El Salvador’s 2022 budget underestimates fiscal financing needs – Fitch
El Salvador’s 2022 budget underestimates the size of next year’s fiscal deficit and financing needs due to its optimistic revenue assumptions, Fitch Ratings says. Prospects for an IMF deal that could ease pressures on El Salvador’s ‘B-’/Negative sovereign rating from deteriorating debt sustainability metrics and limited financing options are highly uncertain.
The budget proposal targets a deficit of USD1.25 billion (about 4.5%) GDP, down from Fitch’s forecast of 7.7% in 2021. However, while the government’s real GDP growth forecast of around 2.4% is close to ours, we think the government’s projected 13% revenue increase is unrealistic. We think revenues will at best grow about 6% in line with nominal GDP.
High remittances and government stimulus measures have fuelled consumption and led to a strong economic rebound (Fitch forecasts 8% real GDP growth this year) and outperformance in VAT receipts in 2021, with the government forecasting revenue growth of over 20%. However, these trends are unlikely to continue into 2022.
Anti-evasion and tax administrative measures will yield an estimated USD440 million in additional revenues in 2021, and the government is targeting an additional USD350 million in 2022, which is possible but highly uncertain. Other tax measures are being studied such as exemptions and specific taxes on large contributors, which could help narrow the gap.
Fitch therefore believes the 2022 deficit will be closer to USD1.7 billion or 6.2% of GDP. The budget proposal identifies USD710 million in financing sources for 2022, leaving a USD498 million financing gap. We believe this gap is closer to USD1 billion. Large fiscal deficits have increased financing needs over the past two years, and the government has increasingly relied on short-term issuance in the domestic market. Total short-term government debt (Letes and Cetes) has risen by about USD600 million YTD in 2021 to USD2.6 billion, after increasing by nearly USD1 billion in 2020.
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Fitch assumes that the government can roll over this short-term debt, but refinancing risks have increased in 2022 with concentrated amortizations of short-term debt (over USD1 billion comes due in September and October).The capacity of El Salvador’s banks to increase government funding is unclear and external market rates are high.
The Central American Bank for Economic Integration (CABEI) has been El Salvador’s largest external source in 2021, approving disbursements of USD1.1 billion, but the scope for further large disbursements by CABEI in 2022 is unclear. Closing the large financing gap and rolling over the large stock of short-term debt will therefore prove challenging absent an IMF program and the associated multilateral funding it would unlock.
The government and the IMF appeared close to an agreement in May. But the rapid adoption of bitcoin as legal tender, the dissolution of the anti-corruption body CICIG and the removal of members of the constitutional court and the attorney general complicated the outlook for a program, raising IMF concerns around governance and the ramifications of bitcoin adoption for financial stability. Meanwhile, the government has announced its intention to submit a pension reform bill in the coming weeks, which could have meaningful fiscal and financing implications.
Fitch identified a sharp increase in financing constraints and a deterioration in prospects for fiscal consolidation or growth that further weakened debt sustainability as negative rating sensitivities when we affirmed El Salvador’s ‘B-’/Negative rating in April.
