El Salvador was not lacking. Don’t Thank Bitcoin

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Did one bitcoin a day avoid default? So Presidente, the crypto walkway from El Salvador, would have us believe.

Since January, the country has topped the Citis Emerging Markets Sovereign Bond Index as the best year-to-date outperformer, with returns of 22.2%.

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

Throughout his presidency, Bukele scared off conventional investors and financiers like the IMF. Its bond prices began to fall in mid-2021, after Bukele did normal dictatorship things like firing judges and brutal crackdowns. Worse still, Bukeles was dealing with cryptomania. After embracing Bitcoin and buying a lot of it (2,381 last November), the cryptocurrency selfishly crashed.

Rating agency Fitch said any default was likely to downgrade the country’s debt into junk territory. Moody’s did the same. At the July 2022 low, Salvadoran bonds maturing in 2025 and 2027 were trading at 26.38 and 25.13 cents to the dollar, respectively.

But times have changed. In February, Moodys changed its outlook from negative to stable, citing reduced short-term credit event risk and manageable repayments on the 2025 bond. Its 2025 and 2027 debt now trades at 78.39 and 55 .92 cents on the dollar.

So what’s up?

Savior Complex

After settling the tie, Bukele turned his anger on the media. [A]Almost every international legacy media said that because of our #Bitcoin bet, El Salvador will default on its debt by January 2023, he lamented, saying there was [l]literally, hundreds of articles that did (while apparently struggling to find very many).

Over the past year, almost every international legacy media has said that due to our #Bitcoin bet, El Salvador will default on its debt by January 2023 (since we have an $800 million obligation expiring today).

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

Nayib Bukele (@nayibbukele) January 24, 2023

Bukele linked Bitcoin becoming legal tender in September 2021 with the country’s improved economic situation, saying it gave El Salvador an advantage in the new economic system and boosted private investment from people. escaping censorship.

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

El Salvador found many favors with 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 of economic integration. Redemptions in September and December reduced the principal of the 2025 bond to $348 million from $800 million.

The takeovers have to some extent solved their communication problems. They have gone from catering to the crypto community to catering to traditional investors, says Esteban Tamayo, Citi economist covering the region.

The country even somehow earns a reputation for financial prudence.

When you dig in, while El Salvador has its share of troubles, 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 budget deficit was 2.7% of GDP in 2022, compared to 5.7% in 2021 and 10.1% in 2020 – thanks to the post-pandemic economic rebound, subsidy cuts and the improved tax collection.

There was a revenue bonanza in 2022 as there was better compliance in income tax collection. If you’re in a somewhat autocratic country, you’ll be motivated to pay your income taxes, says Siobhan Morden, managing director of Latin American bond strategy at Santander Investment Securities.

Public debt has also decreased to 78% of GDP, from 82.4% in 2021.

The IMF says the economy is expected to experience moderate real GDP growth in 2023 of 1.7%, following growth of 2.8% 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 crime-fighting initiatives have not endeared him to human rights defenders, the unprecedented reduction in crime has contributed to robust economic and investment activity, according to the IMF. Bukele asked Congress to accept a state of emergency last March, giving him the power to prosecute the notorious Barrio 18 and MS-13 gangs. However, he is accused of sweeping up and disappearing innocent people as well as gang members. Less crime means there’s a lot to like for investors, as well as tourists who love bitcoin, surfing and the Miss Universe pageant. Less for the detractors of arbitrary detentions and cattle prisons.

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

There is always budget flexibility. Fiscal adjustment could occur under the inertia and spending constraints of dollarization, because you can’t spend what you can’t borrow, Santander said in a note.

The Savage-ador

It also appears that Bukeles bitcoin dalliance has not sunk ship just yet. It’s partly because he bombed. In the final statement of its January mission, the IMF said that the risks have not materialized due to the limited use of Bitcoin so far, according to the University of Chicago, less than 20% of companies l accept alongside the greenback. The volcano bonds discussed, meanwhile, come out with a whimper, our view is that traditional investors won’t participate, making it less likely they’ll try to issue them, Tamayo said. The experience of the flop proved to be a help rather than a hindrance.

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

They destroyed their reserves, which is never a good plan, says Stephen Bailey-Smith, portfolio manager at Global Evolution. To me, they still need to tighten monetary policy, at least to maintain the differential with the Federal Reserve funds rate to stem import demand and prevent locals from taking money overseas.

The same pension reform that gave the government withdrawal rights also increased rights by 30%, likely creating larger debts for the Salvadoran treasury.

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

Access to international capital markets is another issue, with Moodys saying 2025 bond payments are achievable as long as multilateral disbursements remain around scheduled levels. A deal with the IMF also seems elusive.

If you have a high stock of debt, you won’t be able to reduce it overnight, you need to run a primary budget surplus for several years to reduce it, says Siobhan Morden of Santander Investment Securities.

El Salvador’s problem is that there are very limited financing alternatives, they have saturated their local markets and they don’t have much access to multilateral money because they don’t have an IMF program.

And with an election looming, investors are wondering if Bukele can keep the purse strings tight.

He has kept spending fairly stable, which is really encouraging. But can he continue to do so, in the year before the [February 2024] election? asks Bailey-Smith.

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

Further ReadingEl Bagholder strikes again

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