Caribbean & Central America - June 2024

On 23 May international credit ratings agency Moody’s upgraded El Salvador, but worries over the economy are growing in the country amid rising poverty rates.

Moody’s said it had upgraded El Salvador’s long-term foreign currency issuer and senior unsecured ratings to Caa1 from Caa3, with a stable outlook, citing a “material decrease in credit risks, from very high-risk levels” and a “lower likelihood of liquidity stress episodes”. Moody’s underlined that moderate and relatively stable fiscal deficits have seen government financing needs decline from 13.2% of GDP in 2023 to 11.1% in 2024, with a further decline to 9.1% forecast in 2025. 

The agency highlighted the government’s restructuring of its external debt in April. By buying back notes maturing in 2025, 2027, and 2029 and refinancing with two different 2030 notes the government has relieved some short-term pressures, according to Moody’s. One new instrument is a US$1bn note used to finance the purchase and other spending, with a yield of 12%. While this is expensive debt for the government to service, Moody’s qualifies the yield as “elevated” rather than “distressed”.

The second new instrument is more controversial: a 2030 note that will pay a coupon of 0.25% until October 2025, when that rate will increase to 4% if El Salvador has not either agreed a financial deal with the International Monetary Fund (IMF) or achieved a B2 or B credit rating from two of the three main credit rating agencies.

President Nayib Bukele who began his second five-year term on 1 June pledging to prioritise the economy, has hailed the ratings upgrade as evidence that his management of the economy is working, and there are some bright spots. At the end of March the president of El Salvador’s central bank (BCR), Douglas Rodríguez, reported that El Salvador’s GDP grew by 3.5% in 2023, up from 2.8% in 2022, with growth of 3%-3.5% projected for this year. Rodríguez cited as the main driver of growth, falling levels of violent crime following Bukele’s crackdown on gangs which began in March 2022.

A BCR presentation highlighted an increase in foreign direct investment (FDI) to El Salvador which reached US$759.7m in 2023, up from US$170.9m in 2022 – the highest in five years. The BCR presentation also underlined growth in the tourism sector, citing a record 3.4m visitors in 2023, up 36% on 2023, while revenue generated by tourism reached US$2.75bn, up 47.8% on 2022.

While Bukele does have some positive indicators to highlight, not everything is as it seems. One example is the fall in the non-financial public sector (NFPS) deficit from 5.5% in 2021 to 2.6% in 2022 and 2.3% in 2023, its lowest level since 2007, which Moody’s references in its rationale for the ratings upgrade. The agency recognises that falling deficits are due in part to the December 2022 pension reform, which allowed the government to reduce transfers to the private pension system. This means that Bukele has been able to massage the numbers by separating the pension system from central government spending.

The reform also allowed Bukele to fudge the figures on the country’s fiscal performance through the use of securities known as pension obligation certificates (certificados de obligaciones previsionales - COP). These certificates mean the government won’t pay interest on debts with the pension fund for four years. Since the reform was passed at the end of 2022, as of April the state had taken out US$1.6bn from the pension fund, leading to allegations that Bukele is using retirement savings as a source of financing for other spending and putting the sustainability of the system at risk.

In March, a research note by British multinational bank, Barclays Bank, recommended selling Salvadorean bonds maturing in 2027 and 2029 in part due to concerns over “an opaque financing arrangement involving the recently reorganized pension system”.

More pressingly, the poverty rate has continued to rise. Official figures cited by national newspaper La Prensa Gráfica in April show that 1.9m Salvadoreans, equivalent to more than 30% of the population, were unable to afford a basic basket of goods in 2023. La Prensa Gráfica notes that this is the highest level since 2018. It cites a local economist Carlos Argueta as attributing this to the fact that inflation, which closed 2023 at 1.23%, has pushed up prices at a time when wages have remained low.

It is therefore unsurprising that a survey by local think tank Fundaungo published on 14 May found 75.1% of respondents cited the economy, as the biggest challenge facing the country, up from 28.9% end 2021. Meanwhile 48.7% of respondents said that the government should control the price of the basic basket of goods, create more jobs, or boost salaries.

These figures underline the importance of the economy in Bukele’s second term. For the moment he is riding a wave of popularity due to the success of his security policies, but this will decline if he cannot improve the economic situation. Bukele has an opportunity to impact workers’ lives by increasing the minimum wage, which has not been increased since 2021 and has to be reassessed this year by law. While leading consumer rights organisation Centro para la Defensa del Consumidor (CDC) called for a minimum wage increase of 25% and civil society group Mesa por la Soberanía Alimentaria is urging a 40% rise, this seems unlikely to happen due to the government’s precarious financial position, which also limits Bukele’s ability to ramp up social spending. 

A deal with the IMF would provide a lifeline by bringing down the overall cost of borrowing and providing a fiscal anchor that would grant access to international capital markets at more affordable rates, according to Moody’s. Negotiations with the IMF have been ongoing for years but have stalled in part due to wrangling over Bukele’s implementation in 2021 of a reform making cryptocurrency bitcoin legal tender. One reading of the situation is that Bukele has been stalling for time using increasingly complex accounting tricks as he tries to work out a way to avoid agreeing to the IMF’s usual requirements on transparency. With the issuance of a new bond linked to the signing of a deal, it appears that Bukele is attempting to have his cake and eat it too. 

It is highly unlikely that El Salvador will achieve a B or B2 credit rating with two of three major ratings agencies, and so an IMF deal would be the only remaining solution to a significant increase in borrowing costs that would further complicate El Salvador’s fiscal situation and leave the country closer to default. Bukele would then be able to try and blame the Fund for a future default, meaning that the bond has been interpreted in some quarters as an attempt to bounce the IMF into giving him a deal without the usual conditions around transparency.

In the absence of a deal Moody’s believes that “weak governance will continue to undermine policy predictability”. Bukele may also find that his attempts to kick the can down the road have a limit, and he needs to agree to the IMF’s terms in order to agree a deal and secure loans that can be used to boost investment and social spending to kickstart the economy and secure his political future.

Tourism

A report published in May by the United Nations World Tourism Organisation (UNWTO) singles out El Salvador as one of the countries in the world to have achieved the largest increases in tourist arrivals in Q1 2024 compared with levels registered prior to the coronavirus (Covid-19) pandemic which struck in 2020. According to the UNWTO report, tourist arrivals to El Salvador were up 90% in Q1 2024 compared with Q1 2019. More generally, the UNWTO highlights Central America as the subregion to have registered the second largest increase in Q1 2024 after North Africa, seeing 15% more international arrivals than before the pandemic. The report also highlights Guatemala in Central America, which it said posted growth of 41% in Q1 2024 compared with Q1 2019 with regard to tourist arrivals.

Exports down

A new report released on 5 June by the Inter-American Development Bank (IDB) highlights that in the first quarter of 2024, El Salvador experienced a 13.7% year-on-year decline in exports, further deepening the average contraction over 2023 (–8.7%).