El Salvador hasn’t defaulted. Don’t thank Bitcoin

Did a bitcoin per day keep default away? So El Salvador’s crypto-touting Presidente would have us believe. 

Since January, the country has led Citi’s emerging market sovereign bond index as the top outperformer year to date, with returns of 22.2 per cent.

And in late January, Nayib Bukele announced (over Twitter, of course) that his country had dodged default. With help from the Central American Bank for Economic Integration (CABEI) and the Development Bank of Latin America (CAF), El Salvador repaid in full an $800mn bond which was set to mature a week later. 

Throughout his presidency, Bukele has spooked investors and conventional financiers like the IMF. The prices of its bonds began to tumble in mid 2021, after Bukele did normal dictator-like things, like firing judges and brutal crackdowns. Worse still was Bukele’s face plant into cryptomania. After embracing Bitcoin and buying up plenty (2,381 as of last November), the cryptocurrency selfishly collapsed.

Rating agency Fitch said a “default of some sort” was probable downgrading the country’s debt into junk territory. Moody’s did the same. At their nadir in July 2022, El Salvadoran bonds maturing in 2025 and 2027 traded at 26.38 and 25.13 cents on the dollar respectively.

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

So, ¿Que pasa?

Saviour complex

After settling the bond, Bukele turned his wrath on the media. “[A]lmost every legacy international news outlet said that because of our “#Bitcoin bet”, El Salvador was going to default on its debt by January 2023,” he lamented, claiming there were “[l]iterally, hundreds of articles” that did so (while apparently struggling to find very many of them).

In the past year, almost every legacy international news outlet said that because of our “#Bitcoin bet”, El Salvador was going to default on its debt by January 2023 (since we had an 800 million dollar bond maturing today).

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

— Nayib Bukele (@nayibbukele) January 24, 2023

Bukele has connected his 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 escaping censorship.”

But was it really Bitcoin that helped El Salvador dodge default? Perhaps the truth is much more mundane. 

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

“The buybacks to some extent fixed their communication issues. They changed from catering to the crypto community back to catering to traditional investors,” says Esteban Tamayo, a Citi economist covering the region.

The country is even earning 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,” says Aaron Stern, chief investment officer and managing partner at Converium Capital.

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

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

Public debt has also decreased to 78 per cent of GDP, down from 82.4 per cent in 2021. 

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

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, says the IMF. 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 operatives. 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 pen prisons. 

Meanwhile investors are heartened that the government has some additional levers to pull. In December the government passed a pension system reform bill which imposed a cap of $3,000 per month and gave it the ability to tap into private pension savings as a source of income. While dipping into pension pots would be a bold move for even a popular President, investors are somewhat assured that the option is open. 

“There is still budget flexibility… fiscal adjustment could occur under the inertia and spending constraints of dollarisation since you cannot spend what you cannot borrow, ” Santander said in a note.

El Salvage-ador

It also looks like Bukele’s bitcoin dalliance hasn’t sunk the ship — for now. Partially, this is because it has bombed. In the concluding statement of its January mission, the IMF said that the “risks have not materialised due to the limited Bitcoin use so far,” — according to the University of Chicago, less than 20 per cent of businesses accept it alongside the greenback. The mooted volcano bonds, meanwhile, are going out with a whimper — “our view is that traditional investors won’t participate – making it less likely that they will try to issue it,” said Tamayo. The experiment flopping has proven a help rather than a hindrance.

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

“They’ve been smashing up their reserves, which is never a good plan,” says Stephen Bailey-Smith, a portfolio manager at Global Evolution. “For me they need to further tighten up monetarily, at least in order to maintain the spread with the Federal Reserve funds rate to stem import demand and prevent locals taking money offshore”.

The same pension reform which gave the government dipping rights also increased entitlements by 30 per cent, likely creating larger liabilities for El Salvador’s treasury.

The country’s domestic debt stock, 8.75 per cent of GDP, is high too, due to high spending and tax revenue hits during Covid-19. It still has nine international dollar bonds worth $6.4bn, roughly 30 per cent of its gross domestic product.

Access to international capital markets is a further issue, with Moody’s saying the 2025 bond payments are achievable “so long as multilateral disbursements remain around programmed levels.” An IMF deal also looks elusive. 

“If you have a high debt stock you’re not going to be able to reduce that overnight, you have to generate a primary fiscal surplus for several years to work that down,” says Siobhan Morden from Santander Investment Securities.

“The problem that El Salvador has is that there are very limited financing alternatives, they’ve saturated their local markets and they do not get a lot of access to multilateral money, because they do not have an IMF program.”

And with an election coming up, investors are fretting about whether Bukele can keep the purse strings tight.

“He’s held expenditure quite flat, which is really encouraging. But can he continue to do that, in the year before the [February 2024] election?” asks Bailey-Smith.

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

Further reading
El Bagholder strikes again