Recent actions by El Salvador’s government highlight the erosion of domestic checks and balances since February’s elections, Fitch Ratings says. These actions are likely to hinder negotiations for an IMF program, increasing the risk that El Salvador cannot meet its large and growing financing gaps in the coming years.
The supermajority won by President Nayib Bukele’s New Ideas party and its allies ended the legislative gridlock that had hampered policy implementation and the ability to tap external funding, which requires approval by a two-thirds majority in the National Assembly, whether from official or private sector sources.
However, the election has emboldened the president to enact some sweeping measures, such as dismissing five Constitutional Court justices and the attorney general, approved by the National Assembly in May in its first session since the elections. This was followed by El Salvador’s withdrawal in June from an anti-corruption accord with the Organization of American States (OAS).
Bukele has also made unpredictable economic policy choices, such as the decision to adopt bitcoin as legal tender alongside the dollar and a proposed 20% increase in the minimum wage that will likely have fiscal implications.
The IMF and the government appeared close to agreement on fiscal and monetary measures that would be required in a program (such as a 4%-of-GDP fiscal adjustment and increasing banks’ reserve requirements). However, we believe any program would also include efforts to improve governance, including anti-corruption measures. The planned adoption of bitcoin has created further uncertainty after the IMF said that it “raises a number of macroeconomic, financial and legal issues that require very careful analysis.”
Without an IMF program, it is unclear how the government plans to meet its financing needs in 2022-2023. We estimate 2021 funding needs at USD4.37 billion (17.8% of GDP). There is limited room to increase short-term debt, which is high at USD1.4 billion in Letes and USD645 million in Cetes.
Assuming that all of this is rolled over, we estimate the funding gap for this year at about USD929 million, rising to just over USD1 billion million in 2022 and over USD1.75 billion in 2023. The Central American Bank for Economic Integration (CABEI) has approved over USD1 billion in new loans to El Salvador during the last 12 months and will continue to be a major funding source.
The National Assembly has approved borrowing of over USD1.8 billion since May, but many approvals were for infrastructure or other specified programs. We estimate USD624 million can be used for budgetary purposes. For the infrastructure projects, we assume roughly one-third will be disbursed evenly between 2021-2023 (USD400 million each year).
The next major international debt maturity is a USD800 million bond due in January 2023. We believe El Salvador’s banks are willing to roll over their short-term sovereign debt holdings of Letes, although many banks expect that the USD645 million of Cetes due in September, originally intended to bridge the funding gap, will be repaid with multilateral disbursements. The government’s funding gap would be much larger if this loan were repaid without new multilateral borrowing.
However, the banks are unlikely to increase their sovereign exposure, and their capacity to do so is constrained by slowing rates of deposit growth, while they maintain high reserves to face pressures that could arise from a possible deterioration in loan quality. A gradual reversal of the reduction in the banking system’s liquidity reserve requirement would further limit its capacity to finance the government.
The Negative Outlook on El Salvador’s ‘B-’ sovereign rating reflects the deterioration in debt sustainability metrics caused by last year’s Covid-19-induced recession, large fiscal deficits in 2020-2021, over-reliance on domestic market borrowing for high government funding needs, and vulnerability to weaker external market financing conditions.
