The Big Idea
El Salvador | Limbo
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. This material does not constitute research.
El Salvador’s bonds yields are retracing back to their recent worst levels. The country’s diplomatic tensions with the US are undermining International Monetary Fund relations. And El Salvador still has no alternative medium-term financing plan. These are the things that should eventually undermine what has been a carry trade, with prices bouncing within a narrow range at the lows since late September. The debt looks like a “nervous neutral” at best with a bias to shift back to underweight.
The official admission from the US of difficult diplomatic relations only reinforces the low probability of an IMF program. The economic team has shifted IMF discussions to Washington, DC, this week. However, it’s important to emphasize that an Article IV review is not a loan-funded program, and the economic agenda remains subordinated to the political agenda. There has also been local criticism about the 2022 budget that may push gross financing needs higher with no transparency yet on funding sources. These two themes—IMF relations and funding sources—remain the two main determinants that undermine liquidity, raise solvency risks and explain the continuing distressed yields.
Exhibit 1: El Salvador – Central government sources and uses (excluding pensions)
Source: official, APS, https://fusades.org/publicaciones/ADEC_Continu%CC%81a%20la%20presentacio%CC%81n%20de%20proyectos%20de%20presupuesto%20con%20irregularidades.pdf,
*actual CETES
The recent admission from US Ambassador Manes that diplomatic relations with El Salvador remain “complicated” reaffirms steady deterioration since the country’s autocratic shift on May 1. The intentions of this open admission are not clear. It could be the US is making a more aggressive overture to resolve diplomatic tensions, or it could be a warning that there could be further backlash beyond the individual sanctions from the Engel list. The bottom line is that complicated US diplomatic relations should complicate IMF relations since the US is the largest shareholder.
There are some that argue that more severe budget constraints next year should eventually subordinate politics to economics. There hasn’t yet been any pragmatism from the Bukele administration to address the shortfalls of the autocratic political agenda or any obvious commitment to embrace a coherent economic program. A debt ratio near 100% of GDP requires commitment to fiscal discipline. There is still a high structural fiscal deficit in 2022, and debt ratios are still far from 2019 pre-Covid levels. There is also still the unresolved threat of financial repression and resorting to locals as lenders of last resort. The low LETES amortizations in 4Q21 should provide some near-term relief; however the regulatory restrictions on LETES issuance and the declining demand for CETES issuance are constraints heading into next year.
The well-respected local think tank FUSADES also qualifies the 2022 budget assumptions as unrealistic with bias for much higher gross financing needs next year. The official data shows $1.23 billion in gross financing needs including a fiscal deficit of $718 million, $270 million in external amortizations and $242 million in net domestic amortizations. It’s not clear how they calculate the net domestic amortizations with perhaps full rollover of the stock of LETES but yet $571 million CETES maturing next year. This alone would boost the gross financing needs from $1.23 billion to $1.56 billion. FUSADES also cites a potential $535 million in discrepancies that could push gross financing needs over $2 billion. 1.) Overestimation of tax income, current and “miscellaneous” transfers for $300 million, 2.) Underestimation of subsidies for $38 million, 3.) Underestimation of tax refunds for $62 million, 4.) Lower transfers to the Judicial Branch for $27 million, 5.) Underestimation of payment of interest on short-term debt for $57 million, and 6.) Omission of payment of interest on debt of municipalities for $50 million. It would require overwhelming fiscal discipline to lower spending to compensate against the overly optimistic tax revenue projections.
FUSADES also rightly points out that the budget doesn’t include any efforts for pre-financing the $800 million January 2023 Eurobond amortization. There are two important takeaways: 1.) the structural central government fiscal deficit may be much higher at 4.3% of GDP instead of 2.5% of GDP (ex. pensions) and 2.) there is no transparency on how to finance the shortfall. The reliance on $711 million in multilateral issuance may prove unrealistic and insufficient for budget support while domestic demand may have reached saturation. If the autocratic agenda continues to undermine IMF relations, then the financing could quickly shift into financial repression next year with locals the captive lenders of last resort. This may offer some temporary relief through 2022 but does not provide a financing plan for 2023 including the bulky 2023 Eurobond amortization. This reinforces our “nervous neutral” recommendation with still high liquidity risks and bias towards a shift back towards underweight.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.