International financial institutions have praised El Salvador’s recent efforts to repay creditors, but the resulting hit to social spending has pushed tens of thousands into extreme poverty.
On 3 February, international credit ratings agency Moody’s changed the outlook on El Salvador’s long-term foreign-currency issuer rating and long-term foreign currency senior unsecured debt rating to stable from negative. While the overall rating remains poor (Caa3), the change “reflects Moody's view of a decreased risk of a credit event in the near term, following…the recent repayment of the 2023 international bond,” reads a statement from the agency. Moody’s is referring to the successful repayment of a bond which matured on 24 January, funded by disbursements from multilateral banks, particularly the Central American development bank (BCIE) and the Latin American development bank (CAF).
In addition, the agency cites two buyback operations in September and November last year, which reduced the outstanding sum on a bond maturing on 30 January 2025 from US$800m to US$348m. This repayment remains “manageable” as long as multilateral banks continue to lend to El Salvador as forecast, added Moody’s. The agency believes that narrower fiscal deficits have helped to reduce the amount of borrowing, with the non-financial public sector deficit falling from 5.6% of GDP in 2021 to 4% in 2022. This was helped by growth in government revenues, which were 11.7% higher for January-November 2022 compared to the same period the previous year, while government spending only increased by 1.6% year-on-year.
On 10 February, the International Monetary Fund (IMF) published a concluding statement following an IMF mission which visited the country from 30 January - 8 February for an Article IV consultation. It underlined efforts to boost growth by improving security, promoting tourism, and increasing human capital, as well as the fact that the “economy grew at a robust pace last year,” with an estimated 2.8% growth. The IMF also highlighted how “strong remittances and tourism revenues have contributed to the robust activity and investment dynamics”.
Wall Street investors have also hailed the Bukele government’s efforts to repay creditors, and Salvadorean bonds have been the second strongest performer among emerging markets this year after Lebanon, according to the Bloomberg sovereign bond index. “We went from scepticism, from looking at the numbers and hearing his announcement of paying down the bond, to basically being surprised in a good way by his very strong willingness to pay,” Federico Kaune, head of emerging-markets fixed income at Switzerland-headquartered UBS Asset Management, told Bloomberg in an article published 16 February.
- Bukele hails developments
President Nayib Bukele trumpeted the developments on Twitter. “Those that bet against our country lost hundreds of millions of dollars, while those that invested in our bonds had the second highest profitability in the world,” he tweeted on 17 February.
But while things might be looking more positive for bond traders, the Salvadorean population is suffering, according to Ricardo Castaneda, senior economist at the Instituto Centroamericano de Estudios Fiscales (Icefi), a Guatemala-based think tank. Castaneda told Salvadorean media outlet El Faro that 165,000 people in El Salvador have fallen into extreme poverty in the past two years as the government has prioritised paying creditors over social spending. “In fact, the largest budget allocation in the 2023 budget is for debt repayments,” Castaneda told El Faro in an article published 1 February.
The Bukele government has cut spending on hospitals and has failed to introduce measures to help families deal with a cost-of-living crisis brought on in part by high inflation caused by Russia’s invasion of Ukraine, said Castaneda. The economist believes that Bukele is so desperate to secure financing that he is prioritising debt repayments over helping the most vulnerable in society.
In addition, Castaneda highlights the fact that El Salvador has struggled to attract foreign direct investment in recent years, which he blames on an increased risk profile due to deteriorating institutionality and a lack of clear economic policy. One important source of uncertainty is Bukele’s adoption of the cryptocurrency bitcoin as legal tender in September 2021. The move was criticised by international financial institutions at the time, and it remains a cause for concern.
While the IMF admits that bitcoin risks have not materialised so far, due to lack of adoption of the cryptocurrency, it sees “underlying risks to financial integrity and stability” because bitcoin remains legal tender, and because of the recent Digital Assets Law, approved in November last year, which is designed to boost adoption of crypto assets. Negotiations over IMF lending to El Salvador ended over the country’s adoption of bitcoin, and ratings agency Fitch Ratings cites the move as a key factor in limiting the country’s sources of funding. Coupled with a high debt burden, this means that borrowing costs will remain high, added Fitch in a statement published 2 February.
Moody’s also warns that “still-high financing needs, a lack of access to international capital markets, low debt affordability, and the lack of a credible medium-term fiscal and financing framework will continue to weigh on creditworthiness”. The agency cites a deterioration in the quality of policymaking in recent years, as well as weak governance, in affirming its Caa3 rating, which means the country’s debt obligations are subject to high credit risk. While the risk of a default has decreased in the short-term, thanks to the recent bond repayment, there remains an “elevated probability” of a credit event, according to Moody’s.
While Bukele may have succeeded in keeping the wolf from the door for now, there remain structural issues with the Salvadorean economy. Some of the problems are self-inflicted, such as the adoption of bitcoin, but external pressures such as the war in Ukraine are also making life harder. Bukele has managed to boost economic activity by cracking down hard on criminal gangs, but his sky-high approval ratings may suffer as the human rights implications of his policies become more apparent. Coupled with increasing poverty rates, Bukele may have to choose between pleasing investors or placating Salvadorean voters ahead of the 2024 election.
Economy – the main public concern
At the end of last year, a poll of 1,273 people by El Salvador’s Universidad Centroamericana (UCA), a Jesuit university, showed that Salvadoreans believe that the economy is the biggest challenge facing the country, with inflation as the biggest economic concern for Salvadorean families.
Pension reform
In December, lawmakers approved pension reforms, fulfilling one of Bukele’s campaign pledges. The move will increase the minimum monthly payment to US$400, with a cap of US$3,000, as well as establishing a national pensions institute (ISP) to oversee contributors’ rights and regulate pension funds. According to Fitch Ratings, the reforms “will likely lead to an increase in long-term pension liabilities despite higher employer contributions”.
Others, including Icefi and El Salvador’s chamber of commerce and industry (Camarasal), have also raised concerns over the impact on public finances.
For its part, the IMF, in its 10 February statement, illuminates one possible motivation for the reform, predicting that the proposed debt exchange between old and new bonds “could provide some temporary Treasury cashflow relief,” a welcome development for a government that is struggling to keep the lights on. However the IMF also predicts larger medium term liabilities due to the increase in entitlements, as well as potentially “large contingent liabilities as the new law grants a blanket public guarantee for all pension-related claims”.