizations, some foreign firms are considering bids on the sugar refineries. There is discussion about possible privatization of ANTEL, the telephone company and CEL, the electric company. There is no discrimination against foreign investors at the time of the initial investment nor after the investment is made. El Salvador, a nation recovering from a twelve year civil war, has only a very limited number of research projects. FUSADES, the private sector development organization, is funding some interesting projects in non- traditional agriculture. It has carried out agricultural research on non- traditional products since the mid-1980s. Looking at import policies, the Cristiani Administration early on implemented tariff reductions and reduced restrictions. Most tariffs are between 5 and 20 percent, although there are a few items in the 25-30 percent range. Foreign companies and local companies operate freely in this economic environment that encourages free trade. Section A2: Conversion and Transfer Policies -- El Salvador's Sound Financial Management El Salvador has a freely convertible currency that at present trades at about 8.7 colones per dollar. This currency is buoyed by family remittances of over 800 million dollars per year from Salvadorans who reside outside the nation. The nation's banks, of which all except one are in private hands, and the large number of casas de cambio (foreign exchange houses) actively trade dollars and colons. In this environment based on the free convertibility of the colon, foreign businesses have no problem making remittances of profits, repatriating capital, or bringing in capital for additional investments. There is no delay in exchanging dollars for colons or vice-versa. Banks often publish their buying and selling rates for dollars in the local newspapers. Foreign investors and executives in El Salvador have a variety of financial options. Checking accounts may be held in colons or dollars. Savings accounts in dollars or colons are available. Loans are generally made in colons. There has been a slight colon nominal depreciation during the last few years, although there has been no depreciation in 1994. A hallmark of the Cristiani Administration has been sound monetary policy. As of Dec. 31, 1993, the nation had net international reserves of 667 million dollars, equal to about four months of imports. It appears that the new administration will continue this sound monetary policy. Section A3: Expropriation and Compensation - No Pending Cases Upon the expiration of a fifty-year lease in 1986, the GOES (Pre-Cristiani) nationalized the assets of the San Salvador Electric Company. The nationalization created a dispute between the GOES and the CAESS shareholders, eighty-five percent of whom were U.S. citizens. The expropriation case reached a settlement in 1992 and CAESS shareholders received the first payment of ten million dollars. In March 1993, the GOES concluded payments of cash and bonds to the former CAESS shareholders and the case was settled to the satisfaction of all parties. This was the only recent expropriation case in El Salvador. The nation is a member of the International Center for Settlement of Investment Disputes (ICSID). Prospective investors in El Salvador note that Vice-President Borgo Bustamante made an eloquent speech in support of the private sector and private property during the recent election campaign. Every indication is that the incoming government will strongly support private enterprise and that El Salvador will continue to be a nation without expropriation problems. In April 1960 the United States Government and the GOES signed an investment guarantee treaty, the purpose fo which was to guarantee U.S. investors against losses that could arise from currency inconvertibility or expropriation. However, the bilateral investment treaty (BIT) between the US and El Salvador encompassing all aspects of investmetn has not been negotiated. A copy of this treaty may be obtained from the Economic Section of the Embassy. Section A4: Dispute Settlement Investment disputes in El Salvador generally seem to fall into two groups: A) Differences of opinion between a company and the government over contract obligations of the government, and, B) Differences of opinion over responsibilities in an agent/distributor type relationship. The first category usually involves a foreign company complaining that the GOES has not lived up to its contract obligations, such as promised import tax waivers, or renewal of a lease of a government owned facility. Faced with these difficulties, some foreign firms have sought relief through the court system while others have renegotiated their arrangements. In the second category, those problems that relate to agent/distributors, foreign firms that wish to terminate a local agent/distributor relationship have incurred liabilities beyond their expectations. Often lawyers wind up negotiating the termination of these agreements. U.S. firms may encounter problems in El Salvador that relate to laws that have not been updated, in part because of the twelve year civil conflict. The USAID program "Administration of Justice," aims at improving El Salvador's legal system. The National Assembly is revising many of the nation's laws. The phrase "Modernization of the State" is gaining importance as a key goal of the new government. The nation's legal system includes a commercial code which may be revised in the near future. This commercial code sets forth the rights and obligations in business areas, such as mortgages and contracts. An important activity of banks and the saving and loan associations is making mortgage loans. A5: Performance Incentives El Salvador's investment legislation does not include performance requirements. Nor are there any requirements that national citizens own shares in companies. However, any foreign investors choose an able local partner as an important part of their business strategy in El Salvador. A6: Right to Private Ownership and Establishment Foreign companies can freely establish businesses in El Salvador. To the best of our knowledge there are no sectors restricted to only national ownership with the exception of utilities owned by the state such as the telephone company (ANTEL), the water and sewer company (ANDA), and the electric company (CEL), plus coastal fishing (artisinal). Recently the National Assembly passed legislation that will allow for private sector participation in telephone and mail services. It is our understanding that CEL is working on programs to have private companies own, develop and manage electric generating facilities. A private company entered into a joint venture with ANTEL to establish a cellular telephone service. El Salvador has never had a large number of publicly owned companies as have other Latin American nations. Many of the remaining public companies, such as the sugar refineries, are being prepared for sale to the private sector. A7: Protection of Intellectual Property Rights In June, 1993 El Salvador passed an Intellectual Property Rights (IPR) bill that provides for patents, copyrights, trademarks, sound recordings, and video recordings. This law is presently in effect, except for clauses relating to sound recordings, which will enter into effect on June 16, 1994. El Salvador is a signatory of the Geneva Phonograms Convention, the Rome Convention, the Berne Convention for the Protection of Literary and Artistic Works, and the Paris Convention for the Protection of Industrial Property. USTR continues to watch El Salvador's enforcement of its IPR law, which entered into full force in June 1994. It is estimated that pirate cassette manufacturers have about 90 percent of the sound cassette market in this nation. On a positive note, in December 1993 the GOES seized about 1,800 pairs of bogus shoes in an important IPR case. The distributor is now negotiating with the foreign manufacturer for a supply of legitimate shoes. El Salvador was under Generalized System of Preferences (GSP) review under the intellectual property rights criteria. El Salvador received a "pend" status in the 1993 review which implies that, granted that the (GSP) program is renewed by the US Congress, El Salvador will be under review for the 1994 GSP annual review. A8: Regulatory System The Central Bank and the Superintendent of Banks regulate the banking system. Interest rates were decontrolled in 1992 and are now determined by market forces. The telephone, electric, and water companies are largely self- regulated. The Ministry of Economy sets bus fares and routes. Electric rates are set by the GOES. Petroleum prices are left to the marketplace, with the exception of diesel (a cross subsidy for the bus system) and LPG, which is subsidized as a measure to help the poor. With the exception of the public utilities, government laws and practices promote competition. The tax codes have been modified in recent years by lowering the top marginal rates and expanding the base of contributors. A9: Capital Markets and Portfolio Investment The security market in El Salvador is dominated by short term government, parastatal and private debt instruments, often traded on the nation's fast growing stock exchange. Most firms are family held corporations, although the recently privatized banks have large numbers of shareholders. Banks allocate credit on commercial terms and are conservative in their lending practices, whether the prospective borrower is foreign or local. There are a variety of options available in the financial markets, but many companies, both foreign and local, may find long term financing difficult to obtain. Many local companies complain that loan interest rates, presently starting at about 20 percent for a loan in colons, are too high, given the inflation outlook of ten percent in 1994. In a speech at the end of 1993, the President of the Central Bank, Engineer Roberto "Bobby" Orellana, said that he thought interest rates should come down and that the government would approve new entrants in the banking system to increase competition. However, the Central Bank still has not lowered the discount rate from 14 percent. Since that speech one new bank, that concentrates on import-export credits, and two financieras have been authorized. The Embassy is now preparing a report on El Salvador's stock market that will provide a more in-depth view of the nation's capital markets. A10: Political Violence El Salvador is consolidating its peace process that concluded 12 years of civil conflict. The recently issued Tenth Report of the United Nations Observer Mission in El Salvador (ONUSAL) recognizes a general improvement in the overall human rights situation. In contrast to the Ninth Report's Emphasis on the "Reactivation of Illegal Groups known as Death Squads," the new report embraces the idea of "Private Political Motivation" as a factor in some crime that may have first appeared to be organized political actions. The report focuses on the need to complete the pending judicial and police reforms in order to eliminate the environment of impunity for criminals that exists in El Salvador. The report cites the "Gradual Generation in El Salvador of conditions for the enjoyment of Human Rights, distinct from those existing in the past." Those readers interested in additional information on this subject may wish to obtain a copy of the Tenth Human Rights Report by ONUSAL. Section B: Bilateral Investment Treaties The United States and El Salvador signed an investment guarantee treaty in April 1960 designed to protect U.S. investors in the event of expropriation or currency inconvertibility. The United States and El Salvador also have a framework agreement for meetings of a Trade and Investment Council, often known as TIC meetings. During the 1993 bilateral TIC meetings held in Washington DC, the USG introduced the topic of an all envompassing bilateral investment treaty which would include investment related provisions such as national treatment, transfers, expropriation, investment disputes, tax policies, etc. The USG and GOES have negotiated a Tax Information Exchange Agreement, but signature of this agreement is held up until El Salvador modifies its commercial code. At present, El Salvador has 28 commercial and 18 technical cooperation treaties in effect. Three of these treaties (Mexico, Spain, and Venezuela) contain references regarding the promotion of coinvestment. El Salvador, along with Guatemala and Honduras, has begun negotiations with Mexico on a free trade agreement. The GOES acceded to the GATT in 1991. Section C: OPIC The Overseas Investment Corporation (OPIC) pursuant to its bilateral agreement with El Salvador, has an active program in El Salvador. Just last year OPIC approved insurance coverage for the expansion of a U.S. bank in El Salvador. The insurance covers currency inconvertibility, expropriation and civil strife, as well as corporate financing. El Salvador is a member of the multilateral investment guarantee agency (MIGA). Section D: Labor - A Strong Work Ethic The largest share (34 percent) of El Salvador's labor force of approximately 1.5 million workers is in the agricultural sector. This is followed by services (21 percent), commerce (18 percent) and manufacturing (15 percent). The GOES raised the minimum wage in early 1993. The minimum wage in the industrial and commerce sectors is 935 colons (roughly 107 dollars) a month. A study done in mid-1993 found that urban employees with minimal skills generally earned at least twenty percent more than the minimum wage. In agriculture, the minimum wage is 17 colons per day (1.75 dollars) plus another three colons per day for food. Coffee plantation owners reported that they often paid above the minimum wage to attract sufficient workers during the harvest. In March 1994, ANEP, the umbrella organization whose membership includes almost all private sector organizations in El Salvador, called for increasing the minimum wage. Urban unemployment in 1993 was 8.1 percent. Visible underemployment, depending on the study, would add three to seven percent to the unemployment figure. However, it should be pointed out that some contractors in the construction business are encountering problems finding sufficient skilled workers for the amount of construction now underway in El Salvador. According to social security enrollment statistics, the formal sector created 36,800 new jobs in 1993. Salvadoran labor is known as hard working and highly trainable. The productivity of Salvadoran workers is often the determinant in a new investor's decision to locate in El Salvador. Antidotal stories abound about Salvador's labor force. One of the most commonly told and retold stories is how the employees of a large shoe factory, faced with curfew restrictions during the worst offensive of the civil war, chose to arrive just before curfew, work during the night, and then go home in the early morning. In the Peace Accords signed in January, 1992, the GOES committed itself to seeking consensus on revised labor legislation. Faced with the possible loss of Generalized System of Preferences (GSP) rights, the Salvadoran national assembly approved amendments to the labor code based on ILO recommendations. The Constitution of December 1983 guarantees the right of employees to organize into associations and unions. Employers are free to hire union or non-union labor. Closed shops are illegal. The Labor code requires that labor disputes go through separate stages of collective bargaining, conciliation and arbitration before a strike can be legally declared. There are about 150 active unions, public employee associations, and cooperative organizations, which represent over 300,000 Salvadorans, approximately twenty percent of the labor force. D1: Benefits -- What the Law Requires Most employees are guaranteed certain benefits under the law. Employers are required to provide the following: -- 15 days paid vacation, including a thirty percent bonus calculated on the fifteen days. -- Social Security payments of 8.25 percent of annual salary. (Note: The employee also contributes a matching 8.25 percent.) -- Five percent of payroll toward an employee housing program -- Christmas bonus based on employees' seniority. (Note: Generally equal to about one month's wages.) -- Severance pay for worker's who are dismissed "without justification" of one month's pay for - each year employed. -- In addition, El Salvador has one of the two largest official holiday lists in Central America. E. Foreign Trade Zones -- A Fast Growing Sector of the Economy In today's El Salvador, one of the most dynamic sectors is "maquila," the assembly of apparel and other products for export. According to the Central Bank, in 1992 the gross value of apparel assembled in El Salvador was 198,240,000 dollars while the value added was 42,133,000 dollars. In 1993, the gross value jumped to 294,728,000 dollars and the value added to 71,137,000 dollars. Alhtough all of the space is now rented in the San Bartolo Export Processing Zone and the El Progreso Zone only has limited space available, the San Marcos and El Pedregal zones are expanding. The San Marcos Zone, located near San Salvador on the road to the international airport, has 38,500 square meters of space with another 7,000 square meters under construction. The El Pedregal zone, located near the international airport, has a total of 50,720 square meters of space; 45,320 square meters were just completed, of which 24,600 square meters are available. Not all maquila companies are in export processing zones as Salvadoran law allows maquila operations in other areas. For instance, one foreign maquila firm is located in a converted warehouse facility about a mile from the U.S. Embassy. The laws governing companies in Export Processing Zones are the same for local and foreign companies. This program was outlined in Section A1. F. Capital Outflow Some Salvadoran companies are investing in other nations, especially in Central America as the Regional Integration process breaks down barriers to investment. TACA, Salvador's privately owned national airline, has controlling shares in other airlines in the region. Quality Bus, which has twice-a-day executive bus service with Guatemala, has joint Salvadoran- Guatemalan capital. The leading Salvadoran department stores, Siman Almacenes and Kismet, both have stores in Guatemala City. There are no restrictions on capital outflow, nor are there any incentives for investing in other countries. G. Foreign Investment Statistics The following table is based on statistics provided by the Ministry of Economy. - Table I Investment by Country (US $ millions) Country Total 1991 1992 1993 Total - Thru 1990 U.S.A. 96.52 6.14 0.37 1.20 104.23 Panama 27.42 1.98 1.57 1.37 32.27 Japan 24.17 3.04 0.52 0.31 27.54 Canada 24.46 1.91 0.12 -- 26.49 Holland 10.82 1.44 0.61 -- 12.87 U.K. 5.90 4.48 1.97 0.19 12.54 Switzerland 4.70 3.28 -- 0.26 8.24 Virgin Islands 7.53 3.93 0.52 -- 11.98 Others 6.08 6.60 3.33 3.50 19.71 Free Zones 6.60 30.84 26.00 63.44 Total 218.28 36.88 38.00 32.64 320.08 Notes: Prior to 1989 the Virgin Islands was included in the "Other" category and the "Free Zone" category did not exist before 1991. H. Major Foreign Investors -- New Firms and New Commitments Many firms have taken advantage of El Salvador's improved investment climate since the civil war ended. One important newcomer is Bimbo, Mexico's giant bakery conglomerate which purchased the Victoria bakery and is now producing Bimbo bread for the Salvadoran market. Helados Holanda, another Mexican firm with ties to Bimbo, has opened a string of attractive ice cream stores in the country. Exxon and Texaco have both spent substantial sums of money on new and upgraded gasoline stations. These new and upgraded stations include large convenience markets, are very well lighted, and are usually open for twenty- four hours a day. Some of these stations serve as night time gathering places for people (largely middle class) with cars, a phenomenon that has attracted foreign press interest. Many of these stations also have ATMs and rent video movies. Texaco is also investing in new terminal facilities. Exxon, a partner is a refinery in El Salvador, has invested in refinery upgrades. Sara Lee, the large U.S. garment firm, recently invested in facilities in the El Pedregal Export Processing Zone. Industrias Nombres, another textile firm with U.S. ownership, has expanded its facilities in Antiguo Cuscatlan, an area that is part of greater San Salvador and near the U.S. Embassy. In this same area, McCormick Spices has a plant. Western Petroleum, which makes ethanol for the U.S. market, is located along Salvador's Coast near Acajutla. Kimberly Clark, Crown Zellerback, Perry Manufacturing, and National Cash Register are other U.S. firms with substantial investments in El Salvador. The giant German chemical firm, Bayer, is an important investor in El Salvador and supplies agrochemicals to much of the Central American market from El Salvador. British American Tobacco has an important cigarette manufacturing facility that has the license to manufacturer Lucky Strike cigarettes in El Salvador. One new U.S. investor is Millicom, which entered into a joint venture with ANTEL to provide cellular telephone service. Xerox, IBM and 3M company all have large offices in San Salvador. I. Statistical Information for Prospective Investors Prospective investors may find the following cost figures and statistics of interest as they consider El Salvador as an investment site: A. Electricity for commercial and industrial use is about eight cents a kilowatt hour. B. Airlines serving El Salvador and the United States include American Airlines, United Airlines, Continental, TACA, and Iberia. There are also several all cargo airlines that serve El Salvador. C. Facilities for apparel assembly in an export zone rent for about 3.50 dollars per month per square meter. Therefore, a 20,000 square foot facility, which is about 1,855 square meters, where about 200 operators could work, would rent for 6,493 dollars a month. Facilities outside an export zone rent for 2.50 to 3.00 dollars a square meter, although this space is getting more difficult to locate. D. Taxation: On September 1, 1992, the GOES implemented a ten percent value added tax (VAT) to replace the decades-old five percent stamp tax. The VAT has increased tax revenue, broadened the tax base, and provided about 42 percent of El Salvador's tax revenue in 1993. Exports are exempt from the VAT. According to the 1991 income tax law, published on Dec 21, 1991in the "Diario Oficial," resident corporations as well as non-resident corporations pay income tax on taxable income above 75,000 colons (about 8,720 dollars), unless otherwise exempt, for instance, those in an export zone. The tax rate is fixed at 25 percent on amounts above 75,000 colons. Less than 200,000 Twenty percent on the excess of 80,001 colons plus 6,300 colons. 200,001 - 594,000 Thirty percent on the excess of 200,001 colons plus 30,000 colons. Above 594,001 Twenty-five percent on the excess of 594,001plus 148,500 colons. As stated in Section A1, firms located in export processing zones enjoy a twenty year tax holiday on corporate income tax payments.