The Big Idea

El Salvador | Financing options

| January 20, 2023

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.

El Salvador has started the year strong, helped in part by the appeal of its 12% to 19% carry. And confidence in the credit should improve further after its bulky $604 million amortization payment on January 24. This should smooth out the payment calendar through 2025 if not all the way to 2027. The liquidity risks for the country shift to financing alternatives as well as possible fiscal adjustments to help service coupon payments over the next two years. El Salvador remains good tactical relative value and the top regional performer to start the year.

The headline legislative approval of a digital securities law shows progress in sourcing innovative financing.  But there are challenges. There is skepticism about the appetite for blended Bitcoin and El Salvadorean credit risks, especially with regulatory restrictions on US institutional investors. There is also high execution risk in an environment with a weaker Bitcoin, no financial intermediaries, regulatory restrictions and local law jurisdiction. This doesn’t yet appear like a realistic vehicle for financing the budget, debt amortizations or Eurobond debt liability management.

There are only a few realistic financing options:

  • Incremental access to multilateral loans
  • Incremental access to domestic investors, and
  • A drawdown of the stock of treasury assets at the central bank.

For politicians, it’s more palatable to finance as opposed to cut spending. However, the ultimate recourse is forced fiscal adjustment as dollarized countries cannot spend what they cannot borrow. The chronology of financing stress typically follows a strategy to first exhaust financing alternatives, then draw down the stock of assets and then ultimately cutback spending to lower gross financing needs. The willingness to pay remains quite strong after consecutive buyback operations and ahead of the January amortization payment.  It’s also encouraging that policy risk focuses on orthodox alternatives (buybacks, innovative financing) while avoiding heterodox alternatives (domestic financial repression).

The ideal financing should source external liquidity and avoid competing internally for funds. CABEI President Mossi confirmed that the $450 million loans disbursed this week as well as the recently approved $250 million CAF loan would ensure payment for the Eurobond amortization this month.  These inflows should prevent against further foreign exchange reserve loss. There have been concerns about the lower foreign exchange reserve position. However, it’s important to remember that the foreign exchange reserves are less relevant for fully dollarized countries. There are no convertibility or foreign exchange risks under dollarized economies. It’s more a question of maintaining a stable foreign exchange coverage ratio with the decline in foreign exchange reserves (central bank USD assets) equal to the decline in treasury deposits (central bank USD liabilities).

However, the repayment risks would still benefit from higher treasury deposits at the central bank and a financing strategy that sources external funds. The aftermath of the Eurobond payment will merit a reassessment of financing alternatives. The Bitcoin investor community doesn’t seem like a stable and consistent source of funding while the alternatives still focus on incremental multilateral loans (CAF/CABEI) and even incremental domestic financing (though admittedly local auctions suggest a mature phase).

The budget management is also critical with debt service registered below-the-line and competing with domestic liabilities on current spending.  The full year data has just been released for 2022 on tax collection.  The annual 12% year-over-year increase was impressive; however there has been a marked slowdown into year end at 4% year-over-year in the fourth quarter of 2022. The boost in income tax validates the official view of enhanced compliance and collection efficiency. The deceleration later in the year on income tax collection reflects a mature phase of efficiency gains and a more marked deceleration in VAT collection.  This then suggests a more difficult phase of budget management that implies more pressure on identifying financing alternatives or cutting back on spending (with potential social and political backlash with lower GDP growth).

There is no fast track towards acute budget stress, especially on the small $500 million in annual Eurobond debt service. This should reinforce the favorable carry trade for El Salvador as the highest current yielding ‘B’ credit and the positive event risk ahead of the January 24 amortization payment. However, the Bukele administration will have to shift to a more adept strategy on sourcing incremental financing and reinforce the fiscal consolidation to reduce the gross funding needs.

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

 

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

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