The Big Idea
El Salvador | Liquidity watch
Siobhan Morden | January 15, 2021
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Limited financing options for El Salvador should dictate the country’s spending priorities for the time being. Budget flexibility could improve with the turnover of the legislature after May 1 elections or if Eurobond markets re-open for low rated issuers. A funding accident looks unlikely since the country needs to maintain access to shallow local markets. But there is high risk of reaching for Eurobond markets as soon as conditions permit; domestic amortizations remain high and financing looks rigid over the next few months. Eurobond issuance of around $700 million before March would provide breathing room until El Salvador can shift to multilateral borrowing for the remainder of the 2021 needs.
El Salvador’s first domestic auction this year on January 12 saw a low $15 million in demand with a 23% bid-to-offer ratio ahead of high LETES amortizations in the first quarter of 2021. This will force a re-prioritization of spending and more potential austerity after the country’s spending cutbacks in the last quarter of 2020.
The financing stress for ‘B’ credits continues into 2021. El Salvador has prospects for Eurobond issuance and negotiations with the International Monetary Fund for a formal program that addresses both liquidity and solvency concerns. There was a brief moment for El Salvador to re-tap Eurobond markets heading into this year; however, recent volatility probably delays new issuance from weaker credits.
The timing is not opportune for El Salvador. It’s debt still trades at high, nearly distressed yields, and it’s 2052 debt has shifted to below par. The context would be around $700 million in long-dated issuance in interim financing ahead of midterm elections. This should not be overly disruptive and would lower rollover and financing stress until the turnover of the legislature on May 1. That should shift financing back to delayed approval of multilateral loans.
It would be preferable to issue Eurobonds after IMF negotiations at lower yields; however, limited domestic funding and a high fiscal deficit may force El Salvador back to Eurobond markets sooner. The marketing pitch to investors will also have to emphasize future plans for formalizing IMF talks or otherwise risk weak demand for the much worse debt ratios that threaten future repayment. The alternative, on restricted access to external credit, forces cutbacks in spending similar to the last quarter of 2020 to prioritize repayment of domestic debt amortizations.
There are large LETES amortizations this year after unprecedented crisis-related issuance last year, with an estimated $750 million in coming in the first quarter of 2021. The Bukele administration presumably will prioritize treasury bill repayment over current spending. There has been forced pragmatism on the budget in late 2020, and we highlight the legislative approval of a more rational budget in 2021 with a 7% reduction in the originally published budget and a subsequent decline in financing needs. The$1.885 billion financing needs (including pensions) appear reasonable on assumption of $700 million in Eurobond issuance and delayed approval of $646 million in multilateral loan commitments on stronger political/budgetary flexibility post elections that narrows the funding gap to $315 million.
There have been accusations that the Bukele administration would resort to fiscal laxity once controlling the Assembly in the second half of 2021. However, it is important to weigh the rigidity of dollarization and the saturation of local markets; the entirety of the 2021 funding program relying on external credit. The options then quickly narrow to either forcibly cutback spending or rely on external credit. The legislative control of the Assembly may allow for higher debt issuance authorization; however, this does not imply access to external credit. The local markets typically represent captive liquidity while external markets would require policy pragmatism that assures future debt repayment.
The current 9.5% Eurobond coupons are not sustainable. Investor demand is limited after the recent deterioration in debt ratios (90% of GDP) and persistant high fiscal deficits (-7.2% of GDP including pensions in 2021). The IMF program is critical for reducing the cost of financing as the byproduct of a coherent policy framework that reassures debt sustainability. The supply risk and high beta status explain the recent underperformance; however, the near-term policy options focus on either forced austerity or eventual Eurobond issuance that would lower rollover risk but without substituting the need for an IMF program following elections. This suggests the possibility of much lower normalized yields if positive IMF news comes out after elections. The IMF relations would become a priority if external markets remain unreceptive to Eurobond issuance.