The Big Idea

El Salvador | Next IMF program

| January 29, 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.

A little euphoria over Costa Rica’s new IMF program has helped lift El Salvador Eurobond prices. For weeks, distressed yields have underestimated the IMF option. With announcements of formal IMF programs in Costa Rica and Panama, the IMF has become the most effective source of funding with declining political stigma.  El Salvador now stands out as one of the few remaining LatAm/CAC countries with yields still wide of pre-Covid levels. Domestic headlines in El Salvador have been relatively stable, access to domestic markets consistent and tax collection has completely recovered to pre-Covid levels allowing budgetary flexibility. The full recovery above par on the ELSAL’2052 may increase near-term supply risk, but it seems more opportunistic to wait until after elections next month.

Valuations on El Salvador look increasingly out of sync against negative global rates, a mature phase of stabilization and declining rollover risks.  El Salvador, at near double-digit yields, contrasts with the normalization toward pre-Covid levels across emerging markets. Domestic treasury auctions have gone well, and budgetary flexibility has improved after the forced unwind of Covid-related spending and the full recovery in taxes through December. Value-added taxes are up through December an impressive 9% year-over-year.  The economic activity data for November, scheduled for release on February 29, should reaffirm normalization across the economy at a faster pace than LatAm peers thanks to counter-cyclical fiscal stimulus. This suggests higher budgetary flexibility because of a lower structural fiscal deficit and full recovery in revenues. This does not resolve the under-funded budget for this year, however, especially considering the saturation in local funding markets. The risk premium on Eurobonds reflects the higher stakes of a dollarized economy on around the choice of either resorting to the IMF or opting for more heterodox alternatives.

The Bukele administration has been unpredictable. Unnecessary tension with congress has restricted financing flexibility while also prioritizing counter-cyclical fiscal stimulus ahead of midterm elections next month.  This political tension should shift lower next month, with polls predicting an impressive win for Nuevas Ideas. That would allow President Bukele to control the congress. The policy priority should then shift back to budgetary management.  There is increasing flexibility on expectations of approval of delayed multilateral loans when the Assembly turns over on May 1. However, delays in formalizing IMF negotiations are not practical given the logistics of funding the budget next year. The IMF anchor is necessary for Eurobond access, and the country needs intermittent funds until the Assembly turns over and allows formalization of an IMF program. These funds are also critical for relieving stress from the recent budgetary cutbacks since the fourth quarter of 2020 and as a cushion against high domestic debt amortizations in the first quarter of 2021.  The alternative heterodox measures, like forced domestic debt restructurings or worse, are not viable. They bring high execution risks that could backlash into broader economic and political crisis.  It also stands to reason that frequent informal IMF talks would formalize after elections as opposed to reverting towards radical and isolationist measures.

The markets are now re-pricing for positive event risk, especially since open commitment from President Bukele would translate into much lower execution risk. This is where El Salvador compares favorably to Costa Rica, with a stronger Bukele administration, high approval ratings, majority control of congress and a mature phase of economic recovery. The ELSALV’2052 are now making new price highs with yields compressing towards 9% and potentially a much faster normalization compared to Costa Rica, especially since El Salvador’s more centralized decision-making process doesn’t require months of discussion across society.

Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539

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