Caribbean & Central America - December 2022

On 9 November, El Salvador’s President Nayib Bukele announced that his country would start negotiating a free trade agreement (FTA) with China.

Bukele made the announcement alongside China’s ambassador to El Salvador Ou Jianhong and talked up a potential trade agreement as “very important” for the country, citing the size of China’s economy. “For a long time, El Salvador had been isolated from that potential,” he said. An FTA would mark the latest stage in El Salvador’s alignment with China after the two nations established ties in 2018 under former president Salvador Sánchez Cerén (2014-2019) of the Frente Farabundo Martí para la Liberación Nacional (FMLN) party. In order to do so, El Salvador had to end relations with Taiwan, and on 7 November a court upheld a decision to suspend an FTA signed with Taipei in 2007.

The deepening of ties with Beijing also comes at a time of worsening economic distress due to a failed bet on the cryptocurrency bitcoin and mounting fears of default. In September 2021 a law took effect adopting bitcoin as legal tender, and President Bukele has bought tokens with public funds. However, use of bitcoin has been limited and the value of the cryptocurrency has plummeted. El Salvador has lost an estimated US$70m on its bitcoin investments, according to Ricardo Castaneda, a senior economist at Guatemala-based think tank, Instituto Centroamericano de Estudios Fiscales (Icefi), which he said is significant in a country where that sum is equivalent to the annual budget of the agriculture ministry he said.

The bitcoin experiment has also discouraged the International Monetary Fund (IMF) from agreeing an economic support package that would have helped El Salvador to meet its debt payments. “If Bukele dreamed that he could create a different and innovative political economy, against the advice of the IMF, that dream has failed,” said Luis Membraño, a Salvadorean economist, told British newspaper The Guardian in an article published on 15 November. “There are no easy alternatives, no short-cuts.”

Fears of a default have been mounting for some time. In September, international credit ratings agency Fitch downgraded El Salvador’s Long-Term Foreign Currency Issuer Default Rating (IDR) to ‘CC’ from ‘CCC’ warning that a “default of some sort [was] probable”. Fitch cited “El Salvador's tight fiscal and external liquidity positions and extremely constrained market access amid high fiscal financing needs and a large US$800m external bond maturity in January 2023.” On 7 November El Salvador’s Vice President Félix Ulloa sparked speculation that China had agreed to step in and help, telling Bloomberg that China had offered to help the country refinance its foreign debt. However, a spokesperson for China’s foreign ministry told Bloomberg that he was not aware of the matter, and Ulloa soon rowed back on his comments.

Bukele had hoped to end his country’s reliance on traditional lenders by betting big on bitcoin, but the failure of the experiment has seen him backed into a corner. While China has distanced itself from suggestions that it would buy El Salvador’s distressed debt, closer relations with El Salvador make a certain amount of sense for both parties.

Bukele has tried to end his reliance on relations with the US amid Washington’s criticism of democratic backsliding during his term in office, and China maintains a policy of non-involvement in domestic politics. Beijing has also been working to increase its presence in Latin America for strategic reasons, and locking in close relations with El Salvador fits that pattern, Castaneda told Deutsche Welle (DW) a German public state-owned international broadcaster, in an article published 17 November.

That said, it is difficult to envisage how China will be able to help El Salvador escape from the economic bind in which it finds itself. Researcher Désirée Reder of the Hamburg-based German Institute for Global and Area Studies (GIGA) told DW in the same article that El Salvador could see some benefits in terms of infrastructure, but “nothing is free” and China will expect something in return, including exclusivity in certain commercial relationships or projects in sensitive areas. And Evan Ellis, a senior associate at the US-based Centre for Strategic & International Studies, told The Guardian that China is like a “payday lender,” adding that “they often find a way to tie the loans to long-term commercial and strategic benefits opening the way for Chinese companies”.

While many countries in Latin America are deepening commercial ties with China for varying reasons, Bukele’s decision looks to have been influenced by the way in which his government has damaged relationships with traditional partners such as the US and the IMF. This means that his position is much weaker, and he will likely be forced to agree terms that are more economically advantageous to China in order to secure financial assistance.