The Big Idea
El Salvador | Stealth gains
Siobhan Morden | February 11, 2022
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.
The technicals are finally kicking in for El Salvador, with distressed prices finding a floor. The country’s debt shows high current yield and good potential for positive total returns. El Salvador has been one of the top performers so far this month despite volatile US equities and higher US yields. There is no clarity yet on debt sustainability over the medium term. But there is still a serious effort to muddle through over the near term with recent strong commitments to pay the 2023 Eurobonds. These comments mostly helped the 2023s see a 3-point bounce. Willingness-to-pay also has helped boost the rest of the curve. The supportive technicals and continuing efforts to manage liquidity stress strengthen the case for fair value in El Salvador at current levels.
The loud reaffirmation of debt repayment—Minister of Finance Zelaya assuring a “zero percent chance of default”—should perhaps raise a red flag, especially for a finance minister that has failed to deliver on prior promises, namely an IMF program. That’s the skeptical view. Low bond prices on the 2023s are now more sensitive to pulling-to-par then pulling-to-default with less than 12 months to maturity. The strong reaffirmation to pay is important since bonds are equally dependent on willingness and ability to pay. There are still buffers of liquidity at an early phase of cash flow stress such that willingness to pay may be more important than ability to repay. El Salvador does not look like it is on a fast track to economic and debt crisis.
Perhaps the reaffirmation to pay reflects a broader strategy to seek legitimacy. There was an obvious effort to normalize IMF relations with the full publication of the Article IV annual review. The commitment to Bitcoin also includes plans to develop San Salvador as a global BTF financial center. This is the strongest argument not to break financial contracts with a Eurobond default perhaps thwarting plans to develop a financial center as a hard deterrent against foreign direct investment. The Blockstream financial product advisors talk up the Bitcoin benefits of the volcano bond but mostly ignore the high credit risk of El Salvador on what is clearly a hybrid instrument of both BTC and El Salvador credit risk. The access to external credit through volcano bonds also depends on stable credit risk.
It’s worrisome that there are no specific financing details to back up these strong statements. There was also some confusion about the IMF’s role on referencing potential budget support for debt repayment. Finance Minister Zelaya has lost credibility in the aftermath of an elusive IMF program. The latest liquidity indicators in January still show robust foreign exchange reserves that include the $400 million IMF SDR. We also closely watch the monthly release of the monetary indicators to monitor the more than $600 million Treasury deposits at the central bank as well as the monthly fiscal data to monitor for forced spending restraint and financing options. As typical in early phase of cash flow stress, and especially for smaller countries with smaller gross financing needs, there are cashflow options. We have identified sufficient funding needs through January 2023 on either drawing down the stock of liquidity with a re-priority of spending or worst-case scenario of financial repression with the local the lenders of last resort.
The volcano bond (EBBB1) could provide some interim relief, although the initial $1 billion proceeds are already pre-allocated for a Bitcoin fund and Bitcoin city investment. Minister Zelaya updated the issuance timeframe for March 15-20 only after the publication of domestic financial regulations. Blockstream CSO Mow indicated soft demand at $500 million ahead of the formal marketing launch. The potential for a recurrent source of liquidity and subsequent series of EBB issuance depends on the initial demand that exceeds the $1 billion placement. If there is only retail demand, then officials may need to next shift to local markets as lenders of last resort, or preferably, shift towards fiscal discipline under funding constraints. The 2023s may benefit from an early phase of liquidity stress. However, the longer tenors are more sensitive to a medium-term plan that requires a recurrent source of financing coincident to a fiscal anchor or (optimistically) a shift to private capex-led higher growth for future debt repayment capacity.