Caribbean & Central America - January 2024

Nayib Bukele is expected to easily win a controversial second presidential term in El Salvador’s February election and the country’s economic prospects have improved slightly, although his policies could spell trouble in the future.

Bukele came to power in June 2019, the year before the coronavirus (Covid-19) pandemic struck. His government’s response cost around 16.5% of GDP, according to the World Bank (WB), and general government gross debt rose from 71.3% of GDP in 2019 to 88.1% in 2020, according to International Monetary Fund (IMF) figures. Then, in September 2021, legislation was passed to make the cryptocurrency bitcoin legal tender in El Salvador, the first country in the world to do so. This marked a significant departure from existing economic orthodoxy and saw the value of the country’s sovereign bonds fall sharply. It also soured relations with the IMF, which had been expected to shore up the country’s economy with a financing deal.

Concerns over the impacts of the decision to make bitcoin legal tender only increased as the price of the cryptocurrency crashed from its historic peak in November 2021, and surveys showed that few Salvadoreans were making use of bitcoin in their daily lives. Despite this, Bukele forged ahead with plans to mine the cryptocurrency in the country, and by December 2023 he had announced that the government’s bitcoin investments had turned a profit. However, the US$3.6m in profits claimed by Bukele would have a negligible effect on the country’s finances. Nonetheless his commitment to the project appears undimmed, with the December 2023 announcement of a residency programme for 1,000 large scale investors through a ‘Freedom Visa’ programme which has the backing of Hong Kong-based cryptocurrency firm Tether.

These moves suggest an attempt to implement deep reforms of the country’s economic system to end its reliance on multilateral institutions such as the IMF, but it appears that Bukele may be forced to return back to the fold. After El Salvador’s complicated relationship with the lender took a new twist in April 2023, when the government blocked a regular IMF report on the country’s finances, sparking concerns over a lack of transparency and speculation that Bukele was attempting to bury worrying data, relations with the IMF have improved of late, with renewed interest in negotiating a new financing programme.

Rodrigo Valdés, director of the IMF's Western Hemisphere Department, told Reuters in an article published on 13 October that engagement with El Salvador has been “very productive,” but an agreement is “not there yet.” Valdés underlined that the IMF would require some structural measures in order to agree a deal, although he stopped short of naming the bitcoin experiment specifically, but also emphasised that Bukele’s popularity presents an opportunity for him to take decisive actions. This is also enabled by his likely continued control of the legislative assembly, where the dominance of his Nuevas Ideas (NI) party, which controls 56 out of 84 seats, means Bukele’s policies can pass without significant political opposition.

The government also received a boost on 7 November, when international credit ratings agency Standard & Poor’s improved the country’s credit rating to B-, citing a reprofiling of local debt which mitigates the risk of default. In effect the government is repaying short-term debts owed to local banks and then issuing new debt obligations for longer periods, which reduces the risk of a financing crunch, according to S&P. However, while the agency does highlight the immediate fiscal relief brought about by these actions, it also says that El Salvador “remains vulnerable because of its high debt and interest burdens and its limited monetary flexibility”. This illustrates the fact that Bukele is still facing something of an economic bind moving forward.

Despite the fact that a second term is unconstitutional, Bukele’s bid for re-election was rubber-stamped by allies in the supreme court. On 1 December he took leave of absence for six months, replaced by his private secretary, to enable him to stand in the elections, in line with a creative interpretation of the constitution made by pliant magistrates. He also enjoys sky-high approval ratings thanks to a crackdown on gangs, which has improved the security situation for ordinary Salvadoreans while attracting criticism over its impact on human rights. As a result, Bukele looks set to return for a second term as president, with persistent economic challenges high on the agenda. While bonds have rallied and concerns over a default have eased, debt remains higher than pre-pandemic levels and the fiscal position “remains fragile,” according to the WB, which adds that narrowing financing alternatives are contributing to liquidity pressures. In addition, S&P is forecasting a drop in the country’s GDP growth, from 2.6% in 2022 to 2.5% in 2023, and then to 2.2% in 2024.

Foreign direct investment has also slumped, recording a negative balance of -US$101m in FDI inflows in 2022 [EB-23-08]. This 133% decrease compared to 2021 is because US$294m was divested from the manufacturing sector, and investment in services also fell 35% year-on-year. This suggests how Bukele’s increasingly authoritarian governing style and refusal to release economic data has affected investor confidence, and the US Department of Commerce said that El Salvador’s “macroeconomic context and declining rule of law present some challenges” in an investment climate statement published in December 2022.

The WB recommends prioritising investments in human capital and enhancing public and private investment, as well as promoting access to high-quality jobs, and Daniel Serrano, a researcher at the Universidad Centroamericana (UCA) in San Salvador, has also said that El Salvador requires a new model of redistributive investments to boost economic growth. In a presentation reported by the media at the end of November, Serrano called for a significant rise in investment to US$1.852bn, saying that in 2019 (which he described as a normal year), the state invested just US$1.002bn.

Given the fiscal pressures on the government, Bukele will need to do more to attract foreign firms who may have been spooked by controversy around transparency, the bitcoin experiment, and his security crackdown. “The lack of investment is a serious constraint,” former central bank president Carlos Acevedo told the Financial Times in an article published 1 December. However, there is little to suggest that Bukele is preparing to relax his creeping authoritarianism, with local media outlet El Faro publishing a roundup of what it called “The road to dictatorship” on 2 December, citing the accumulation of power, corruption, the construction of a police state, and attacks on citizens’ rights as key areas of concern.

While many Salvadoreans have been willing to overlook these factors due to Bukele’s security achievements, this goodwill will soon run out if the economy hits the buffers, said Acevedo. “The second term will be much harder if he doesn’t manage to respond to people’s economic expectations,” he added. This realization also appears to have forced Bukele to reconsider his attitude towards the IMF, and the government is actively seeking a new debt deal.

IMF deal?

In October Finance Minister Jerson Posada said that the “objective is to be able to reach an agreement” with the IMF, and later that month Bukele himself said he expected a deal to be reached after the February 2024 elections. IMF officials have so far refused to comment on whether the lender would make a deal subject to changes to the country’s policy on bitcoin, but it appears that Bukele may have to make some concessions to orthodoxy if he is to keep the economy from flagging.