One of the biggest challenges in El Salvador has been to manage the decline in the coffee sector, formerly the backbone of the economy, and to develop new growth sectors for a more diversified economy. The collapse of worldwide coffee prices has caused substantial reduction in coffee production and decreased rural employment. While as recently as 1988 coffee exports accounted for more than half of export earnings, in 2004 they were 7.0%. Moderate climate and a hard-working and enterprising labor pool comprise El Salvador's greatest assets. El Salvador has sought to leverage these assets in creating new export industries through fiscal incentives for free trade zones, and currently there are 15 free trade zones in El Salvador. The largest beneficiary has been the maquila industry, which directly provides 88,700 jobs, and primarily consists of cutting and assembling clothes for export to the United States. The apparel industry has greatly benefited from the Caribbean Basin Trade Partnership Act, which allows these goods to enter the United States duty free under certain conditions. Moreover, the U.S.-Central America Free Trade Agreement (CAFTA), negotiated by the five countries of Central America with the United States in 2003, will make these benefits permanent.

El Salvador ratified the agreement in December 2004, the first nation in Central America to do so. CAFTA will benefit several important sectors of the economy, including the textile/apparel industry, by expanding access to the U.S. market. CAFTA also provides mechanisms to develop less competitive areas of the economy, including agriculture, as the agreement is phased in.

Fiscal policy has been the biggest challenge for the Salvadoran Government. The 1992 peace accords committed the government to heavy expenditures for transition programs and social services. Although international aid was generous, the government has focused on improving the collection of its current revenues. A 10% value-added tax (VAT), implemented in September 1992, was raised to 13% in July 1995. The VAT is the biggest source of revenue, accounting for about 52.3% of total tax revenues in 2004.

Remittances from Salvadorans working in the United States sent to family members are a major source of foreign income and offset the substantial trade deficit. Remittances transferred through the banking system and, therefore, counted by the Central Bank have increased steadily in the last decade and reached an all-time high of $2.5 billion in 2004--approximately 17.1% of gross domestic product (GDP). Beginning January 1, 2001, the Salvadoran Government approved the ìMonetary Integrationî law that made the U.S. dollar legal tender alongside the colÛn. Dollars have gradually replaced colÛnes, which are no longer printed. In practice the economy has become dollarized, with the colÛn only used in isolated rural areas.

El Salvador obtains concessional loans for development projects from the World Bank, Inter-American Development Bank, the Bank for Central American Integration, and certain other international institutions. Starting in August 1999, El Salvador also has sold bonds in private international financial markets. These sales have been used to fund Salvadoran Government operations. El Salvadorís external debt in February 2005 was about $4.8 billion.

Reconstruction from Mitch was still underway when in January and February 2001 the country experienced two devastating earthquakes that left nearly 2,000 people dead or missing, 8,000 injured, and caused severe dislocations across all sectors of Salvadoran society. Nearly 25% of all private homes in the country were either destroyed or badly damaged, and 1.5 million persons were left without housing. Hundreds of public buildings were damaged or destroyed, and sanitation and water systems in many communities put out of service. The total cost of the damage was estimated at between $1.5 billion and $2 billion.

Following the 2001 earthquakes, the U.S. Government responded immediately to the emergency, with military helicopters active in initial rescue operations, delivering emergency supplies, rescue workers, and damage assessment teams to stricken communities all over the country. USAID's Office of Foreign Disaster Assistance had a team of experts working with Salvadoran relief authorities immediately after both quakes, and provided assistance totaling more than $14 million. In addition, the Department of Defense provided an initial response valued at more than $11 million. For long-term reconstruction, the international community offered a total aid package of $1.3 billion, more than $168 million of it from the United States.

El Salvador has already signed free trade agreements with Mexico, Chile, the Dominican Republic, and Panama, and increased its exports to those countries. El Salvador, Guatemala, Honduras, and Nicaragua also are negotiating a free trade agreement with Canada. The five Central American countries are working towards a construction of a Customs Union, and they have already harmonized their customs duties and most products.

U.S. support for El Salvador's privatization of the electrical and telecommunications markets markedly expanded opportunities for U.S. investment in the country. More than 300 U.S. companies have established either a permanent commercial presence in El Salvador or work through representative offices in the country. The Department of Commerce maintains a Country Commercial Guide for U.S. businesses seeking detailed information on business opportunities in El Salvador.