The Big Idea

El Salvador | Almost there

| September 8, 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.

The rally in El Salvador bonds almost defies gravity with prices now comfortably in the 70s. El Salvador has now converged with split-rated ‘B’/’BB’ credits such as The Bahamas. And yields of 11% to 12% are maybe a few percentage points away from levels needed to access Eurobond markets. The recovery comes on the back of a series of policy measures that ultimately shows commitment to honor debt payments. There are still unresolved solvency risks. The country runs a fiscal deficit of 2% of GDP and has a high debt stock. But the potential to broaden access to financing would provide further flexibility and lower default risk.

El Salvador bonds have added impressive gains over the past two weeks on top of YTD total returns of 91%. The price action has seemed to build on daily gains with minimal if any profit-taking, implying a continuing structural underweight from conservative real money investors.  The total returns may also contribute to a fear of missing out, with no relative return comparison anywhere among emerging market credits. The successful near normalization of credit spreads may in itself force a review of credit risk and raise the issue of whether markets were overly pessimistic on default risk.

The headline Google investment was the obvious trigger to the action of the last two weeks. The investment itself is not transformational. However, it does suggest the potential for higher foreign direct investment and an important reversal from the net negative foreign direct investment in 2022.  It also suggests the potential for an alternative growth model with high tech the obvious extension from the Bitcoin launch two years ago.  There is no quick fix from 2% to 3% GDP trend growth, but the efforts to seek foreign investment underscore intentions to honor debt payments and pursue investor-friendly policies.  There was also the headline agreement with local banks to further develop the local bond markets on extending maturities on debt auctions. Longer tenors should reduce already low rollover risks and immunize against any potential shocks.

The bottom line is that the Bukele administration is now consistently showing a market-friendly approach to policy management. It further reaffirms willingness-to-repay after the important Eurobond debt buybacks last year. The smooth repayment calendar kicked off the second phase of outperformance earlier this year on the liquidity relief and low event risk. There was also the important consolidation of fiscal accounts improving from a 9.1%-of-GDP pandemic deficit in 2020 to a near normalization of 1.8% of GDP deficit in 2022.  This virtuous circle on asset re-pricing in itself may also soon provide broader financing flexibility if the cumulative measures open external market access. This would not resolve the solvency risks, but it should again lower financing risks that perpetuates paying for longer.

Breakeven return analysis now postpones potential default into 2029 with current bond prices inferring payments through January 2029 at the typical sovereign recovery value of 30. There are still a few bulky amortization payments of $800 million in 2027 and $600 million in 2029 as well as the stump $248 million payment in 2025. The conviction on these repayment scenarios requires clarity on the fiscal adjustment (2% deficit to fiscal balance) and the broader financing access (Eurobond markets or the IMF) or maybe even an alternative growth model based on tourism and the high-tech sector (monitoring foreign direct investment as leading indicator). The alternative growth model becomes a viable alternative for debt solvency on a medium-term perspective if El Salvador can source external financing. There is still some near-term breathing room on low rollover risks to monetize still high carry returns while monitoring the medium-term solvency risks. This has been the main rational for maintaining the good relative value recommendation but will require closer monitoring on higher sensitive to external risks and higher market beta.  The shorter tenors should remain the main beneficiary on stronger liquidity risks with the 2027s and 2029s still inverted on the curve.

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

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