El Salvador has not defaulted. No thanks Bitcoin

Kept a bitcoin per day standard away? So El Salvador’s crypto-pronounced Presidente would have us believe.

Since January, the country has led Citi’s government bond index for emerging markets as the best returner so far this year, with a return of 22.2 percent.

And in late January, Nayib Bukele announced (via Twitter, of course) that his country had avoided default. With the help of the Central American Bank for Economic Integration (CABEI) and the Development Bank of Latin America (CAF), El Salvador fully repaid an $800 million bond due a week later.

Throughout his presidency, Bukele has scared investors and conventional financiers such as the IMF. The prices of the bonds started to fall in mid-2021, after Bukele did the usual dictator-like things, like firing judges and brutal attacks. Even worse was Bukele’s faceplant in cryptomania. After embracing Bitcoin and buying up in droves (2,381 as of last November), the cryptocurrency selfishly collapsed.

Ratings agency Fitch said “some form of default” was likely to downgrade the country’s debt into junk territory. Moody’s did the same. At their nadir in July 2022, El Salvador bonds maturing in 2025 and 2027 were trading at 26.38 and 25.13 cents on the dollar, respectively.

But times have changed. In February, Moody’s changed the outlook from negative to stable, citing a “reduced risk of a near-term credit event” and “manageable” repayments on the 2025 bond. Its 2025 and 2027 debt are now trading at 78.39 and 55.92 cents on the dollar.

So, What’s up?

Salvation complex

After patching up the tape, Bukele turned his anger on the media. “[A]Almost all the older international news outlets said that because of our “#Bitcoin bet” El Salvador was going to default on its debt by January 2023. sorry, claimed that it was “[l]iterally, hundreds of articles” that did (while apparently struggling to find very many of them).

In the last year, almost all the older international news channels said that because of our “#Bitcoin bet,” El Salvador was to default on the debt by January 2023 (since we had an $800 million bond due today).

Literally hundreds of articles https://t.co/rEiK7K13U4

— Nayib Bukele (@nayibbukele) 24 January 2023

Bukele has linked making Bitcoin legal tender in September 2021 with the country’s improved economic fortunes, saying it gave El Salvador an “advantage in the new economic system” and spurred private investment from “people who escaped censorship.”

But was Bitcoin really helping El Salvador avoid default? The truth is perhaps much more mundane.

El Salvador regained the good graces of many investors in July 2022, after announcing a $1.6 billion bond buyback using special drawing rights from the IMF and a $200 million loan from the Central American Bank for Economic Integration. Buybacks in September and December reduced the principal amount of the 2025 bond to $348 million from $800 million.

“The buybacks solved communication problems to some extent. They changed from catering to the crypto community back to catering to traditional investors,” said Esteban Tamayo, a Citi economist who covers the region.

The country even earns something of a reputation for financial prudence.

“When you dig in, while El Salvador has its share of difficulties, the amount of debt is manageable and the budget is under control,” said Aaron Stern, chief investment officer and managing partner at Converium Capital.

According to Fitch, the government’s fiscal deficit was 2.7 percent of GDP in 2022, down from 5.7 percent in 2021 and 10.1 percent in 2020 – driven by the post-pandemic economic recovery, subsidy cuts and increased tax collection.

“There was a windfall in 2022, because there was better compliance with tax collection. If you’re in a slightly autocratic country, you’re going to be motivated to pay your income tax, says Siobhan Morden, managing director of Latin America fixed income strategy at Santander Investment Securities.

Public debt has also fallen to 78 percent of GDP, down from 82.4 percent in 2021.

The IMF says the economy is on track for moderate real GDP growth in 2023, 1.7 percent, after expanding by 2.8 percent the previous year. This is in line with its peers in Latin America and the Caribbean, but below its peers in emerging and developing economies.

While Bukele’s anti-crime initiatives have not endeared him to human rights advocates, the “unprecedented reduction in crime” has contributed to robust economic and investment activity, the IMF says. Bukele asked Congress to agree to a state of emergency last March, giving him the power to go after the notorious Barrio 18 and MS-13 gangs. However, he is accused of sweeping up and disappearing innocents as well as gang members. Less crime means there’s plenty to like for investors as well as tourist fans of Bitcoin, surfing and the Miss Universe pageant. Less so for critics of arbitrary detentions and cattle prisons.

Meanwhile, investors are encouraged that the government has some extra levers to pull. In December, the government passed a bill reforming the pension system that introduced a cap of $3,000 per month and gave it the ability to tap private pension savings as a source of income. While it would be a bold move for even a popular president to dip into pension pots, investors are somewhat confident that the option is open.

“There remains budgetary flexibility … fiscal adjustment can occur under inertia and spending constraints to dollarization since you cannot spend what you cannot borrow,” Santander said in a note.

El Salvage-ador

It also appears that Bukele’s bitcoin dalliance hasn’t sunk the ship – for now. Partly this is because it has bombed. In the closing statement of its January mission, the IMF said that “the risk has not materialized due to the limited use of Bitcoin so far,” – according to the University of Chicago, less than 20 percent of businesses accept it alongside the dollar. The featured volcano bonds, meanwhile, are going out with a whimper — “our view is that traditional investors will not participate — making it less likely that they will try to issue it,” Tamayo said. The experiment that flops has turned out to be a help rather than a hindrance.

But whether the world’s most online dictator can keep the wheels on is another question. The current account deficit rose to 8 percent of GDP in 2022, due to soaring import volumes, with international reserves falling to around two months’ worth of imports.

“They’ve blown their reserves, which is never a good plan,” says Stephen Bailey-Smith, a portfolio manager at Global Evolution. “To me, they need to further tighten monetarily, at least to maintain the spread with the Federal Reserve’s funds rate to curb demand for imports and prevent locals from taking money offshore.”

The same pension reform that gave the government rights to dip also increased rights by 30 percent, likely creating greater liabilities for El Salvador’s treasury.

The country’s domestic debt stock, 8.75 percent of GDP, is also high due to high spending and tax revenues during Covid-19. It still has nine international dollar bonds worth $6.4 billion, about 30 percent of gross domestic product.

Access to international capital markets is a further concern, and Moody’s says the 2025 bond payments are achievable “as long as multilateral disbursements remain around programmed levels.” An IMF agreement also looks elusive.

“If you have a high debt stock, you won’t be able to reduce it overnight, you need to generate a primary fiscal surplus for several years to work it down,” says Siobhan Morden of Santander Investment Securities.

“The problem that El Salvador has is that there are very limited financing options, they have saturated their local markets and they don’t get much access to multilateral money, because they don’t have an IMF program.”

And with an election coming up, investors worry about whether Bukele can keep his purse strings tight.

“He has kept his expenses fairly flat, which is very encouraging. But can he continue to do so, in the previous year [February 2024] choice?” asks Bailey-Smith.

While it was Bukele’s crypto capers that grabbed the headlines, his real priorities seem much more pedestrian.

Further reading
El Bagholder strikes again